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Learn all about accounting, finance, business strategy, economics, and financial math from the basics to the advanced. I've taught and tutored these subjects for years, helping everyone from teens to postdocs, CPAs and MDs.
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An investment in equity securities occurs when a small business purchases some equity or ownership interest in another company. How this investment is treated in the accounting books depends on the extent of control the investing company has over the investee company.
If the investor company has no significant influence over the investee, generally owns less than 20% of the investee, then this investment is classified as Fair Value Through Net Income (FVTNI). The investment is recorded at fair value on the investor company’s balance sheet. Any unrealized gains or losses from this investment are recorded in the investor company’s net income.
If the investor company does have significant influence over the investee, generally from owning between 20% and 50% of the investee, then the investment is accounted for using the equity method. Under the equity method, the investment is recorded by the investor company at the acquisition cost and then regularly adjusted for the investor company’s share of the investee’s net income or loss. Any dividends received by the investor company from the investee are treated as reductions in the investment.
If the investor company has control over the investee, generally from owning more than 50% of the investee, then the investment is accounted for with the acquisition method. Under the acquisition method, the investor company records the investment at the fair value of the consideration given. At year-end the investor company’s and the investee company’s financial statements are consolidated.
| Ownership Amount | Influence | Accounting Treatment |
|---|---|---|
| Up to 20% | No influence | Fair Value Through Net Income |
| 20%-50% | Significant influence | Equity Method |
| At least 50% | Control | Consolidated Financial Statements |
A business combination occurs when two or more companies combine to form a new company. With a business combination, the companies that were combined each keep their previously held separate legal identities. Their assets, liabilities and operations, however, are not combined into this new company. Business combinations can be achieved through a merger, in which two or more companies combine to for a new company, or through an acquisition, in which one company purchases another company.
A business consolidation occurs through an acquisition, in which one company purchases another company. The acquired company’s financial statements are consolidated with the financial statements of the acquiring company such that there will now be one set of financial statements instead of two.
The economic entity principle states that a parent company and its subsidiaries are a single economic entity for financial reporting purposes. Therefore, all of a parent company’s subsidiary companies’ financial statements must be consolidated with the parent company unless one of the following two exceptions exist.
When the year-end of the subsidiary company is less than three months different from the parent company’s year-end, then just use the subsidiary company’s normal financial statements. If there are any significant events or transactions that occur during the gap period, then the parent company must make those material adjustments.
When the year-end of the subsidiary company is more than three months different from the parent company’s year-end, then the subsidiary company must prepare special financial statements that correspond to the parent company’s year-end. These financial statements need to include all transactions that occur during the gap period.
The subsidiary company first consolidates with its subsidiary company. Then, the parent company consolidates with the subsidiary company.
Why would doing it in this order matter? Materiality. The smaller a company, the smaller is its materiality threshold. If the largest company started the process, then its materiality threshold would render events and potential issues that would have been material to the smaller company immaterial.
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Over the years, I have happily and confidentially advised a wide range of clients from a plumber near Pittsburgh to a robotics startup to a multi-state pediatrics practice. I am always your primary point of contact and hold myself accountable for your success.
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Hi there! I'm Matt. I'm a Christian, husband and father of four. I'm a graduate of Calvin, Harvard, Cardiff and Johns Hopkins Universities. I have a PhD in Economics, an MBA in Finance and an MS in Data Analytics. I'm a numbers guy who can communicate well!
I began this service to work directly with the small and mid-sized business owners who grow our great country's economy. Since 1999, I've worked with owners across industries from high tech IT and robotics to small farmers and artists. I've also helped and advised nonprofits from churches to civic organizations.
I also served as a Finance Staff Officer and eventually as the National Division Chief for Measurement Research within the US Coast Guard. The research and methods I created there continue to guide strategic decisions to this day.
I enjoy being active outdoors, especially in wild lands. Hiking, biking and fly fishing are some of my favorite pastimes.
I also love dogs! I'm an AKC obedience evaluator, and I train service and therapy dogs.
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