three different approaches to the financial reporting of investments in corporate equity securities.

Paper details:
describe the three different approaches to the financial reporting of investments in corporate equity securities.
* I attached 2 pages you should use them to describe the differences between them.
At present, generally accepted accounting principles (GAAP) recognize three differ,
ious ent approaches to the Manual reporting of investments in corporate equity securities:
3} l. The fair-value method.

2. The consolidation of financial statements.

Don't use plagiarized sources. Get Your Custom Essay on
three different approaches to the financial reporting of investments in corporate equity securities.
Just from $13/Page
Order Essay

3. The equity method.

The financial statement reporting for a particular investment depends primarily on the

degree of influence that the investor (stockholder) has over the investee, a factor most

often indicated by the relative Size of ownership.’ Because voting power typically accom-
panies ownership of equity shares. influence increases with the relative size of ownership

The resulting influence can be very little, a significant amount, or, in some cases, com-

plete control.

Fair-Value Method

In many instances, an investor possesses only a small percentage of an investee companys

outstanding stock, perhaps onlya few shares. Because of the limited level of ownership,

the investor cannot expect to Significantly affect the investees Operations or decision
making. These shares are bought in anticipation of cash dividends or in appreciation of
stock market values. Such investments are recorded at cost and periodically adjusted to
fair value according to the Financial Accounting Standards Board (FASB) Accounting

Standards Codification (ASC) Topic 320, Investments-Debt and Equity Securities.
Because a full coverage of limited ownership investments in equity securities is presented

in intermediate accounting textbooks, only the following basic principles are noted here:

Initial investments in equity securities are recorded at cost and subsequently adjusted
to fair value if fair value is readily determinable (typically by reference to market
value); otherwise, the investment remains at cost.2

Equity securities held for sale in the short term are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings.

Equity securities not classified as trading securities are classified as available-for-sale
securities and reported at fair value with unrealized gains and losses excluded from
earnings and reported in a separate component of shareholders equity as part of
other comprehensive income.

0 Dividends from the investments are recognized as income for both trading and available-
for-sale securities.

The above procedures are followed for equity security investments when neither signifi-

cant influence nor control is present. However, as observed at the end of this chapter,

FASB ASC TOpic 825, Financial Instruments, allows a special fair-value reporting

option for available-for-sale securities. Although the balance sheet amounts for the invest-

ments remain at fair value under this option, changes in fair values over time are recog-
nized in the income statement (as opposed to other comprehensive income) as they occur.

Consolidation of Financial Statements

Many corporate investors acquire enough shares to gain actual control over an investees

operation. In financial accounting, such control is often achieved when a stockholder

accumulates more than 50 percent of an organizations outstanding voting stock. At that

l The relative size of ownership is most often the key factor in assessing one company’s degree of influence

over another. However, other factors (e.g., contractual relationships between firms) can also provide influ-

ence or control over firms regardless of the percentage of shares owned.

2 ASC (para. 325-20-35-1 and 2) notes two exceptions to the cost basis for reporting investments:

1. Dividends received in excess of earnings subsequent to the date of investment are considered returns
of the investment and are recorded as reductions of cost of the investment.
2. A series of an investee’s operating losses or other factt$ ‘3 We
investment has occurred that is other than temporary a (1% eflggfize , fiamc’an ner

rect
POint. rather than simply influencing the investees decisions, the investor oftctu Xagciicas
the entire decision-making process. A review of the financial statements 0 qnies is
largest organizations indicates that legal control of one or more subSidiary.Cofnpimfimt
an tgmost universal practice. PepsiCo, Inc., as just one example, holds a majority
mt e voting stock of literall hundreds of corporations.

Investor control over an iynvestce presents a special accounting 91121119993; Non}; :13;
When a majority of voting stock is held, the investor-investee relationship 18 so C 0568
connected that the two corporations are viewed as a single entity for reporting p urp all);
Hence, an entirely different set of accounting procedures is applicable. Control. gepe’gual
recluires the consolidation of the accounting information produced by the mdm ‘n
companies. Thus, a single set of financial statements is created for external3report1 g.-
Purposes with all assets, liabilities, revenues, and expenses brought together. The vant
ous procedures applied within this consolidation process are examined in subsmllfim
Chapters of this textbook.

The FASB ASC Section 810-10-05 on variable interest entities expands the use of con-
solidated financial statements to include entities that are financially controlled. through
special contractual arrangements rather than through voting stock interests. Prior to the
accounting requirements for variable interest entities, many firms (e.g., Enron) flVOlded
consolidation of entities in which they owned little or no voting stock but otherwxse were
controlled through special contracts. These entities were frequently referred to as spe-
cial purpose entities (SPEs)” and provided vehicles for some firms to keep large amounts
of assets and liabilities off their consolidated financial statements. Accounting for these
entities is discussed in Chapters 2 and 6.

Equity Method

Another investment relationship is appropriately accounted for using the equity method.
In many investments, although control is not achieved, the degree of ownership indicates
the ability of the investor to exercise significant influence over the investee. Recall Coca-
Colas 29 percent investment in Coca-Cola F EMSAs voting stock. Through its ownership,
Coca-Cola can undoubtedly influence Coca-Cola F EMSAs decisions and operations.

To provide objective reporting for investments with significant influence, FASB ASC
Topic 323, Investments-Equity Method and Joint Ventures, describes the use of the
equity method. The equity method employs the accrual basis for recognizing the investors
share of investee income. Accordingly, the investor recognizes income as it is earned by

the investee. As noted in FASB ASC (para. 323-10-05-5), because of its significant influ-
ence over the investee, the investor

has a degree of responsibility for the return on its investment and it is appropriate to

include in the results of operations of the investor its share of earnings or losses of the

investee.

Furthermore, under the equity method, the investors share of investee dividends
declared are recorded as decreases in the investment account, not as income.

In todays business world,.many corporations hold significant ownership interests in
other companies Without havmg actual control. The Coca-Cola Company, for example
owns between 20 and 50 percent of several bottling companies, both domestic and inter:
national. Many other investments represent joint ventures in which two or more compa.
nies form a new enterprise to carry out a specified operating purpose. For example, Ford
Motor Company and Sollers formed FordSollers, a passenger and commercial vehicle

manufacturing, import, and distribution company in Russia. Each partner owns 50 per-
cent of the joint venture. For each of these investments, the investors do not possess
absolute control because they hold less than a majority of the voting stock. Thus, the
preparation of consolidated financial statements is inappropriate. However, the large
percentagei of ownership indicates that each investor possesses some ability to affect the
ecis’o-
investee s t n making process. Scanned by Camscanner