Question 5-2

a. Evaluate the accounting for investments when holding between 20 and 50% of equity
securities of an investee from the view of an analyst of financial statements.
Answer:
Shareholding of an investor between 20 and 50% in an investee company represents a
significant influence type of shareholding. The investor that holds this portion of shares is
generally called as associate investor. Analyst of financial statement requires to use equity
method to evaluate accounting in this equity securities case. Under equity method, a
company reports the carrying value of its investment regardless of fair value movement in
the market. Red flag that an analyst must take note is hidden individual assets and liabilities
of investee company on investor’s financial statement because usually only the investor’s
share of net assets is shown. As a result, parent company can use equity method to hide
unfavorable figures from investors. For example, a low profit made by parent company can
be window-dressed by reporting high profits from its subsidiaries. On the other hand,
parent company can choose to not disclose subsidiary numbers if the numbers are going to
bring down the value of parent company.
b. When are losses in noncurrent security investments recognized? Evaluate the
accounting governing recognition of these losses.
Answer:
Losses in noncurrent security investments should be recognized at the end of accounting
period like other long-term assets. To analyze accounting of the losses incurred on long
term investment, it is important to identify the objectives behind these investments,
whether they are meant for trading or available for sale or held to maturity as in the case of
bond security investment. All motives in using these noncurrent security investments
require different accounting treatments and red flag can happen, especially when it involves
losses which is a negative signal to investors of a company. Management could use their
own judgement to use selective accounting rule to make the losses less noticeable.