Fair Value vs. Cost Method for Investments
- Graziano Stefanelli
- Jun 27
- 3 min read

The methods used to account for investments in other companies are crucial for accurate financial reporting, comparability, and analysis.
Two primary accounting approaches—fair value and cost method—are applied based on the nature of the investment and the level of influence or control the investor holds.
Fair Value Method: Overview and Application
The fair value method is the standard approach for accounting for most passive equity investments—typically those where the investor owns less than 20% of the voting shares and does not have significant influence over the investee’s operations. Under this method, investments are initially recognized at cost, but subsequently measured at their fair market value at each reporting date. Any unrealized gains or losses arising from changes in fair value are recognized directly in net income (under US GAAP) or, in some cases, other comprehensive income (under IFRS if the FVOCI election is made). This method provides investors and financial statement users with up-to-date information reflecting the current market value of investment holdings.
Accounting for Fair Value Changes
Changes in the fair value of investments are accounted for at each reporting date. For example, if the value of a company’s shares increases from one reporting period to the next, the unrealized gain is recognized in the income statement. Conversely, unrealized losses are also recognized immediately, impacting reported earnings. This real-time reflection of market changes enhances transparency but can also introduce more volatility into reported results.
Example Journal Entry (Unrealized Gain):
Dr. Equity Investments
Cr. Unrealized Gain on Investments (Income Statement)
Example Journal Entry (Unrealized Loss):
Dr. Unrealized Loss on Investments (Income Statement)
Cr. Equity Investments
Dividend and Interest Income under Fair Value Method
When an investor receives dividends (or interest, for debt securities) from fair value investments, the income is recognized separately from unrealized gains and losses. Dividend income is recorded when the right to receive payment is established, and does not affect the investment’s carrying value.
Cost Method: Overview and Application
The cost method is primarily applied to investments where fair value cannot be readily determined, and the investor does not have significant influence. Under the cost method, the investment is initially recorded at purchase price (plus any transaction costs) and is not remeasured to market value each reporting period. Instead, the carrying amount remains unchanged unless there is evidence of impairment or observable price changes from identical or similar investments.
Recognition of Income under Cost Method
Under the cost method, the investor recognizes dividend income only when cash dividends are received. Unlike the fair value method, there is no adjustment for changes in the underlying value of the investee unless the investment is sold or impaired. If impairment occurs and the decline in value is other than temporary, the investment must be written down to its estimated recoverable amount, with the loss recognized in earnings.
Example Journal Entry (Dividend Received):
Dr. Cash
Cr. Dividend Income
Example Journal Entry (Impairment):
Dr. Loss on Investment Impairment
Cr. Investment in Equity Securities
Transition between Cost and Fair Value Methods
Accounting standards require companies to reassess their ability to reliably measure fair value at each reporting date. If fair value becomes observable for an investment previously carried at cost, a remeasurement is required, and all unrealized gains or losses to date are recognized at that time. Conversely, if fair value becomes unobservable, companies may use the practicability exception under US GAAP to revert to the cost method with appropriate disclosures.
US GAAP vs. IFRS: Comparison of Methods
Under US GAAP (ASC 321), most equity investments without significant influence are measured at fair value with changes in net income, except where the practicability exception is applied. IFRS 9 requires equity investments to be measured at fair value, but companies can irrevocably designate at initial recognition certain investments as fair value through other comprehensive income (FVOCI), where gains and losses are never recycled to profit or loss. Cost is only used in rare circumstances where fair value is not reliably measurable.
Disclosure and Presentation Requirements
Both US GAAP and IFRS require clear disclosure of the measurement basis used for equity investments, along with the carrying amounts, fair values, and any gains or losses recognized. If the cost method is used, entities must explain why fair value is not reliably measurable and provide additional detail on the risks and uncertainties associated with such investments.
Summary Table: Fair Value vs. Cost Method
Feature | Fair Value Method | Cost Method |
Subsequent Measurement | Fair value at each reporting date | Historical cost (unless impaired) |
Unrealized Gains/Losses | Recognized in net income (US GAAP) or OCI (IFRS) | Not recognized |
Dividend Income | Recognized separately when declared | Recognized when received |
Impairment | Reflected immediately through remeasurement | Recognized only if decline is other than temporary |
Disclosure | Fair value hierarchy, methods, and risks | Justification for using cost, impairment info |
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