Crash Course in Accounting and Financial Statement Analysis, Second Edition

Intercompany Investments

Companies often make investments for various strategic reasons:

• Partnerships and joint ventures

• Investments in start-up technologies, new regions

In accounting, such investments can be broadly placed into three categories, generally depending on the percentage of ownership in them and the resulting level of control over them:

1. Cost Method

   • Under 20% ownership

   • Level of Influence: None/Little

2. Equity Method

   • Usually between 20% and 50%

   • Level of Influence: Significant

3. Consolidation Method

   • Usually over 50% ownership

   • Level of Influence: Control

Source: Used with permission. Microsoft 2005 Annual Report.

[View full size image]

Cost Method Investments

When a company holds less than a 20% ownership interest in another company, the investment is measured at its cost (acquisition price) if there is not a readily available market to determine fair market price.

Equity Method Investments

Strategic investments, typically associated with a 20% to 50% ownership interest in another company, are measured at their cost (acquisition price). As the investee’s equity increases (net income) or decreases (dividends), the investor’s equity value in the investee increases or decreases over time in proportion with the ownership level.

Fair Value SFAS 115 requires publicly traded securities to be recorded at their fair market value. Notice that this is a deviation from the historical cost principle. ...