For example, if company A acquires a 40% stake in company B by buying 8,000,000 million equity shares US$ 5 each, then the investment value is recorded initially at cost in the balance sheet. Dividends are accounted for as return on investment and reduce the listed value of shares. Under this method, the investment is initially recorded in the same manner as the cost method, but the amount is subsequently adjusted as per the investee company’s profits or loss by applying the shareholding ownership percentage. The equity method is used when a company exerts a significant influence or control over another company usually, the shareholding percentage is capped between 20% and 50% in order to qualify for the equity method of accounting. The dividend received from company B out of the shareholding is recorded as income in the profit and loss account. The investment value remains unchanged regardless of fluctuations in the market price of stocks of company B. For example, if company A acquires a 5% stake in company B by buying 1,000,000 equity shares US$ 5 each, then the investment cost of US$ 5,000,000 is recorded as an investment in company A’S balance sheet. Dividends earned from the investment are recorded as income in profit and loss account and are accounted for in the calculation of tax. Under this method, the investments in the stocks are recorded at cost of purchase and are not modified until the shares are sold. Investments in equity shares of the investee company leading to the holding of less than 20% are generally accounted for under this method. The cost method is used when a company does not exert a significant influence over another company usually, the shareholding percentage is capped at a maximum of 20% to determine the extent of control. Following is an overview of the 2 methods and examples to illustrate them. The cost method is used when a company does not exert a significant influence over another company whereas the equity method is used when a company exerts a significant influence or control over another company. When companies acquire a stake over another company, there are two accounting methods that could be used: cost method and equity method. A parent must not only have power over an investee and rights to variable returns but also must have the ability to exercise its power over investee by affecting its returns out of its involvement. Rights can be voting rights or out of contractual arrangements. The ability to use its power over the investee to affect the number of the investor’s returns.”Ī power arises from rights.Exposure, or rights, to variable returns from its involvement with the investee.the investor has existing rights that give it the ability to direct the relevant activities (the activities that significantly affect the investee’s returns) Jiten wrote this essay in Module 4 of the Valuation Master Class.Īccording to International Financial Reposting Standards number 10:7, “An investor controls an investee if and only if it has the following elements: This is a Valuation Master Class student essay by Jiten Dialani from May 14, 2018.
0 Comments
Leave a Reply. |
AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesCategories |