Consolidation, equity method accounting and cost accounting for investments

3. The equity method

A corporate investor applies the equity method of accounting for investments when the investor possesses a significant interest. This is often the case when the investor holds between 20 and 50 percent of the voting common stock (or equivalent) of an investee.

The ability to exercise significant influence is a matter of judgment and causes many interpretations. Among conditions that indicate presence of significant influence are representation on the board of directors of the investee, participation in the policymaking process of the investee, material intercompany transactions, and technological dependency.

Under the equity method, an investor recognizes income as it is earned by an investee because it has a degree of responsibility for the financial results of the investee. At the same time, dividends received from the investee reduce invested amount.

4. Fair value and cost methods

In case an investor holds a small number of shares in an investee (less than 20 percent) and has no significant influence, such investments are recorded either at fair value (if readily determinable fair value exists) or at cost. The cost may be periodically adjusted for fair value.  In contrast to the equity method, dividends under such investments are recognized as income.

In addition to common stock with no significant control, such investments comprise primarily fixed-income securities, publicly traded industrial, utility and government bonds, asset-backed securities, and commercial mortgage loans.

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