Question

what are the three levels of influence that an investor can have over an investee company? what is the appropriate accounting treatment for each level of influence?

Answer 1

Three levels of influence that an investor can have over an investee company:-

1.Minority – passive:-Finally, minority passive ownership exist when the investor holds less than 20% of the company’s shares. This gives the owner no significant influence over the company. Investments in this company are accounted for using the cost method or the market method, and may be classified as public or marketable securities.

2.Minority – active:-

Minority active ownership exists when the investor holds 20-50% of the company’s shares. This gives the investor the ability to influence management decisions, but not to control it entirely. Investments in this company are accounted for using the equity method.

3.Majority ownership

Majority ownership exists when an investor holds more than 50% of a company’s shares. This gives the investor effective control of the company. Investments in this company are then accounted for using the consolidation method. Note that having exactly 50% of a company’s shares does not necessarily mean effective control for an investor, as another investor holding the other 50% would result in a split.

Appropriate accounting treatment for each level of influence:-

1.Minority – passive:-

• If an investor owns less than 20% of a company but holds significant influence in it, then it may use the equity method to account for its investments in said company.
• Under the equity method, the investment is initially recorded at historical cost and adjustments are made to the value based on the investor's percentage ownership in net income, loss, and dividend payouts.
• Net income of the investee company increases the investor's asset value on its balance sheet, while the investee's loss or dividend payout decreases it.
• The investor also records its percentage of the investee's net income or loss on its income statement.

2.Minority – active

• The equity method is used to value a company's investment in another company when it holds significant influence over the company it is investing in.
• Under the equity method, the investment is initially recorded at historical cost and adjustments are made to the value based on the investor's percentage ownership in net income, loss, and dividend payouts.
• Net income of the investee company increases the investor's asset value on its balance sheet, while the investee's loss or dividend payout decreases it.
• The investor also records its percentage of the investee's net income or loss on its income statement.

3.Majority ownership

• When an investor company exercises full control, generally over 50% ownership, over the investee company, it must record its investment in the subsidiary using a consolidation method.
• All revenue, expense, assets, and liabilities of the subsidiary would be included on the parent company's financial statements.