How do you account for an investment?

When a company purchases an investment, it is recorded as a debit to the

appropriate investment account (an asset), offset with a credit to the account
representing the consideration (e.g., cash) given in exchange for the asset.
After the initial recognition, the accounting gets a bit more complex. The
changes in value, or “income” from an investment are accounted for in a
myriad of different ways, many of which depend on what type of investment it
is. This article will focus on the accounting treatment of intangible
investments, specifically equity securities.
In 2016 the FASB issued ASU 2016-01, Financial Instruments—Overall
(Subtopic 825-10): Recognition and Measurement of Financial Assets and
Financial Liabilities (ASU 2016-01) to address the recognition, measurement,
presentation, and disclosure of certain financial instruments. More specifically,
ASU 2016-01 established ASC 321, Investments — Equity Securities (ASC
321) to present new accounting treatment for equity securities. Additionally,
the previously existing standard, ASC 320, Investments — Debt
Securities (ASC 320), was updated to provide accounting and reporting
guidance only for investments in debt securities.
Prior to ASU 2016-01, both debt and equity securities were classified as held-
to-maturity, available-for-sale, or trading and accounted for accordingly. This
treatment is still in effect for debt securities under ASC 320, but the
accounting for equity securities has changed.

What is an equity security?

An equity security is a financial instrument representing ownership in another
entity. The most prevalent types of equity securities are common stock and
preferred stock. The financial instrument is an investment in the entity’s net
assets or equity. An investor will purchase the equity securities of an entity in
hopes the entity will make a profit and in turn, the investment will appreciate.
How do you account for an equity security?
The various accounting treatments for equity securities are discussed in ASC
810, Consolidations (ASC 810), ASC 323, Investments – Equity Method and
Joint Ventures (ASC 323), and ASC 321. The applicable accounting method is
determined based on a number of factors, the most important of which are:
1. The percentage of ownership the equity security represents
2. The amount of control the investor can exercise over the entity
As indicated by the titles of the various accounting topics above, the three
main methods of accounting for equity securities are:
 Consolidation
 Equity method
 Fair value

