Cassidy Bonito
AC321- Advanced Accounting
Professor Hoying
April 27th, 2020
Fair Value vs. Equity Method
Earlier in the semester we talked about stock investments for chapter 2. Everyone
is able to put in an equity investment into a company of their choosing, this is known as
buying stock. Stock prices depend on the corporation’s value and may fluctuate on the
daily. Buying stock allows you to become a shareholder in that company and depending
on the type of stock bought, common or preferred, depends on what you can do with it.
Common stock allows the shareholders to have voting rights but does not guarantee any
dividends to be given back. Preferred stocks provide no voting rights but usually
guarantees a dividend payment. When dealing with stock investments there are two
types of methods one can use. The most common being the fair value (cost) method
which measures the estimate or actual value of an asset. The other method is the equity
method where the investor company “reports the revenue earned by the other company
on its income statement, in an amount proportional to the percentage of its equity
investment in the other company.”
1
Both of these methods are useful and a company will
use one based on the significant amount invested in said companies. They are also used
when dealing with consolidations, but I personally will not get into that complicated topic.
1
https://www.investopedia.com/terms/e/equitymethod.asp
In order for a company to use the appropriate accounting method when buying
shares, they must analyze the amount of “influence the buyer has over the investees”
2
Both of these methods depend on the parent and subsidiaries at hand. Parent
companies are the ones that are buying while the subsidiaries are being bought. The fair
value method is usually used when there is not as much significant influence, or a high
percentage. If one does obtain that influence then it is best to use the equity method. In
class we discussed that the main rule is if it is above twenty percent acquired that the
equity method should be used and if it is below twenty percent the fair value method is
used.
Fair Value deals with the actual selling value of the asset at hand that the buyer
agrees to pay and is originally set by the seller, either way both parties will prosper from
the arrangement. In order to calculate the fair value you must evaluate the profit margin,
