Definition
The term revenue from investments in stock refers to an approach companies can use to determine when to record income generated by their investments in common stock. There are several methods a company can use to account for these long and short-term investments. Each method has a slightly different approach to account for a stock's change in value or dividends received.
Explanation
Companies can make both long and short-term investments in the common stock of another company. When making a long-term investment, ownership falls into three categories: controlling interest, significant influence, and passive interest. Depending on the ownership interest status, a company would use the equity, cost, or lower of cost or market method to record transactions associated with dividends received or a change in the value of the securities held.
Each of the three methods to record revenue from investments in stock is listed below. This includes the ownership characteristics, as well as the implications to the balance sheet and income statement.
Equity Method: Characteristics
Applies when a company has:
Controlling Interest: 50% or more of the voting stock is held by the company (investor).
Significant Influence: 20% to 50% of the voting stock is held by the company (investor), with significant influence over the decision making process of the investee.
Accounting treatment:
Balance Sheet: all investments are carried at historical (acquisition) cost, periodically adjusted for the investee's earnings or losses. Dividends received lower the carrying value of the investment.
Income Statement: a proportional share of the investee's net income is recognized as an increase to revenues, while a loss and the payment of dividends would decrease the value of the investment and flow to the income statement.
Cost Method: Characteristics
Applies when a company has:
Passive Interest: the company (investor) holds less than 20% of the investee's voting stock or is unable to exert significant influence over the decision-making process.
Accounting treatment:
Balance Sheet: all investments are carried at historical (acquisition) cost until sold. Adjustments to the carrying value should also be made if it's clear that original cost is no longer a justifiable value. For example, the investee might declare a liquidating dividend.
Income Statement: dividends received from the investee are recorded as revenue on the investor's income statement.
Lower of Cost or Market: Characteristics
Applies when a company has:
Marketable Equity Securities: typically includes current assets where the investor does not have significant influence over the decision making process of the investee.
Accounting treatment:
Balance Sheet: all investments are carried at their aggregate historical (acquisition) cost or market value, whichever is lower. Adjustments to the carrying value should be made each time the balance sheet is prepared.
Income Statement: the excess of cost over market value are included in net income when held as a current asset. The excess of aggregate cost are included in the equity section of the balance sheet if the asset is noncurrent.
Related Terms
marketable securities, ownership interest, equity method, cost method, lower of cost or market
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