Question

Explain what method is used to account for investments in equity securities with 20% to 50% ownership. Briefly describe how dividends received and share of net income are accounted for under this method

Answer 1

Accounting method is determined by the amount of control of and influence over operating decisions the company purchasing the stock has over the company issuing the stock. If the investment is

• less than 20% - Investment valued using Fair value method/ Cost Method
• 20% - 50% - Investment valued using Equity Method
• 50% or more - Investment valued on Parent's books using Cost Method or Equiy Method(Investment eliminated in Consolidation)

Here I will be explaining the method used to account for investments in equity securities with 20% to 50% ownership - EQUITY METHOD

Here investor has significant influence ie, some sort of control in the company.

Record investment at cost ( ie purchase value) and subsequently adjust the amount each period for

• the investor's proportionate share of the earnings (losses) and
• dividends recieved by the investor

Under this method no entry is passed when the share value goes up/down( as in fair value method)

Let me show the accounting treatment with the following example

1. Imagine an Investor purchased 30% of ABC Company for 100,000

Equity Investment             100000

                      Cash                       100000

2. Assume ABC Company earned 200,000 in net income

Equity Investment                       60000            (200000 x 30%) since only 30% share is there

                     Investment Income          60000

( The net income will increase the investment a/c. When there is a loss; the loss account is debited and equity Investment account is credited)

3. Assume ABC Issued 40000 as Dividend

Cash                              12000              (40000 x 30%) - since only 30% share is there

            Equity Investment         12000

( here investment account is credited because the 12000 dividend recieved is already accounted in the net income recieved by the comany ( in the second entry). Remember, dividend is comming out of revenue. And if we are crediting the dividend revenue account, then it will account the income twice )

If you have any question or clarification needed please let me know. I will reply as soon as possible.

Thank You!