Consolidation
In the broadest sense, to consolidate means to combine. In accounting,
consolidated financial statements combine the assets, liabilities, and other
accounts of a group of entities to present them as a single entity. The purpose
of consolidation is to report the aggregate financial position of the parent
company (investor) to company stakeholders. Corporations or larger
companies use consolidated financial statements to present the combined
operating results of their entire business, but various departments, divisions,
or subsidiaries may also have standalone, or individual financial statements.
Consolidation accounting
Consolidation accounting is governed by ASC 810. When a parent company
has a controlling financial interest over a subsidiary (investee) company, the
parent company will account for the investment, or ownership, in the
subsidiary by consolidating, or combining their financial statements into one
report. In general, a controlling financial interest means the parent owns more
than 50% of the subsidiary. However, a parent company with
a lesser ownership percentage may also have a controlling interest in another
legal entity if they have significant control over key decisions and the
right/obligations to significant income/loss of the investee.
Considerations for consolidation
Once the parent determines they have a controlling financial interest over
another entity, the following criteria must also be considered to move forward
with consolidation:
1. The investment entity must be a legal entity (ASC 810 specifically excludes
employee benefit plans, governmental organizations, certain investment
companies, and money market funds.)
2. Determine which consolidation model should be applied – the voting interest
entity model or the variable interest entity model.
The voting interest entity model, or voting model, was established in the
1950s as guidance for consolidating entities whereby a controlling financial
interest is presented primarily as ownership of the majority of voting rights.
Over the years businesses and finances have become increasingly complex
and, in the early 2000s, FASB introduced the variable interest entity (VIE)
model and specific accounting guidance for its unique circumstances.
A VIE is a legal structure where the party with the controlling interest does not
necessarily have the majority of the voting rights. If the voting model was used
 for consolidation in these cases, the controlling party, or primary beneficiary,
would not be required to consolidate the subsidiary, which results in
misleading consolidated financial statements. To address the situation the
FASB developed the VIE consolidation model and a set of criteria to
determine the appropriate accounting. The various criteria to identify a VIE
and its primary beneficiary and guidance on applying the VIE model of
consolidation are detailed in ASC 810. For the remainder of this article, the
consolidation model we refer to is the voting interest model.
Accounting for the initial investment
The initial journal entry to record the parent’s investment under the voting
interest model is to debit an investment asset account for the purchase price
and credit cash or other account for the type of consideration exchanged. In
addition, the parent records the assets and liabilities of the purchased
subsidiary at fair value according to the guidance provided by ASC
805, Business Combinations (ASC 805). The parent company stops here if
only presenting standalone financial statements. However, to present
consolidated financial statements, which is required under ASC 810 when the
parent has a controlling interest in a subsidiary, the parent company combines
their financial statements with the financial statements of the purchased
subsidiary.
To consolidate the entities, the parent company adds together the financial
statements of both entities with a few adjustments:
1. The non-controlling interest of the parent company is removed from the
subsidiary’s financial statements (if applicable).
2. The investment asset account of the parent and the remaining equity of the
subsidiary are eliminated, or adjusted off of their respective financial
statements.
3. Any additional transactions between the parent and subsidiary, known as
intercompany transactions, are eliminated, or adjusted off of their respective
financial statements. Some common examples of these eliminations are
intercompany receivables/payables and intercompany sales.
Non-controlling interest (NCI) is the amount of the subsidiary that the parent
company does not own or control. (For example, if the parent company owns
80% of the subsidiary, 20% is the NCI or minority interest of that subsidiary.)
For an accurate financial representation of the parent’s ownership of the
subsidiary, the NCI is subtracted from the subsidiary’s financial position before
consolidation.
On the balance sheet, NCI is presented as a separate line in the parent’s
equity section, which represents the net assets or net financial position
attributed to the subsidiary. The initial recognition of NCI occurs during the
purchase accounting proscribed by ASC 805 when the fair value of the
purchased assets and liabilities and the fair value of the NCI are recorded.
In addition, the amount of the investment balance recorded by the parent is
removed from the parent’s financial statements and the offsetting equity
balance is removed from the subsidiary’s financial statements as part of
consolidation (step 2 above). Lastly, any intercompany transactions or
balances are eliminated from the parent and subsidiary financial statements
(step 3 above). After these adjustments, the consolidated financial statements
include only the equity of the parent company, and the net investment in the
subsidiary is represented by its assets and liabilities combined with the parent
company’s assets and liabilities.
Accounting for subsequent activities
Changes in the amount of investment of the subsidiary, such as the parent
purchasing additional shares of ownership or divesting some of their
ownership, are accounted for by adjusting the investment asset. The NCI’s
value changes due to the subsidiary’s profits and losses. These changes are
presented on the parent company’s income statement as a separate line item.
In addition, the parent company consolidates current financial statements from
the subsidiary each financial period to include the subsidiary’s present
financial position and results of operations in the consolidated financial
statements.

The equity method

The equity method of accounting applies to an equity security investment if
the investing entity does not have enough control over the investee to
consolidate under ASC 810 but does have the ability to exercise significant
influence over the investee’s operating and financial policies.
Accounting for the equity method
The Equity Method of Accounting for Investments and Joint Ventures under
ASC 323 discusses the accounting treatment of investments under the equity
method and includes illustrative examples of some of the transactions
common to equity method accounting.

Fair value
Equity securities not meeting the consolidation criteria of ASC 810 or the
equity method criteria for ASC 323 are accounted for using the fair value
method described in ASC 321. The fair value method of accounting previously
existed for equity securities, however under ASU 2016-01 and ASU 2018-
03 Technical Corrections and Improvements to Financial Instruments –
Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets
and Financial Liabilities (ASC 2018-03) the applicable accounting treatment
was updated.
Accounting for the fair value method
Whereas previously an equity security was measured at fair value and any
changes in fair value were recorded to other comprehensive income (OCI) or
net income, depending on the classification of the security, currently an equity
security under ASC 321 is measured at fair value and any changes are
always recorded to net income. Additionally, ASC 321 provides for a
measurement alternative if the fair value of the equity security is not readily
determinable.