CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingMedium
A company is preparing its financial statements and needs to classify an investment in another company's equity securities. The company owns 15% of the investee's outstanding common stock and can exert significant influence over the investee's operating and financial policies. How should this investment be accounted for?
- AConsolidation Method
- BFair Value Method (FV-OCI)
- CFair Value Method (FV-NI)
- DEquity Method
Show answer & explanationAnswer & explanation
Correct answer: D. Equity Method
When an investor holds between 20% and 50% of an investee's voting stock, or demonstrates significant influence with less than 20% ownership, the equity method of accounting is generally required. The scenario explicitly states significant influence.
Why the other options are wrong
- A. Consolidation is used when the investor has control, typically over 50% ownership.
- B. FV-OCI is used for certain equity investments where there is no significant influence and the election is made.
- C. FV-NI is used when there is no significant influence and the investment is not designated as FV-OCI.
Equity Method of Accounting
The equity method is used when an investor has significant influence over an investee's operating and financial policies, typically with 20-50% ownership, or demonstrated influence at lower percentages.
- Investor records its share of investee's net income as investment income.
- Dividends received from investee reduce the investment account, not income.
- Investment is initially recorded at cost and adjusted for income/losses and dividends.
Memory trick: Influence determines the method, control means consolidation.