When an investor purchases stock in a company, the stock's market value may go up or down due to market conditions and the health of the business. Most stocks fluctuate in value, so accountants don't record the change in value. However, if a stock permanently declines -- that is, it goes down and the investor doesn't think it has a chance of going up again, the accountant must record the change as a loss against the investor's income.
Loss to Income
In most cases, decline to an equity security's market value is not recorded as an adjustment to the investment. However, if the security falls below market value and an accountant believes the decline to be permanent, the equity security should be listed as its fair-market value, and the decline of the security should be listed as a loss against income.
Determining whether a decline is permanent can be somewhat subjective. However, the Accountants' Handbook says that if an investor is unable to recover the investment's carrying value, or the amount the investor originally paid for the security, or if the investment's history shows decline and losses, the accountant may consider the decline to be permanent.
Using Equity Method
The equity method of accounting is only one method of accounting for shareholders' equity in the financial statement. Accountants must use this method if the investor has influence over the investee company's financing and operations. If the investor holds a significant number of shares of stock in the company -- usually between 20 and 50 percent of voting stock -- the investor is considered to have influence over the company, and the investor's accountant uses the equity method to account for stocks.
The equity method records transactions in a manner that shows the relationship between the investor and the investee. The accountant usually maintains two separate ledgers. One ledger lists the balance of assets and liabilities for the investment account and the other ledger is a statement of investment income. If an investment goes into permanent decline, the accountant lists the loss on the statement of investment income and lists the asset's market value as the asset amount on the balance sheet.
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