Question

Explain why under fair-value accounting for an equity investment, changes in the fair value of the investor’s ownership shares of the investee affects the income the investor recognizes from its ownership of the investee?

Answer 1

According to the fair value accounting for equity, the value of the shares are revalued on the basis of some trading index from similar market. As a result, the book or market value of the shares may get increased or decreased due to unrealized profit or loss. If the investor sells the shares now, he gets the revalued amount, keeping the dividend income aside. For example, the investor buys the share of par value $100 at a price of $105. Now after revaluation as per fair value accounting, the shares are valued at $107. If he sells now, he will get $107. So he earn a profit of 107-105 = $2. This surplus premium will be added to his dividend income to arrive at his total income from the investment. Thus fair-value accounting for an equity investment affects the income the investor recognizes from its ownership.