Comparison between the Cost Method, Equity Method, and Fair Valuation.pptx

Consolidation Methods

1. Comparison between the Cost Method, Equity Method, and Fair Valuation The cost method, equity method, and fair valuation are three different accounting methods used to account for investments in other companies. Each method has its own set of principles and requirements.

2. Cost Method The cost method is the simplest method of accounting for investments. Under the cost method, the investor records the investment on their balance sheet at the initial cost. He does not adjust the investment value unless there is evidence of a permanent decline in value. For example, if an investor purchases 10% of Company A's shares for $1 million, they would record the investment at $1 million. They would not adjust the value unless there is evidence of a permanent decline in value.

3. Equity M ethod The equity method is used when the investor has significant influence over the investee, but does not have control or joint control. Under the equity met`hod , the investor records the investment on their balance sheet at the initial cost. The investor adjusts the value of the investment based on their share of the investee's profits or losses. For example, if an investor purchases 25% of Company B's shares for $10 million and Company B earns a net income of $4 million in a given year, the investor would record $1 million (25% of $4 million) as income on their income statement and increase the value of their investment on their balance sheet by $1 million.

4. Fair Valuation Fair valuation is used when the investor does not have significant influence or control over the investee, and when the investment is classified as available-for-sale or held-for-trading. Fair valuation records the investment on the balance sheet at its fair value. This is the estimated value of the investment based on current market conditions. For example, if an investor purchases 10% of Company C's shares for $1 million and the market value increases to $1.5 million, the investor would record the investment on their balance sheet at $1.5 million.

5. The cost method is used for simple investments where the investor does not have significant influence over the investee. The equity method is used when the investor has significant influence over the investee but does not have control or joint control. Fair valuation is used when the investor does not have significant influence or control over the investee and the investment is classified as available-for-sale or held-for-trading.