Answer:
a. How much equity income should the investor report in its net income (i.e., as part of the current year income statement)?
b. What amount should the investor report for the Equity Investment in its balance sheet at the end of the year?
Explanation:
Since the investor company uses the equity method, the journal entry to record the purchase of the stock should be:
Dr Investment in XYZ company 750,000
Cr Cash 750,000
When the dividends are received, the following journal entry is made:
Dr Cash 80,000
Cr Investment in XYZ 80,000
At the end of the year, the investor must report:
Dr Investment in XYZ 280,000 (= $700,000 x 40%)
Cr Revenue on investment in XYZ 280,000
Dividends are not considered income when you use the equity method, they only reduce the value of the investment.
Value of the investment account = $750,000 - $80,000 + $280,000 = $950,000
