This memo serves to answer your query regarding the proposed investment of our company in the Series A Preferred Stocks of Pills-R-Us.
The purchase of such preferred shares will have to be recorded in our books as an investment. The equity method of accounting for investments, in this case, cannot be applied. The following details the Financial Accounting Standards Board (FASB) statements on the subject:
· FASB Interpretation No. 35, Criteria for Applying the Equity Method of Accounting for Investments in Common Stock (An Interpretation of APB Opinion No. 18) issued in May 1981 clearly specifies that the equity method can be applied only to common stocks.
With the advent of more sophisticated investment products and alternatives, some rules have begun to be questioned as to applicability. As an example of these cases, there have been issues raised to favor the application of the equity method in recording preferred shares, especially when such shares give the holders thereof significant influence in the management of the company. Details were all documented in the following summary:
· EITF Issue No. 02-14: Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock. Prepared on August 26, 2002, this document presents views of various sides without giving any conclusion and without arriving at any decision on the matter.
Many objections have been published against this, though, and to-date has not yet been promulgated as a new standard rule.
For your information.
(Sgd) Thomas Smith
Financial Accounting Standards Board. (1981). FASB Interpretation No. 35. Criteria for Applying the Equity Method of Accounting for Investments in Common Stock. Retrieved October 22, 2008 from http://22.214.171.124/pdf/fin%2035.pdf.
Accounting Research Manager. (2008) FASB Emerging Issues Task Force. Retrieved October 22, 2008 from http://fars.accountingresearchmanager.com/wk/rm.nsf/c2b0ddf05404e5ad072564d5007e122b/088e57001a8a381586256c29005d927b?OpenDocument&rnm=120454.