When a company invests in equity securities with 20% to 50% ownership in the investee’s voting stock

When a company invests in equity securities with 20% to 50% ownership in the investee’s voting stock, the investor can significantly influence the investee’s decisions. Group of answer choices True False

The correct answer and explanation is:

Correct Answer: True

Explanation:

When a company invests in the equity securities of another company and acquires ownership of 20% to 50% of the investee’s voting stock, it generally obtains significant influence over the investee’s operating and financial policies. This level of ownership is important because it often allows the investor to participate in decisions such as appointing board members, influencing strategic direction, and other key corporate activities.

Why is this True?

1. Definition of Significant Influence:
   • Significant influence means the power to participate in the financial and operating policy decisions of the investee, but it does not imply full control.
   • Control typically happens with ownership greater than 50%, but with 20% to 50%, the investor can still affect decisions significantly.
2. Accounting Treatment:
   • When significant influence exists, the investor uses the equity method of accounting for the investment.
   • Under the equity method, the investment is initially recorded at cost and subsequently adjusted for the investor’s share of the investee’s profits or losses.
   • Dividends received reduce the carrying amount of the investment.
3. Why 20% to 50%?
   • Less than 20% ownership usually means the investor is a passive investor, with little or no influence, and investments are generally accounted for as available-for-sale or fair value through profit or loss.
   • More than 50% usually indicates control, which requires consolidation of financial statements.
   • The 20%-50% range is recognized as the threshold where influence, but not control, typically exists.
4. Practical Implications:
   • Investors with significant influence may negotiate terms, appoint directors, or influence decisions such as dividend policy and investment plans.
   • This influence can affect the investee’s operations and financial results, which is why accounting standards require recognition of the investor’s share of profits or losses.

Summary:

Ownership of 20% to 50% voting stock typically means the investor can significantly influence the investee’s decisions, even if it does not have outright control. This level of influence has specific accounting and financial reporting implications, reflecting the investor’s role in the investee’s financial performance and governance.