Question

Discuss the appropriate accounting treatment to use when (a) an investor acquires enough additional common stock during a year to change from accounting for the investment as a trading security to using the equity method and (b) an investor using the equity method sells enough common stock so that its portion of ownership falls below 20%

Answer 1

Part a)

Under the equity method, the following changes will be required to be made:

1) The investor restates the investment in the investee by the passing the following journal entry:

Account Titles	Debit	Credit
Investment Account	XXXX
Retained Earnings		XXXX

The amount reported through the above journal entry will be the difference between the previous share/percentage in investee income less any amount of dividends from the date of acquisition till the date the investor acquires siginificant influence in the investee.

2) Any amount previously recorded in the allowance and unrealized gain/loss on the shares recorded at fair value will also be eliminated.

3) Once the equity method has been adopted, the company will report any increase/decrease in the book value (change from fair value) of investments for any share of investee's net income and dividends.

_____

Part b)

In the given case, the equity method will no longer be used as the ownership would fall below 20%. Under the equity method, any share in the income of the investee will no longer required to be adjusted. The amount of income previously recorded (under the equity method) will continue to be reported as a part of the book value of investment account. Once the change has been made, the value of investment in the investee will be recorded as a trading security.