Equity Method and Disclosure

Posted: August 26th, 2021

Case 10-3 Equity Method and Disclosure

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Case 10-3 Equity Method and Disclosure

Question (a): DynamicDisclosure of the Investment Option

Equity method refers to an accounting approach employed by enterprises to evaluate the revenues earned in investment options when corporations make investments. Usually, firms report income from investments in the income statements, but the reported values are based on the business’s shares in the firm’s assets (Block et al., 2019). These values are based on the scope of the equity investment. In the case of Dynamic Company, itacquired 40% outstanding capital stock of Cart business; hence, it should be disclosed in the books of accounts by making the relevant entries (Schroeder, Clark & Cathey, 2019). The investment should be reported at the purchase cost. The corresponding entries fromthe long-term investment are reported in the company’s balance sheet as fixed assets under the investments in associates. Therefore, the cash dividend received from Cart Company on 15^th November 2017 should be treated as an income to the Dynamic Company. As well, appropriately recorded in the income statement.

Question (b): Report at Fair Value

However, when Dynamic Company reportsthe investment made to Cart Company at a fair value, there will be some differences in the income statements and the firm’s balance sheets. The difference between the purchase cost and the fair value is reported in the books of accounts as a notional gain or loss(Hsu & Wu, 2019). Notional gain arises when the fair value is higher than the purchase cost. Conversely, thenotional loss is when the purchase cost is more than the investment’s fair value. Thus, the notional gain is the credit difference, and the notional loss is the debit difference. As such, the notional gain is disclosed as a credit amount in the retained earnings, but the notional loss is disclosed as a negative figure or debit balance under the retained earnings in the company’s balance sheet(Schroeder, Clark & Cathey, 2019).However, notional gains and losses are not disclosed in the income statement as they are only speculative until they are realized.

References

Block, J., Fisch, C., Vismara, S., & Andres, R. (2019). Private equity investment criteria: An experimental conjoint analysis of venture capital, business angels, and family offices. Journal of corporate finance, 58, 329-352.

Hsu, A. W. H., & Wu, G. S. H. (2019). The fair value of investment property and stock price crash risk. Asia-Pacific Journal of Accounting & Economics, 26(1-2), 38-63.

Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial accounting theory and analysis: text and cases. John Wiley & Sons.