This audio will introduce you to accounting treatment when an investor changes to equity method of accounting, or, changes from the equity method of accounting to the cost adjusted for fair value method of accounting.
When an investor changes from the cost adjusted for fair value method of accounting to the equity method, the investment account must be adjusted retroactively, and prior years’ income statements and retained earning balances, must be retroactively restated. Note that an investor will change to the equity method of accounting only when an investor makes additional purchases of the stock, and is able to exercise significant influence, over the operating and financial decisions of the investee. ASC Topic 323 states that investments of more than 20% or more of the investee’s outstanding stock, carry a presumption that the investor has the ability to exercise significant influence. Hence in most cases, when an investment of less than 20% increases to more than 20%, the investor will retroactively change from the cost adjusted for fair value method to the equity method of accounting for investments.
Such retroactive change to the equity method, requires a prior period adjustment for the difference in the investment account and retained earnings account. Such difference, is between the amounts that were recognized in prior periods under the cost adjusted for fair value method, and the amounts that would have been recognized if the equity method had been used. In addition, any balance in the unrealized holding gains or loss accounts must be reversed.
When an investor is unable to influence the investee’s financial and operating policies, the investor will discontinue the used of equity method of accounting for investments. In such cases, when the investor discontinues the use of equity method of accounting for investments, retroactive restatement is not allowed. Thus, the earnings or losses which related to the shares retained by the investor that were previously recognized by the investor, continue to remain as a part of the carrying value of the investment. If dividends received by the investor in the subsequent period, exceed the investor’s share of the investee’s earnings for such period, the excess shall be accounted for as a return of capital. Such excess shall be recorded as a reduction in the investment’s carrying amount.