9 Questions
How are initial investments in equity securities recorded?
At original cost
What is the treatment for dividends received in excess of earnings after the investment date?
Treated as a reduction of the investment cost
How are short-term equity holdings (trading securities) reported?
At fair value with unrealized gains/losses included in earnings
What is the accounting treatment for non-trading equity securities (AFS)?
Reported at fair value with unrealized gains/losses included in earnings
What method is used when the fair value of an equity security is not readily determinable?
Cost method
According to the passage, which of the following is a recognized approach to the financial reporting of investments in corporate equity securities?
The fair-value method
What is the primary factor that determines the financial statement reporting for a particular investment?
The degree of influence the investor has over the investee
According to the passage, what is the definition of fair value?
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
What is the relationship between the relative size of ownership and the degree of influence an investor has over an investee?
The degree of influence is directly related to the relative size of ownership.
Study Notes
Equity Securities Investments
- Equity securities are bought in anticipation of cash dividends or stock market value appreciation.
- Initial investments are recorded at cost and periodically adjusted to fair value if readily determinable.
- Two exceptions to cost basis for reporting investments:
- Dividends received in excess of earnings subsequent to the date of investment are considered returns of the investment and are recorded as reductions of cost of the investment.
- A series of an investee’s operating losses or other factors indicating a decrease in value of the investment that is other than temporary should be recognized accordingly.
Reporting Methods
-
Fair-Value Method
- Equity investments begin at purchase price, then adjust to current market value when easily known, otherwise keep original cost.
- Short-term equity holdings (trading securities) go to fair value, impacting earnings directly.
- Non-trading equity (available-for-sale securities) at fair value, unrealized gains/losses in other comprehensive income.
- Both short-term and long-term equity receive income recognition for dividends.
-
Cost Method (for investments without readily determinable fair values)
- Investments in equity securities are measured at cost when fair value is not readily determinable and the investment provides neither significant influence nor control.
- Income from cost method equity investments usually consists of the investor’s share of the investee’s profits.
Financial Reporting of Investments
- Generally Accepted Accounting Principles (GAAP) recognize three approaches to financial reporting of investments in corporate equity securities:
- Fair-value method
- Cost method for equity securities without readily determinable fair values
- Consolidation of financial statements
- Equity method
- Financial statement reporting for a particular investment depends primarily on the degree of influence that the investor has over the investee, indicated by the relative size of ownership.
This quiz covers the different approaches to financial reporting of investments in corporate equity securities as recognized by Generally Accepted Accounting Principles (GAAP), including the fair-value method, cost method, consolidation of financial statements, and equity method. The reporting for an investment depends on the level of influence the investor has over the investee.
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