Question

Compare and contrast the methods that can be used in accounting for investments. How does a company choose a method? What are the advantages and disadvantages of each?

Answer 1

Methods used in accounting for investments is as follows:

• Cost method and the
• Equity Method.

Under the Cost method, actual cost of the investment is used as the base and the profit/loss is computed basis the sale price of the stock.

Under the Equity method, the company's share in the ownership is considered and earning is taken basis the proportionate value on the basis of share.This method is more complex in nature.

Advantage of using Equity method:

Its provides a parent company with more accurate income statement as compare to cost method of accounting for investment.

In this method Parent company can use this method to hide unfavorable numbers from investors.

Disadvantage of using Equity method:

Its is very difficult to use and understand.

Its fails to show dividends as revenue and instead shows these as deduction.

Advantage & Disadvantage of using Cost method:

In this method dividend does not influence the balance of investment.

Its does not indicate all income from the investment except dividend.