Question

1.Discuss and explain three reasons that companies invest in debt and equity securities. 2. Explain what method is used to account for investments in equity securities with 20% to 50% ownership. Briefly describe how dividends received and share of net income are accounted for under this method

Answer 1

Among the three reasons that companies invest in debt and equity securities of other companies are the following:

• As a safety cushion , to maintain a large enoygh liquid investment balance ot tide the company over an emergency.
• To meet cyclical cash needs(for companies in highly seasonal business).
• To gain a return an idle investment
• To gain influence over the decision of the compaies being invested in.
• To gain complete control over another company . when one company owns more than 50% of another copany ,the financial statement of the first company must combine the financial performance of the other company (its susidiary) with its own performance as if the two companies were one single company.

Debt securities have a maturity value representing the amount to be repaid , afixed oe variable interest rate and a maturity date , when repayment of the debt is due. Equity securities represent ownership in a company and typically carry the right to collect dividends and to vote on corporate matters.

Equity method is used to account for investments in equity securities with 20% to 50% ownership .The equity method is he standard techniques used when one company has a significant investment in anther company.

when a company hold approximately 20% OR MORE OF ANOTHER COMPANY STOCK,IT IS CONSIDERED TO HAVE A SIGNIFICANT CONTROL,which signifies the power one company can exert over another . This power include representation on the board of directors ,partaking in policy development, and the interchanging of managerial personnel.

Example- If a firm owns 25% of a company with a $1 million net income ,the firm reports earning under the equity methods of $250,000.

More than 50%	control	Equity method and consolidation procedure	APB Opinion no.18
20 to 50%	significant influence	Equity method	APB Opinion no. 18
Less than 20%	no significant influence	Account for as trading or available for sale	FASB STATEMENT NO. 115
Ownership interest	control or degree of influence	Accounting method	Applicable standard

EQUITY METHODS EARNINGS ADJUSTMENT

• The equity method acknowledgees tthe substantive economic relatinship between two entities .
• When a company - the investor- has significant influence on the operating and financial result of another company -the investee-it can directly affect the value of the investrs investment.
• With an investmentholding above 20%,the investor usually records its share of the investee's earnings as revenue from investment ,which increase the carrying vaue of the investment.

EQUITY METHOD LOSS ADJUSTMENT

When a investee cmpany reports a net loss, the investor company records it share of the loss as loss on investment ,using the equity method , a company reports the carrying value of it's investment independent of any fair value change in the market . with a significant influence over another's company operating and financial plicies , the investor is basing its investment value on changes in the value of that company 's net assets from opertaing and financial activities and he resulting performances,including earning and losses.

EQUITY METHOD DIVIDEND ADJUSTMENT

• When the investee company pays acash dividend,it decrease the value of the net assets.
• Using the equity methods, the investr company receving the dividend records an increase to its cash balance but , meanwhile,reports a decrease to carrying value its investment.
• Other financial activities that affect the value of the investee net assets should have the same impact on the value of the investor's share of investment.
• The equity method ensures proper reporting on the business situation for the investors and the investee,given the substantive econmic relationship they have.