An investor's level of influence over an investee determines how the investor reports the equity investment in financial statements. One guideline used to determine influence is the percentage of voting stock of the investee that is owned by the investor. Other indications of influence include representation on the Board of Directors, participation in policy-making processes, material inter-company transactions, interchange of managerial personnel or technical dependency.
Differences Between Cost Method & Equity Method | Bizfluent
According to "Renewable Energy Tax Credit Handbook," the acquisition of less than 20 percent of the stock of an investee is considered too small an investment to grant the investor a significant influence over the investee. As a result, this investment is accounted for using the cost method. In this instance, the acquisition costs are debited to the asset account "Equity Investments.
Therefore, this income does not affect the carrying balance of the investment. When the equity investment is sold, a gain or loss is recognized in the amount of the difference between the acquisition cost and the sale price. The "Renewable Energy Tax Credit Handbook" states that the acquisition of between 20 and 50 percent of an investee's stock is considered sufficiently large to grant a noncontrolling investor a significant influence over the investee.
Such a noncontrolling interest implies the investor holds neither positions on the Board of Directors nor key officer positions in the investee. Such an investment is accounted for by the investor using the equity method. In this instance, the value of the stock is periodically adjusted to account for both dividends and earnings or losses of the investee. In this way, acquisition costs are debited to the asset account, "Equity Investments. Use of the equity method should cease from the date that significant influence ceases.
The carrying amount of the investment at that date should be regarded as a new cost basis.
Equity Method Example
Transactions with associates. If an associate is accounted for using the equity method, unrealised profits and losses resulting from upstream associate to investor and downstream investor to associate transactions should be eliminated to the extent of the investor's interest in the associate.
However, unrealised losses should not be eliminated to the extent that the transaction provides evidence of an impairment of the asset transferred. Date of associate's financial statements.
In applying the equity method, the investor should use the financial statements of the associate as of the same date as the financial statements of the investor unless it is impracticable to do so. However, the difference between the reporting date of the associate and that of the investor cannot be longer than three months. Associate's accounting policies.
Differences Between Cost Method & Equity Method
If the associate uses accounting policies that differ from those of the investor, the associate's financial statements should be adjusted to reflect the investor's accounting policies for the purpose of applying the equity method. Losses in excess of investment. If an investor's share of losses of an associate equals or exceeds its "interest in the associate", the investor discontinues recognising its share of further losses.
The "interest in an associate" is the carrying amount of the investment in the associate under the equity method together with any long-term interests that, in substance, form part of the investor's net investment in the associate.
If the associate subsequently reports profits, the investor resumes recognising its share of those profits only after its share of the profits equals the share of losses not recognised. Partial disposals of associates. If an investor loses significant influence over an associate, it derecognises that associate and recognises in profit or loss the difference between the sum of the proceeds received and any retained interest, and the carrying amount of the investment in the associate at the date significant influence is lost. Equity accounting is required in the separate financial statements of the investor even if consolidated accounts are not required, for example, because the investor has no subsidiaries.
But equity accounting is not required where the investor would be exempt from preparing consolidated financial statements under IAS In that circumstance, instead of equity accounting, the parent would account for the investment either a at cost or b in accordance with IAS Venture capital organisations, mutual funds, and other similar entities must provide disclosures about nature and extent of any significant restrictions on transfer of funds by associates.
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Accounting for Investments: Cost or Equity Method
Navigation International Accounting Standards. Quick Article Links. Under IAS 39, those investments are measured at fair value with fair value changes recognised in profit or loss.
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