The way you account for an investment differs based on whether you use the Fair Value Method or the Equity Method to account for the investment.
The Fair Value Method is used when the investor owns less than 20% of the equity of the investee. The Equity Method, on the other hand, is used when the investor has significant influence over the investee. The investor is presumed to have significant influence when it owns 20% to 50% of the investee’s equity.
Here is how these two methods differ with respect to their effect on the investor’s income:
With the Fair Value Method, the investor’s pretax income will be affected by (1) unrealized gains or losses for its investment and (2) any dividends it receives from its investment.
With the Equity Method, the investor’s pretax income will be affected by the investor’s proportionate share of the investee’s net income or net loss.
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