Question

5 Header Q4. (25 marks) 1 Imagine you are investing in a company having more than 30% of investment and you feel the need to update the accounting books, what accounting approach would you use? Your investment is $1 million and the accounting year ends on December 31* 2019, the fair value of the investment goes up to $1.3 million on that date. How would you record in your books? 6 Header

Answer 1

The choice of method of accounting depends on whether the holder of shares has a controlling interest or not. It may happen that a person or company holds 20% or more shares but still does not exercise any control. Thus the main criteria to decide the type of method of recording the investment is the excercise of control.

The investment made by the investor in any company can be accounted by two approaches .

• Equity method :If the sharehodings are between the range of  20% to 50% percent of the investee’s voting shares, then the accounting of investment has to be done by applying the equity method.Under this method, the share of the holder in the investee company's income or losses is shown in  the income statement of the holder. The book value of the assets is also updated with the same. However any receipt of dividend is shown as a deduction from the book value of the investment .

• Fair value method. : As per the principles under GAAP, if the holding is less than 20% it is assumed that there is no  significant influence over an investee . The invstment treated as a non-current asset at the purchase price of the shares.There is a periodical updation in the book value of the investments, in order to maintain the investment at the fair value . The market price of the shares is the basis for making the necessary updation to the cost of the investment . The dividends received are trated as income under the fair value method.

In the given scenario, the investor's shareholding is more than 30% however we do not know if he exercises a significant control or not . Assuming that he also has a significant control, he would be eligible for the equity method of accounting .

As per the equity method, the investor will report the carrying value of its investment without any recogntition of the changes in the fair value of the investment . This is so because the with a significant influence over another company's policies , investment value is based on the changes in the value of that company's net assets inclusive of gains and losses. So the investor will not record the increase in the value of the investment by $0.3million.The investment will be recorded at $1 million only.

KIndly elaborate the above key points.