What is intercorporate investing?
Intercorporate investing can occur when one company makes any investment in another company. These types of investments can be accounted for in different ways depending on the investment.
Generally, the broadest and most complete way of accounting for this type of investment is through the percentage of ownership interest.
- Intercorporate investments refer to any investment that a company makes in another company.
- Accounting for intercompany investments is based primarily on the amount of property that comes with the investment.
- Accounting by ownership is generally segmented into three classifications: passive minority, active minority, and controlling.
Understanding Intercompany Investments
Intercorporate investing occurs when a company makes an investment in another company. Broadly speaking, there can be three categories to classify an intercorporate investment, which can help guide and dictate the accounting treatment used. The three categories generally include: passive minority (less than 20% owned), active minority (20% -50% owned), and majority stake (more than 50% owned). These classifications are general divisions, but companies should also refer to the Accounting Standards Codification (ASC), specifically ASC 805, which details Generally Accepted Accounting Principles for business combinations. Companies can deviate from the top three classifications based on participation controls.
There can be a variety of ways in which a company can choose to make an intercorporate investment. It could be through the purchase of shares of a publicly traded company or a privately negotiated deal for a share of an unlisted company. Investing may also involve purchasing debt from another company, publicly traded or otherwise. The majority interest of a company will normally come from a merger or acquisition.
Types of intercompany investments
Here are some additional details on each of the three classifications for intercorporate investments:
Passive minority: Minority liability includes investments that lead to less than 20% ownership in a company. This can cover a wide range of investments, including debt, because property and voting rights are rarely offered with debt investments. When a minority passive interest is taken, the investment is treated in basically the same way as other securities owned by the company for investment purposes.
Active minority: Minority asset encompasses investments that lead to 20% -50% ownership. In this segment, companies usually use the equity method. This is an important segment because many companies make a significant ownership investment in another company, but do not necessarily want to consolidate the business with consolidated financial statements as required with a majority interest. Taking a 20% to 50% ownership interest offers many opportunities for things like joint ventures, as well as off-balance sheet reporting.
Controlling interest: Companies that have a 50% or more ownership interest in another company should generally use the consolidation method. The consolidation method requires companies to combine their financial reports and present consolidated financial statements. At the top level, this requires a comprehensive balance sheet, an income statement, and a cash flow statement with integrated results.
Intercompany investment accounting
The ownership interest in an intercorporate investment helps provide a general guide to the methodology used in accounting for investment in a company’s finances. In general, there are three main methodologies that correspond to the three broad investment classifications. Note that debt investments generally do not come with an ownership interest or voting rights.
The cost method can be used widely because it covers a wide range of investments that are tied to an ownership interest of less than 20%. Investments in intercompany debt are typically accounted for using the cost method because the debt often does not have ownership rights or voting power.
Within the cost method, there may also be a greater delimitation of investments. These investments will generally be treated in basically the same way as other company-owned securities for investment purposes. Securities may be designated as held to maturity (bonds), held for trading (bonds and stocks), available for sale (bonds and stocks), or strictly held on the balance sheet at designated fair value.
In the equity method of accounting, the initial investment in the target company is recorded on the balance sheet. The value of the investment is adjusted based on the percentage of profit or loss for the owner. Dividends are not recorded as income. Rather, dividends increase cash and reduce the value of the investment to the investor.
Goodwill can also be associated with investments when using the equity method. If the investor pays more than the book value of the investment, the target company may recognize goodwill for the difference.
Having a 50% or more interest in the ownership of another company generally requires the consolidation method. With the consolidation method, companies must combine their financial statements into consolidated financial statements. The consolidation method is common after a merger or acquisition.