Question

Which one of the following varies between the equity, initial value, and partial equity methods of accounting for an investment?

Answer 1

Income recognition and reporting on the balance sheet are the main differences between the equity, initial value, and partial equity methods of accounting for an investment. The equity method recognizes income based on profit share, while the initial value method recognizes income from dividends, and the partial equity is a combination of both approaches.

Step-by-step explanation:

The method that varies between the equity, initial value, and partial equity methods of accounting for an investment is the way income is recognized and the investment is reported on the balance sheet. In the equity method, an investor recognizes income equal to their share of the investee's profits and adjusts the carrying value of the investment accordingly. With the initial value method, the investment is recorded at cost, and income recognition occurs only when dividends are received. The partial equity method is a hybrid, where the investment is initially recorded at cost and subsequently adjusted for the investor's share of profits, less dividends received.

Self-Check Questions on Early-Stage Corporate Finance

1. Very small companies tend to raise money from private investors instead of through an IPO due to the high costs and regulatory complexities associated with public offerings. These companies may not have the resources to meet these demands.
2. Small, young companies may prefer an IPO to obtain necessary capital for growth, gain market exposure, and allow early-stage investors to exit or diversify their holdings.
3. A venture capitalist typically has better information about a small firm's potential to earn profits due to direct involvement and access to internal operations and strategic plans, compared to a potential bondholder who generally has less detailed information.
4. In terms of corporate finance, a bond is similar to a bank loan in that they both involve borrowing funds that must be repaid with interest. However, bonds are traded on the public markets, which can provide broader access to capital and typically longer maturity terms than bank loans.

Calculating Equity in a Home

For example, Fred's equity in his new $200,000 house, after a 10% down payment, is initially $20,000. The rest of the purchase price, $180,000, is financed through a mortgage, which is a liability that will reduce Fred's equity until it is paid off.