Describe the accounting and reporting of investments in common stock

Answer 1

OVERVIEW OF THE ACCOUNTING FOR AND REPORTING OF INVESTMENTS
IN COMMON STOCK

The accounting for investments in common stock depends on (1) the expected holding period,
and (2) the purpose of the investment, as determined by both the percentage held and management intent.

EXPECTED HOLDING PERIOD

The expected holding period determines the balance sheet classification of investments in
securities as current assets or as noncurrent assets. Securities that firms expect to sell within
the next year appear as marketable securities in current assets on the balance sheet. Securities that firms expect to hold for more than one year from the date of the balance sheet appear in investments in securities, classified as a noncurrent asset on the balance sheet. For our purpose, the word investment is reserved for holdings with a long-term purpose.

PURPOSE OF AN INVESTMENT IN COMMON STOCK

The purpose of an investment in common stock and the percentage of common stock held combine to determine the accounting for that investment.

1 . In minority, passive investments, an investor acquires the common stock of another entity (the investee) for the interest, dividends, and capital gains (increases in market prices) anticipated from share ownership. The acquiring (investor) company's ownership percentage is sufficiently small that it cannot control or exert significant influence over the other company. Occasionally, an investor that owns a small percentage of the shares of the investee has the contractual right to elect one or more members of the board of directors of the investee entity. If so, the investor, even though a small percentage holder, could exercise significant influence. U.S. GAAP and IFRS view investments of less than 20% of the voting shares of another company as minority, passive investments in most cases. An investor who intends to hold the shares for less than a year would classify them as current assets; if the expected holding period is longer, the investor would classify them as noncurrent assets (Investments in Securities).

2 . In minority, active investments, an investor acquires common shares of an investee with
the intent of exerting significant influence over the investee's activities, perhaps through
representation on the investee's board of directors. Because many different individuals
or entities own most publicly held corporations, and those owners typically do not collaborate
in voting their shares, an investor can exert significant influence over an investee
with ownership of less than a majority of the voting stock. U.S. GAAP and IFRS view investments of between 20% and 50% of the voting stock of another company as minority, active investments unless evidence indicates that the investor cannot exert significant influence. Minority, active investments appear as noncurrent assets on the balance sheet.

3 . In majority, active investments, an investor acquires shares of an investee so that the investor can control the investee both at the broad policy-making level and at the day-to-day operational level. U.S. GAAP and IFRS view ownership of more than 50% of an investee as implying an ability to control the investee, unless evidence indicates to the contrary. For example, an investor cannot exercise control of a majority-owned investee if a court effectively controls the investee in bankruptcy proceedings or if the investee is a foreign company whose government restricts the withdrawal of assets from the country.