# OCW041: Approaches to Investment Accounting

## Types of Investments: Dependence on Ownership Share

Types of investments include: 20% to 50% (as an asset), greater than 50% (as a subsidiary), and less than 20% (as an investment position).

### Learning Objectives

Distinguish between a 20% to 50%, greater than 50% and less than 20% investment

### Key Takeaways

#### Key Points

• A share is a single unit of ownership in a corporation, mutual fund, or any other organization.
• Equity method in accounting is the process of treating equity investments, usually 20% to 50%, in associate companies. The investor keeps such equities as an asset.
• The ownership of more than 50% of voting stock creates a subsidiary. Its financial statements consolidate into the parent’s financial statements.
• The ownership of less than 20% creates an investment position carried at historic book or fair market value (if available for sale or held for trading) in the investor’s balance sheet.

#### Key Terms

• face value: The amount or value listed on a bill, note, stamp, etc.; the stated value or amount.
• fair market value: The price at which the buyer and seller are willing to do business.
• prima facie: at first sight; on the face of it

A share is a single unit of ownership in a corporation, mutual fund, or any other organization. A joint stock company divides its capital into issuing shares, which are offered for sale to raise capital. A share is thus an indivisible unit of capital, expressing the proprietary relationship between the company and the shareholder. The denominated value of a share is its face value, as calculated by dividing the total capital of a company by the total number of shares.

Shares are valued according to various principles in different markets, but a basic premise is that a share is worth the price at which a transaction would be likely to occur were the shares to be sold. The liquidity of markets is a major consideration as to whether a share is able to be sold at any given time. An actual sale transaction of shares between buyer and seller is usually considered to provide the best prima facie market indicator as to the “true value” of shares at that particular time.

### 20% to 50%

Equity method in accounting is the process of treating equity investments, usually 20% to 50%, in associate companies. The investor keeps such equities as an asset. The investor’s proportional share of the associate company’s net income increases the investment (and a net loss decreases the investment), and proportional payment of dividends decreases it. In the investor’s income statement, the proportional share of the investee’s net income or net loss is reported as a single-line item.

### More Than 50%

The ownership of more than 50% of voting stock creates a subsidiary. Its financial statements consolidate into the parent’s financial statements.

A subsidiary company, subsidiary, or daughter company is a company that is completely or partly owned and partly or wholly controlled by another company that owns more than half of the subsidiary’s stock. The subsidiary can be a company, corporation, or limited liability company. In some cases, it is a government or state-owned enterprise. The controlling entity is called its parent company, parent, or holding company.

An operating subsidiary is a business term frequently used within the United States railroad industry. In the case of a railroad, it refers to a company that is a subsidiary but operates with its own identity, locomotives, and rolling stock. In contrast, a non-operating subsidiary would exist on paper only (i.e. stocks, bonds, articles of incorporation) and would use the identity and rolling stock of the parent company.

### Less Than 20%

The ownership of less than 20% creates an investment position carried at historic book or fair market value (if available for sale or held for trading) in the investor’s balance sheet.

Dow Jones Industrial Average: The DJIA depicts the volume of shares traded over a specific period of time.

## Accounting Methodologies: Amortized Cost, Fair Value, and Equity

Due to different durations of holding and other factors, companies use several accounting methodologies, including amortized cost, fair value, and equity.

### Learning Objectives

Explain the difference between amortized cost, fair value and the equity method for reporting debt securities

### Key Takeaways

#### Key Points

• Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost less impairment.
• Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings.
• Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders ‘ equity.

#### Key Terms

• impairment: A downward revaluation, a write-down.
• fair value: Fair value, also called “fair price” (in a commonplace conflation of the two distinct concepts) is a concept used in accounting and economics, defined as a rational and unbiased estimate of the potential market price of a good, service, or asset.

### Amortized Cost

If a business holds debt securities to maturity with the intent to sell are classified as held-to-maturity securities. Held to maturity securities are reported at amortized cost less impairment.

### Fair Value

Fair value: Fair value, defined as a rational and unbiased estimate of the potential market price of a good, service, or asset.

Fair value, also called fair price, is a concept used in accounting and economics, defined as a rational and unbiased estimate of the potential market price of goods, services, or assets, taking into account such objective factors as:

• acquisition/production/distribution costs, replacement costs, or costs of close substitutes;
• actual utility at a given level of development of social productive capability;
• supply vs. demand;
• subjective factors such as risk characteristics, cost of and return on capital and individually perceived utility.

Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities. These securities are reported at fair value, with unrealized gains and losses included in earnings.

Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities. These securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders’ equity (Other Comprehensive Income ).

### Equity Method

Equity method in accounting is the process of treating equity investments, usually 20–50%, in associate companies. The investor keeps such equities as an asset. The investor’s proportional share of the associate company’s net income increases the investment (a net loss decreases the investment), and proportional payment of dividends decreases it. In the investor’s income statement, the proportional share of the investee’s net income or net loss is reported as a single-line item.The ownership of more than 50% of voting stock creates a subsidiary. Its financial statements consolidate into the parent’s.

The ownership of less than 20% creates an investment position carried at historic book or fair market value (if available for sale or held for trading) in the investor’s balance sheet.

Source: Accounting