Under the equity method of accounting, investors have significant influence over an investee and must account for their investment accordingly. This method requires the investor to recognize their share of the investee's profits or losses in their financial statements. However, not all changes in the investment account lead to a decrease in value. Let's explore which factors do not cause a decrease in the investment account under the equity method.
One factor that does not cause a decrease in the investment account is the recognition of the investor's share of profits from the investee. When the investee generates profits, the investor will record their portion of these profits as income on their financial statements. This increase in income does not lead to a decrease in the investment account but rather reflects the investor's share of the investee's success.
Similarly, the distribution of dividends by the investee does not result in a decrease in the investment account under the equity method. When the investee distributes dividends to its shareholders, including the investor, the investor will receive their share of these dividends. This distribution is not considered a decrease in the investment account but rather a return of capital to the investor.
Mark to market (MTM) is a method of measuring the fair value of accounts that can fluctuate over time, such as assets and liabilities. However, changes in the fair value of the investee's assets or liabilities do not directly impact the investment account under the equity method. The investment account is based on the original cost of the investment and adjustments for the investor's share of profits or losses, not changes in the fair value of the investee's assets or liabilities.
Leverage results from using borrowed capital as a source of funding when investing to expand a firm's asset base and generate returns on investment. While leverage can impact the overall financial position of the investor, it does not directly cause a decrease in the investment account under the equity method. The investment account is primarily affected by the investor's share of profits or losses from the investee, regardless of the investor's use of leverage.
Net worth is the value of the assets a person or corporation owns, minus the liabilities they owe. Changes in the investor's net worth do not necessarily lead to a decrease in the investment account under the equity method. The investment account is based on the investor's original cost of the investment and their share of the investee's profits or losses, rather than changes in the investor's overall net worth.
In conclusion, the recognition of profits, receipt of dividends, changes in the fair value of the investee's assets or liabilities, leverage, and changes in net worth do not directly cause a decrease in the investment account under the equity method. Investors should carefully analyze these factors to understand the impact on their investment accounts and make informed decisions regarding their investments.
