Chapter 2, Problem 2.1Q

What types of investments in common stock normally are accounted for using (a) the equity method and (b) the cost method?

To determine

Introduction: The cost method is used for reporting investments in securities when equity method and consolidation reporting are inapt, whereas, equity method is a way by which external investors are informed.

To state: The types of investments in common stock that are accounted for using cost and equity method.

Explanation of Solution

Cost Method:

Under cost method, intercorporate investment in common stock are accounted at the historical cost. In case of marketable securities, the investment is shown at market value in the balance. This method is used for reporting when consolidation reporting and equity-method is inapt. The cost method is used when the company holds less than 20% in common stock of another company.

Equity Method:

Equity method is generally used when the investment in common stock is 20% or more than 20%. When the company holds 20% or more than 20% common stock of another company, the investor holds the control and significant influence on the investee.