# Equity Method & treatment of dividends

Using the equity method, we report in our NI our proportionate share of the NI of the company we have acquired part of. However, if the acquired firm pays dividend, don’t we exclude that amount from the share of NI we included in our books? how do we treat this dividend? thanks.

Here’s the Q… Company X owns 15 percent of company S and exerts significant control over the operations of the company. The book value of the investment on December 31, 2001, is \$48,000. In 2002, company S earned \$100,000 and paid dividends of \$20,000. The impact of the investment on the income statement of company X is: A) \$3,000. B) \$12,000. C) \$15,000. D) \$0

Are you reffering to equity method for a company acquired? Please clarify. Where the proportion of investments warrants the use of the equity method: 1. You are right with the treatment of the NI for revenue recognition purposes 2. Dividends come in when you have to determine the value of the investment in your books. Here you deduct dividends from your portion of the Net Income and add it to the book value of the investment. Please revert if you need further clarification…

Yes Change in investment a/c ( equity mtd ) = ( NI - dividend ) * proportion =(100,000-20000)*.15 =12000

The answer is C. This looks like a question from Pro

i’m sorry…i’m wrong dividend has no effect on the income statement using the equity mtd… but i guess if the change in investment is asked, it does have an impact

grace grace Wrote: ------------------------------------------------------- > Are you reffering to equity method for a company > acquired? Please clarify. > > Where the proportion of investments warrants the > use of the equity method: > > 1. You are right with the treatment of the NI for > revenue recognition purposes > > 2. Dividends come in when you have to determine > the value of the investment in your books. Here > you deduct dividends from your portion of the Net > Income and add it to the book value of the > investment. > > Please revert if you need further > clarification… ok so from what you’re saying, dividends are only a concern when we are asked to determine the effects on the income statement, whereas on the investment books we disregard the dividends? FSA isn’t my fav. topic period!

…on the contrary…under the equity method dividends don’t feature on the income statement they feature on the balance sheet when you have to calculate the value of the investment - this is book value. Tell me I did not read right… if FSA is not for you, then indeed level II can be an issue…I should think

No, No, No. On the Income statement, you can forget about dividends Income (from acquired company) = % share of ownership * Net Income (of acquired company) The only reason we care about the dividends is so we can allocate the income from the acquistion between an increase in cash (= % share of the dividend) and investment in the acquired company (= % share of (net income of acquired co. - dividend) on the balance sheet. (We assume the non-dividend income stream is reinvested into the acquired company). So to apply to Usif’s example: Income from S = 15% * 100k = 15k But we need to allocate that 15k between an increase in cash and investment in S So on the balance sheet: Cash increases by share of dividend = 15% * 20k = 3k The rest is allocated to “Investment in S” = 15% * (100-20) = 12k

for equity method: Balance sheet: %(NI-Div) Income statement: %NI Cash flow statement: %div shouldn’t it go this way?

> So to apply to Usif’s example: > > Income from S = 15% * 100k = 15k > > But we need to allocate that 15k between an > increase in cash and investment in S > > So on the balance sheet: > > Cash increases by share of dividend = 15% * 20k = > 3k > > The rest is allocated to “Investment in S” = 15% * > (100-20) = 12k so overall assets go up by 15k? just divided into a cash account and investment account?

I think the B/S will be different. In the B/S the amount that is paid as dividends will increase your cash and decrease your investment in the holding company. Can some1 please clarify this.

Under the equity method the investment on your BS is adjusted as follows: Original investment (cost) + %share of NI - %share of Dividends Dividends under the equity method are considered a return of your original investment instead of additional income. Your cash would increase by the %share of Dividends that you received.

yes, now i remember that is correct wanderingcfa…mucho gracias