Question

On January 4, 2020, Cutter Inc., bought 15% of Vekshyna Corporation’s common stock for $60,000. The following data concerning Vekshyna are available for the years ended December 31, 2020 and 2021:

                                    2020                2021

Net income                 $30,000           $90,000

Dividends paid            None             80,000

In its income statement for the year ended December 31, 2021, how much should Cutter report as income from this investment?

Answer 1

If the investor has 20% or more of the voting stock of the investee, this creates a presumption that, in the absence of evidence to the contrary, the investor has the ability to exercise significant influence over the investee. Conversely, if the ownership percentage is less than 20%, there is a presumption that the investor does not have significant influence over the investee unless it can otherwise demonstrate such ability.

When the company does not have significant influence over another company then it uses the cost method when its intention is to keep the asset for the long term.

In the given case scenario, Cutter Inc. bought 15% of Vekshyna Corporation’s common stock for $60,000. That means the Cutter Inc. does not have any significant influence over Vekshyna Corporation’s and the company has now held the investment for 2 years. Therefore, the Cost method can be used by the company.

Therefore, only the dividend income will be taken into consideration as the income for the year ended December 31,2021.

Therefore, total income to be reported = $80,000 * 15% = $12,000.