Cost Method Definition

Forex Glossary

Definition

The word cost method identifies to a accounting procedure utilized when an investor gets passive curiosity about yet another firm. In training, the price process can be employed when an investor (employer ) won’t possess a controlling interest or is not able to exert substantial influence on the investee, but has generated a lasting investment in the corporation.

This bookkeeping method requires businesses to report and carry the investment in cost until disposed , or if it’s evident that historical price is not any longer warranted.

Explanation

Unlike marketable securitiesthat can be short-term investments, an ownership interest in an alternative business represents a longterm investment. Broadly speaking, ownership falls in to three categories: restraining interest, significant sway, and also passive interestrates. When a business holds less than 20 percent of their investee’s unemployment rate, or can’t exert substantial impact on the decisions produced by the investee, the longterm investment has been categorized as passive attention.

When an organization has passive attention, or can’t exert considerable influence on the following, it’s crucial to make use of the cost approach to bookkeeping. This system requires the buyer (employer ) to list the first investment in cost on the balance sheet, and then keep to transport that investment in cost before stocks of stock are partly or completely sold. Adjustments to the carrying value also needs to be made in case it’s evident that initial cost is not any more a justifiable price. As an instance, the investee may possibly announce a liquidating dividend.

The price system also pertains to passive investments in the equity securities of closely held businesses which don’t need thinly traded stock, since those nonmarketable securities usually do not need a distinctly determinable value until sold.

Example

On January 1, Company A acquired 100,000 shares of Company XYZ’s common stock for about $20.00 each share. This acquisition represented 4.0percent of their voting stock of Company XYZ. The journal entry to record that the first investment from Company XYZ will function the Following:

Debit Credit
Long-Term Investment at Company XYZ $2,000,000
Cash $2,000,000

At year end, Company XYZ reported earnings of $4,000,000 and also paid a dividend of $0.50 per share. Under the cost method, Company A doesn’t produce a change to the worth of Company XYZ. The sole journal entry demanded under this Procedure is one that displays the payment of this dividend ($0.50 per share x 100,000, or $50,000):

Debit Credit
Cash $50,000
Revenue from Investment $50,000