Question

How would the four different approaches to the financial reporting of investments in corporate equity securities be used in practice working for a firm?

How would understanding the various forms of business combinations (ie statuary merger, statuary consolidation etc) help in real-life practice give an example?

Answer 1

1. Fair-Value Method

2. Cost Method for equity securities without readily determinable fair values.

3. Consolidation of Financial Statements

4. Equity Method

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" (as defined by the ASC). For most investments in equity securities, quoted stock market prices represent fair values.

The equity method employs the accrual basis for recognizing the investor's share of investee income. Accordingly, the investor recognizes income as it is earned by the investee. Because of its significant influence over the investee, the investor "has a degree of responsibility for the return on its investment and it is appropriate to include in the results of operations of the investor its share of earnings or losses of the investee" (FASB ASC Topic 323). Under the equity method, the investor records its share of investee dividends declared as a decrease in the investment account, not as income.

Equity method is not appropriate when

An agreement exists between investor and investee by which the investor surrenders significant rights as a shareholder.

- A concentration of ownership operates the investee without regard for the views of the investor.

- The investor attempts but fails to obtain representation on the investee's board of directors.