A company has various types of assets on its books, including equity investments such as stocks and other similar securities. Depending on the degree of control and relative ownership percentage, and the corporation’s investment intent, the applicable accounting method for equity investments would report these equity investments either at historical cost or at fair market value.
- Obtain the relative ownership percentage of equity investments. For each stock, partnership interest or other equity investments, determine how much of the entity the investment represents. For public companies, this is a simple calculation of shares held out of the total shares outstanding. For private companies, there may be shareholder agreements that outline the relative ownership percentages.
- Determine from corporate management the investment intent for each respective equity investment. For example, inquire regarding the expected holding period, the expectation of short-term profits and about the risk management policy for limits on permissible unrealized losses.
- Determine applicable accounting method for each investment. Based on the investment intent and relative ownership interest, different accounting policies apply. Long-term, significant stake (20 percent to 50 percent) equity investments are subject to the equity or consolidation method (if under control and greater than 50 percent). Short-term, minority investments are classified as trading securities. Other equity investments that do not meet these criteria are considered available for sale securities by default.
- Record equity investments classified as trading securities on the balance sheet at fair market value, with unrealized gains or losses to operating income. Present available for sale securities at fair value, with unrealized gains or losses directly into equity. Record equity method investments at historical cost, as adjusted by the rateable share of income or loss to the balance sheet. Present controlled subsidiary investments under the consolidation basis, basically adding their financial statements to those of the parent