Question

It is important to understand the concept of "significant influence" as it relates to ownership and control for investments in common stock. Students are to write a paper clearly explaining their perspective of this concept. Equally important is an understanding of the accounting treatment of the cost and equity methods. Students are to provide a written comparative analysis of the differences between the cost and equity methods.

Answer 1

Answer:

An investor's level of influence over an investor is the primary determinant of the method used to account for investments in common stock. The amount of influence refers to the degree of control experted by the company that purchases the stock over operating decisions of the company issuing the stock.

The difference between Cost and Equity methods of investment accounting:

For most investors, the proper way to account for investing profits and losses is with the cost method of Accounting. This method is not the only choice, however. For investments where the investors takes a very large stake and has legitimate influence over the company's business, the equity method could be more appropriate.

Let's compare and contrast so you are equipped with the right Accounting for your stock investments.

The cost method of investment accounting:

It is by far the most common approach for reporting investment grains and losses. That's true for retail investors and institutional investors alike.with this method the actual cost of the investment is used as the baseline, with the profit or loss determined by the final sales price of the stock. For example, you buy a stock at $10,sell it at $15, netting a $5 profit.

The equity method of Accounting investment:

In general, when you own 20% or more of all a company's stock the equity method is the appropriate Accounting choice. The idea is that as a major owner, you will probably have a board seat or other significant influence over the decisions made at the company. With that control, the equity method of Accounting States that the investments performance is more closely tied to the company's operations than it is to the company's stock price.

For example,if an investment company owns 30% of another firm and that firm earned $10 million in profits in a given year, the equity method of accounting would include the firm's pro rata share of that net income as earnings on its income statement. In this case, that works out to $3 million