Investment valued at cost – A method of accounting for an investment, whereby the investment is recognised at cost. The investor recognises revenue from the investment only to the extent that the investor is entitled to receive distributions from accumulated surpluses of the investee arising after the date of acquisition. Entitlements due or received in excess of such surpluses are regarded as a recovery of investment, and are recognised as a reduction of the cost of the investment.
The cost method is used when making a passive, long-term investment that doesn’t result in significant influence over the company. The cost method should be used when the investment results in an ownership stake of less than 20%, but this isn’t a set-in-stone rule, as the significant influence is the more important factor.
Under the cost method, the stock purchased is recorded on a balance sheet as a non-current asset at the historical purchase price, and is not modified unless shares are sold, or additional shares are purchased. Any dividends received are recorded as income in profit or loss, and can be taxed as such (depending on local tax laws). This receipt of dividend also increases the cash flow, under either the investing activities or operating activities of the cash flow statement (depending on the investor’s accounting policies/type of business).
If the investor later sells the assets, he or she realizes a gain or loss on the sale. This affects profit or loss in the income statement, is adjusted for in cash inflows on the cash flow statement, and affects investing cash flow.
If the investee has undistributed earnings, they do not appear in any way in the records of the investor. They may however be disclosed in the notes to the investments value at costs.
Once the investor records the initial transaction, there is no need to adjust it, unless there is evidence that the fair market value of the investment has declined to below the recorded historical cost. If so, the investor writes down the recorded cost of the investment to its new fair market value.
If there is evidence that the fair market value has increased above the historical cost, it is not allowable under IFRS to increase the recorded value of the investment. This is a highly conservative approach to recording investments.
The alternative method of accounting for an investment is the equity method. The equity method is only used when the investor has significant influence over the investee. It is considerably easier to account for investments under the cost method than the equity method, given that the cost method only requires initial recognition and a periodic examination for impairment.
ABC International acquires a 10% interest in Purple Widgets Corporation for $ 1,000,000. In the most recent reporting period, Purple recognises $ 100,000 of net income and issues dividends of $20,000. Under the requirements of the cost method, ABC records its initial investment of $ 1,000,000 and its 10% share of the $ 20,000 in dividends. ABC does not make any other entries.
Traderson Co. purchases 10% of Bullseye Corporation for 2,000,000. At the end of the year, Bullseye announces it will be paying out a dividend of $100,000 to its shareholders.
When Traderson purchases the investment, it records the investment of Bullseye at cost. The journal entries may appear as follows, depending on Traderson’s investment strategy and history. It may classify the investment differently, depending on the type of marketable security it deems, but it will generally classify it as an asset.
At the end of the year, Traderson receives 10% of the $100,000 dividends (as Traderson holds 10% of Bullseyes shares)
See also: Disclosure of interest in other entities
Investment valued at cost Investment valued at cost
Investment valued at cost Investment valued at cost Investment valued at cost Investment valued at cost Investment valued at cost Investment valued at cost
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