I am looking at #1, page 56 Cinnamon has a 19% passive stake in Cambridge. In the table provided, Cambridge has a net income of 40, and pay 20 in dividends. The question asks us: Cinnamon’s ebit includes a contribution from its investment in Cambridge of A) 2.5 B) 3.8 C) 5 The answer is B, the explanation is: Dividends from equity securities that are classified as available fore sale are included in income when earned ******* Here is my question: the table says that Cambridge PAID a dividend of 40, NOT RECEIVED A DIVIDEND OF 40. Why does Cinnamon add to it ebit money that Cambridge PAID in dividends? If Cambridge received a dividend, and Cinnamon owned 19% of Cambridge, I can understand why Cinnamon would receive a % of those dividends. Or, perhaps is it a net number? Cambridge’s Net income was 40, and they paid 20 in dividends, so Cinamon receives 19% of that net number. Thanks in advance to anybody who responds.
> Or, perhaps is it a net number? Cambridge’s Net > income was 40, and they paid 20 in dividends, so > Cinamon receives 19% of that net number. > Bingo.
I think this is a simple investment and in a simple investment the investor only accounts for the actual income received, that is, the divends received. So it has to be 19% of 20
Faffy2009: that fact pattern provides: “Dividends paid is 20.” Does that mean that Cambridge Processing paid 20 or received 20? If they received 20, I understand that 19% of 20 is 3.8 If they paid 20, why would the dividends paid affect Cinnamon, who owns 19% of Cambridge?
Cinnamon has a 19% investment in Cambridge and Cambridge paid 20 of its 40 income in dividends. Since Cinnamon has a 19% investment in Cambridge they, Cinnamon, will receive 19% of those dividends paid by Cambridge, ie, 19% of 20.
I think the key to the question is the ownership percentage. If it was higher, you would recognize your proportion of the net income rather than the percentage of the dividends paid. Inherently, always a potential earnings adjustment from an analysis perspective as one more percentage ownership allows for earnings of an additional 3.8.
To clarify, the first step to accounting for investments is do determine the appropriate recognition. As a general rule, consolidation occurs for investments in which a controlling interest is present (+50%). The equity method is used when there is significant influence, but not control (20%-50%). For investments with little or no influence (e.g., ‘passive influence’) refer to the accounting treatment for available-for-sale securities. In this example, the income is the dividend received: 3.8 [.19 x 20] If the investment was 20 percent, the income would be proportional earnings: 8.0 [.20 x 40]