Equity Investments: Fair Value Reporting Requirements

Equity investments are generally required to be measured at fair value, with changes in fair value recognised in earnings. Under the equity method of accounting, the investor company reports the revenue earned by the other company on its income statement, proportional to the percentage of its equity investment in the other company. The equity method is generally used when a company holds significant influence over the company it is investing in. 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 increases the value on the investor's income statement, while loss and dividend payouts decrease it.

Equity investments are generally measured at fair value

Under the equity method of accounting, the investor company reports the revenue earned by the other company on its income statement. This amount is proportional to the percentage of its equity investment in the other company. The equity method is generally used when a company holds significant influence over the company it is investing in.

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 increases the value on the investor’s income statement, while both loss and dividend payouts decrease it.

Investments in equity securities with readily determinable fair values are generally classified as current in a classified balance sheet. Equity investments are required to be presented as a separate line item on the balance sheet.

Equity investments are required to be presented as a separate line item on the balance sheet

The introduction of ASU 2016-01 brought about significant changes to the model of accounting for investments in equity securities. Now, almost all equity investments are required to be carried at fair value, with changes in fair value included as a component of earnings. This is known as the equity method of accounting. The fair value disclosure requirements included in ASC 820 apply to these investments.

The equity method is used when a company holds significant influence over the company it is investing in. This is usually the case when a company holds 20% or more of another company's stock. However, it is not always the case that a company with less than 20% ownership does not hold significant influence. If a company can exert power through representation on the board, involvement in policy development, or the interchanging of managerial personnel, then they are also required to use 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 increases the value on the investor's income statement, while loss and dividend payouts decrease it.

The equity method of accounting does not apply for certain investments

The equity method of accounting is a technique used to record the profits earned by a company through its investment in another company. It is used when the investor holds significant influence over the investee but does not exercise full control over it. In this case, the terminology of "parent" and "subsidiary" is not used, unlike in the consolidation method where the investor exerts full control over its investee. Instead, the investee is often referred to as an "associate" or "affiliate".

The equity method of accounting does not apply to all investments. For example, it does not apply to investments in partnerships, joint ventures, and LLCs. It also does not apply to investments in common stock held by a nonbusiness entity, such as an estate, trust, or individual. Additionally, the equity method is not applied when the fair value option is elected or when the proportionate consolidation method is used.

The equity method is generally used when a company holds significant influence over the company it is investing in. This usually means owning between 20% to 50% of the investee's shares or voting rights. If the investor has less than 20% of the investee's shares but still has a significant influence on its operations, then the equity method must still be used.

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 increases the investor's asset value, while loss or dividend payout decrease it.

Equity instruments that are held for trading are required to be classified at FVTPL

Equity investments are generally measured at fair value, with changes in fair value recognised through earnings. This is the case under both IFRS and US GAAP. However, IFRS provides an option to recognise changes in the fair value of equity investments in other comprehensive income, without subsequent reclassification to profit or loss.

IFRS 9 introduces a more principles-based approach to the classification of financial assets, which must be classified into one of four categories:

• Fair value through other comprehensive income (FVTOCI) for debt
• FVTOCI for equity
• Fair value through profit or loss (FVTPL)
• Amortised cost

Equity investments and derivatives must always be measured at fair value, and the general classification category is FVTPL. However, IFRS 9 permits entities to irrevocably elect to classify certain equity investments that are not held for trading as FVTOCI.

The classification decision for non-equity financial assets is dependent on two key criteria: the business model within which the asset is held (the business model test) and the contractual cash flow characteristics of the asset (the Solely Payments of Principal and Interest, or SPPI, test).

The fair value option can be elected for equity method investments

When a company purchases equity securities or invests in another company, there are three ways the investment can be reported: the fair value option, the equity method, and the consolidation method.

An investor electing to adopt the fair value option for any of its equity method investments is required to present those equity method investments at fair value at each reporting period, with changes in fair value reported in the income statement. The fair value option can be elected when an investment becomes subject to the equity method of accounting for the first time. For instance, an investment may become subject to the equity method of accounting for the first time when an investor obtains significant influence by acquiring an additional investment in an investee.

The election of the fair value option is irrevocable, unless an event creating a new election date occurs. Therefore, a reporting entity that elects to adopt the fair value option to account for an equity method investment is precluded from subsequently applying the equity method of accounting to that investment. An investor that elects the fair value option and subsequently loses the ability to exercise significant influence would be required to continue to account for its retained interest on a fair value basis.

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