1 answer

Describe the appropriate choice for recording and reporting an investment in equity securities of a business....

Question:

Describe the appropriate choice for recording and reporting an investment in equity securities of a business. How is the level of influence the investor has over the investee's operational and financial decisions will affect the choices of accounting.

Answers

Answer: In a competitive business environment it is imperative for any organisation to have a vigil to ensure that its competitive position is maintained and continuous trust should be there to improve upon its business so as to earn name, fame and in turn profit. Every organisation operates in an environment that is subject to constant change. Hence, unless an organisation adapts itself to the changing environment, success can not be guaranteed.

In view of the above, in order to earn name, fame and in turn profit, organisations adopts various methods to stay focused in the business and for growth, it becomes important to become a part of the other organisation which is engaged in other type of business and normally not in the similar nature of business. In order to achieve this and also to earn profit organisation in spite of investing in capital assets, it invests in the securities of the other organisation and becomes a shareholder and functions accordingly. This benefits in many ways like short term as well as long term gains and the securities become an asset of the organisation.

Now it becomes quite common that after investment by the organisation i.e. investor, in the equity securities in any other organisation i.e. investee, the investment becomes an asset and hence question of recording of that asset in proper manner arises, hence becomes imperative to record and report the same accordingly. Now, recording and reporting of such investment depends on the quantum of acquisition it has made and accordingly, gains control on the company whose security has been purchased. This quantum also determines the level of influence the investor has over the investee's operational an financial decisions.

In order to make the subject matter further more clear a chart has been given below which vividly explains how an investment in equity securities of a business has been recorded and reported as a principle of accounting and the level of influence the investor has over the investee's operational and financial decisions.

Sl. No. % of Investment in equity securities of a business Accounting method
to be adopted
Remarks Level of influence over the investee's operational and financial decisions
1 <20% Fair Value When dividend declared by the investee, income generated, which is recognized. In this case securities are reported at a fair value, otherwise at cost. Normally very little or nil influence over the investee's operational and financial decisions.
2 20% to 50% Equity Method In this case since investor becomes major share owner in the invested company, the investor becomes eligible for share in proportion to the % of the holding, of investee's income and accordingly also gained level of influence over the investee's operational and financial decisions. Significant influence over the investee's operational and financial decisions
3 >50% Consolidation In this case investor takes over the control of the business of the investee and in this process the investor company becomes parent company and investee company becomes subsidiary company and accordingly the parent company enjoys the income generated by the subsidiary company. Due to this take over the investor becomes parent company and investee becomes subsidiary company and in turn the financial statement of both the parent company and subsidiary company are consolidated and shown in the same financial statement.
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