Question

How are the dividends declared and paid by a subsidiary during the year eliminated in the consolidated workpapers under each method of accounting for investments?

Answer 1

A company is considered a subsidiary of another if that second company, the parent, exerts substantial or total control over the subsidiary. The exact relationship and the accounting methods they use directly affect how the parent treats subsidiary dividends. The three applicable methods are the equity method, the fair-value reporting option of the equity method, and the consolidation method.

1. Dividends Receivable

2. Equity Method

3. Fair Value Option

4. Consolidated Method

1. Dividends Receivable

The companies with relatively small investments in other companies, the dividend payout are treated as income. The company receiving the payment books a debit to the dividends receivable account, and a credit to the dividend income account for the payout

2. Equity Method

The equity method applies when the parent company owns 20 to 50 percent of the subsidiary's common stock. The parent must have substantial influence upon the subsidiary for the equity method to apply. The parent company books the purchase cost of the subsidiary's common stock by debiting the investment in the subsidiary account and crediting the cash account

3. Fair Value Option

The Financial Accounting Standards Board created the fair value option to the equity method in 2007. It has several accounting consequences, but most require the parent company to value its investment in a subsidiary at its current fair market value. That value is usually the trading price of the subsidiary's stock

4. Consolidated Method

The financial reports are consolidated when the parent owns the majority of the subsidiary's stock. Consolidation is a complex accounting process that melds together all of the interaction between the parent and subsidiary.