This is what I got from the Notes. If a Company P (“P”) invest 30% in company S (“S”) for $1,000 and S reports a 400 profit and dividend of 100 calculate P’s B/S, I/S, CF for cost and equity method. Cost Method: Balance Sheet: 1,000 Investment in S Income Statement: 30 (100 x 30%) Cashflow Statement: 30 (100 x 30%) Equity Method: Balance Sheet: 1,090 (1000+120-30) Income Statement: 120 (400 x 30%) Cashflow Statement: 30 (100 X 30%) My question is how come the dividend is not recorded in the Income Statement for the equity method. In the Notes, it just says under equity method dividends are under CF. However, on the B/S, you’ve got an entry on the Asset side of 1,000 in Investment in Company S + % of S’s income - % of S’s dividend. On the Equity (RE) side you have an increase in 120 (from the +120 in I/S). What about the “minus dividend” portion? As of right now, the B/S isn’t balanced. Where do you balance the -30? Don’t you decrease the -30 in the I/S as well? and therefore recording a -30 in RE?
Your cash will increase by 30 because of the inflow of dividends. So cash increases by 30, investment increases by 90 and retained earnings increases by 120.
So… the dividend doesn’t go into P’s I/S? Just to clarify. On Schweser Book 2 page 17 it gives the above example. It explains it as: “At the end of 20X6, the carrying value of Company S on Company P’s balance shet will be $1,090 (1,000 original investment + 120 proportionate share of Company S net income - 30 dividend received).” When it says “carrying value” does it mean the entry of “Investments in Assets” in P’s B/S? Or P’s balance sheet as a whole. If it means balance sheet as a whole then the $30 dividend received will, like what idreesz said, increase the cash account by 30 thereby ending the balance sheet with 1,120. So I guess furthering my question is that what do they mean when they say “carrying value” b/c a lot of problems will ask “what is the value of XYZ Parent’s balance sheet from its investment in Sub ZYX at the end of 20X0” If they don’t mean specifically the Investment in Company entry, then the balance sheet would be 1,120 and not 1,090. Right?
No the dividend does not go to the income statement. The entry will be to debit cash and credit Investment in Assets. Carrying value means the value of the investment in assets. “If they don’t mean specifically the Investment in Company entry, then the balance sheet would be 1,120 and not 1,090. Right?” That is correct.
Ah~~ Thanks for the response. Another question. (My accounting basics is really bad so bear with me here). Examples like the one above from Schweser is assuming you are combining both the Sub’s and the Parent’s financial statement together. Like when Schweser gives the example of “Acquisition Method” and Equity Method" and comparing these two side by side, the financial statements they mean is: 1) how the combined parent’s and sub’s financial statement will look like under the Acquisition Method and, 2) how the combined parent’s and sub’s financial statement will look like under the Equity Method and, So there is the parent’s own financial statement, the subsidiary’s own f/s and a “combined” f/s (and it’s either combined together under the equity or acquisition method)? And what they mean is usually the combined financial statement and not the parent’s own financial method before the “combining?” Man… I feel like I’m on a totally different boat … like I’m on a cruise but just realized I’m on an entirely different cruise liner.
Yes, you are perfectly correct on this. It is the combined financial statements under acquisition method that are compared with the combined financial statements under equity method or any other method. No need to be upset Joe, still a lot of time for review and consolidation. Last 10 days may be worth more than prior 1 whole month in terms of gaining confidence.
Thanks man.