Question

1. Explain the equity method with regards to the application of the 20 percent rule, is this always strictly applied?

2. Identify and explain the different types of classifications for investments in equity securities.

Answer 1

1. Equity method with regards to the application of 20% rule is the method of accounting for investor for their investment in the investee when they make significant influence by exercising their voting rights. As investor doesn't have full control over the investee, so they apply 20% rule by the use of Equity method of accounting.

20% rule does not always strictly applied as various other factors effects the exercise of voting rights. These are as follows:

• Investor may not have significant influence over the investee as there are other large number of small shareholders having significant control over the management of the investee.
• Investee opposes the purchase of stock by the investor.
• Investor does not form representation on the investee's board of directors.
• There is an agreement between investor and investee of surrendering the significant rights by the investor.

2. The classification for investments in equity securities depends on the percentage of acquisition of shares. These are as follows:

• Acquisition of less than 20% of investee's shares and have passive interest.
• Acquisition of 20% to 50% of investee's shares and have significant influence over the investee.
• Acquisition of more than 50% of investee's shares and have significant management control and interest.

If the securities are not tradable on stock exchange then it is recorded in book of accounts at cost.