On January 1, 2016, Dermot Company purchased 15% of the voting common stock of Horne Corp. On January 1, 2018, Dermot purchased 28% of Horne's voting common stock. If Dermot achieves significant influence with this new investment, how must Dermot account for the change to the equity method?

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Business

Vaughn Ballard

25 April, 05:11

On January 1, 2016, Dermot Company purchased 15% of the voting common stock of Horne Corp. On January 1, 2018, Dermot purchased 28% of Horne's voting common stock. If Dermot achieves significant influence with this new investment, how must Dermot account for the change to the equity method?

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Annika Ritter · Answer 1

Answer: it must use the equity method for the 2018 financial year but should not make any changes to the 2016 and 2017 financial years.

Explanation:

When Dermot purchased 15% of voting stock in Horne Corp it had just made an investment and had no control over this business or its operations. The normal method of recording an investment (debit. investment and credit. bank) applies. But when he acquired a further 28% in Horne Corp he had a total of 43% (15% + 28%) share in Horne Corp. When a company owns between 20% and 49% of another company, they have significant influence over this company and this company becomes their associate. This means Horne Corp is now Dermot company's associate.

When an associate exists the equity method of recording this investment needs to be used. However the equity method is only applied when the investment becomes an associate and lasts for as long as this investment is an associate. This mean that Dermot will use the normal method of recording an investment for the 2016 and 2017 financial years, and change to the equity method in 2018, when an associate exists.