Meaning
Accounting standard dictates that long-term equity investments be recorded at their initial acquisition cost and adjusted only for impairment or dividend declarations. This cost method is applied under Chinese Accounting Standards for investments where the investor has control but prepares separate financial statements, or holds less than twenty percent voting power without significant influence. The application stops when the investor gains significant influence or joint control, necessitating a shift to the equity method.
Financial Measurement
Initial investment is measured at the cash paid or the fair value of the consideration given plus directly attributable transaction expenses. This cost method keeps the carrying amount of the investment stable over time regardless of the net assets of the investee. Any changes in the investee’s retained earnings do not affect the investor’s balance sheet under this accounting treatment.
Dividend Recognition
Distribution of profits by the investee is recognized as investment income by the investor in the period the distribution is declared. If the declared dividend exceeds the investee’s accumulated net profits generated after the acquisition date, it was historically treated as a recovery of investment cost, though modern guidelines treat all declared dividends as income. This recognition practice prevents the recognition of unrealized paper profits before they are formally distributed.
Impairment Assessment
Investors must conduct regular reviews of the investment’s carrying value to identify any objective evidence of permanent decline in value. When the recoverable amount of the investee falls below the recorded cost, the investor must recognize an impairment loss. This impairment charge cannot be reversed in subsequent periods, ensuring a conservative valuation on the balance sheet.
