9. Accounting for Investments in Other Entities

Question 1

What are the three possible classifications of debt securities?

Answer 1

1. Trading: The organization intends to resell these securities in the near term.
2. Held-to-maturity: The organization has the ability and intent to hold the security until it matures.
3. Available-for-sale (AFS): Any securities not specifically designated as trading or held-to-maturity.

Question 2

What is the “significant influence” ownership threshold?

Answer 2

Generally, if a company owns 20% but less than 50% of another company, it is presumed to exercise significant influence. The significant ownership threshold may also be met at lower levels of ownership if circumstances demonstrate significant influence.

Question 3

What are the three methods of accounting for equity investments based on level of influence, and when does an organization use each method?

Answer 3

1. Fair value method: Used when the organization owns a small amount of stock in another company and cannot significantly influence or control the investee’s operations.
2. Equity method: Used when an organization can exert significant influence, but not control, over the investee’s operations.
3. Consolidation method: Used when an organization can exert control over the investee’s operations.

Question 4

How do companies record dividend distributions and net income related to investments where significant influence is obtained?

Answer 4

If an investor has significant influence over an investee, the investment is accounted for using the equity method. Under the equity method, companies record the investment at cost, then increase/decrease the investment by their pro-rata share of the net income/loss of the investee. The investment is decreased by their pro-rata share of the dividends declared by the investee.

Question 5

List some key characteristics of the consolidation method of accounting.

Answer 5

• Generally, ownership above 50% is presumed to create control.
• The investor presents the financial statements as though the parent and the subsidiary are a single entity.
• The subsidiary assets and liabilities are recognized at fair value at the time of purchase in the consolidated financial statements. Any resulting goodwill is also included in the consolidated financial statements.
• Any amount of ownership that is not held by the investor, the non-controlling interest, will be reflected in the equity section of the consolidated balance sheet