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The Equity Method of accounting for investments (Accounting Books in PDF)
The first several chapters of this text present the accounting and reporting for investment activities of businesses. The focus is on investments when one firm possesses either significant influence or control over another through ownership of voting shares. When one firm owns enough voting shares to be able to affect the decisions of another, accounting for the investment can become challenging and complex. The source of such complexities typically stems from the fact that transactions among the firms affiliated through ownership cannot be considered independent, arms-length transactions. As in many matters relating to financial reporting, we look to transactions with outside parties to provide a basis for accounting valuation. When firms are affiliated through a common set of owners, measurements that recognize the relationships among the firms help to provide objectivity in financial reporting.
THE REPORTING OF INVESTMENTS IN CORPORATE EQUITY SECURITIES (Accounting books in PDF)
In a recent annual report, JB Hunt Transport Services describes the creation of Transplace, Inc. (TPI), an Internet-based global transportation logistics company. JB Hunt contributed all of its logistics segment business and all related intangible assets plus $5 million of cash in exchange for an approximate 27 percent initial interest in TPI, which subsequently increased to 37 percent. JB Hunt accounts for its interest in TPI utilizing the equity method of accounting and stated, “The financial results of TPI are included on a one-line, nonoperating item included on the Consolidated Statements of Earnings entitled ‘equity in earnings of associated companies.’ ”
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Such information is hardly unusual in the business world; corporate investors frequently acquire their own shares of both domestic and foreign businesses. These investments can range from the purchase of a few shares to the acquisition of 100 percent control.
Although purchases of corporate equity securities (such as the one made by JB Hunt) are not uncommon, they pose a considerable number of financial reporting issues because a close relationship has been established without the investor gaining actual control. These issues are currently addressed by the equity method. This chapter deals with accounting for stock investments that fall under the application of this method.