Question

An investor company owns 40% of the outstanding common stock of an investee company, which allows the investor to exercise significant influence over the investee. The Equity Investment was reported at $750,000 as of the end of the previous year. During the year, the investor received dividends of $80,000 from the investee. The investee reports the following income statement for the year:Revenues - $2,400,000 Expenses - 1,800,000 Net income - 600,000 Other comprehensive income - 100,000 Comprehensive income - $700,000 a. How much equity income should the investor report in its net income (i.e., as part of the current year income statement)? $ 0 b. What amount should the investor report for the Equity Investment in its balance sheet at the end of the year? $ 0

Answer 1

Answer:

a. How much equity income should the investor report in its net income (i.e., as part of the current year income statement)?

• $280,000

b. What amount should the investor report for the Equity Investment in its balance sheet at the end of the year?

• $950,000

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