In the book FSA page 25: " under the equity method, investment income is a function of the earnings of teh ivnestee and is independent of the dividend of dividends received. " => the amount paid out as dividend will be a negative entry in the “Investment in Company S” account. However, i had this question: A was in a good financial shape in 2003, with assets of 50 mil at the beginning of the year. that year, it earned $3 million in net income and was easily to maintain its traditional 50% dividend payout ratio. B is the parent company with less than 20% control. Q: in 2003, B should reflect its investment in A on its income statement bny recording: A: 300,000 B: 900,000 C:-200,000 D:600,000 A: D: under the equity method, income will be $3mil * 0.2=600,000; the divdends received by B are already included as part of its share of A’s net income in the equity method. I am confused here , would that be 0.2 * 1.5 mil ( net income - dividend ) in the “Investment in A” in the income statementas described in the example in the book ?? thanks!
The investment is S is a feature of the balance sheet not the income statement. The BS will be (% owned * (NI - Div)) IS will be (% owned * (NI)) and cash flow will just be (% owned * Dividend)
oh yeah, didnt see the income statement… thanks!
Why use the equity method and not available for sale, given that the parent owns less than 20% and no where is it mentioned that the parent has significant control?
With less than 20% control and no influence, it should carry by cost (BS) and income (IS) is dividend only… shouldn’t it be 3m x .2 x .5 = 300,000 ? (A) ???
Yes it should be A. what is the answer?
Obviously, the question rmust ead "has 20% " , not “has less than 20%” to be answerable. Can you figure out why?
Yes, whether B control “20%” or “less than 20%” is critical. If it is 20%, equity is applicable; if less than 20%, must use cost method. Under cost method, historical investment cost on A is recorded on BS, unless A’s dividend is more than its earning in that year. If B has 20% of A, I support answer A.
Well you know it has to be 20%, because whether its 20%, 5%, or 100% you need a specific percentage ownership or you can’t answer the qustion, and the 20% is the only percentage given. Even under cost with a net income and payout ratio, you can’t know your dividend incoem if you don’t know what % of shares you own.