Corporate Financial Reporting and Analysis, 3rd Edition

Chapter 17

Marketable Securities and Investments

Companies often purchase the shares of other companies. In this chapter we discuss the accounting for these investments. Unless otherwise stated, the discussion applies equally to US GAAP and International Financial Reporting Standards (IFRS). Also, we focus on equity investments, although brief mention is made of debt instruments. To illustrate the concepts, we draw on the financial statements of Microsoft, the US-based software giant.

Introduction

When companies own shares in other businesses, the accounting follows one of three methods, depending on the degree of influence or control that the investor exerts over the other company. Three levels of influence/control are possible:

• Passive. In this case, the investor is assumed to exert no influence over the investee company. Generally, passive investment is assumed when the investor owns less than 20% of the outstanding voting shares of the investee. All such investments are accounted for using either the “market method” or the “cost method.”
• Significant influence. Here, the investor is assumed to own enough of the investee (usually called an “affiliate” or “associate” company) to exert significant influence over operating activities and dividend policy. Generally, such influence is assumed when the investor owns between 20 and 50% of the affiliate’s outstanding voting shares. In such cases, the “equity method” of accounting must be used.
• Control. Control is presumed if the investor ...