cost method

Record the investment at "cost"
General rule:
leave it on the books at cost. The investment remains on parent's books at cost . Record income at the parent level only when sub declares a dividend
Generally, the sub's income does not affect parent's investment account balance. However, the parent can not ignore the sub's losses; Parent writes-down investment only if value has been impaired; Write-downs result in a NEW cost basis
The cost method can be written down -- but never written up
                            Investment Account



Used when the investor lacks the ability either to control or to exercise significant influence over the investee

Accounting procedures:
The cost method is consistent with the treatment normally accorded non-current assets
At the time of purchase, the investor records its investment in common stock at the total cost incurred in making the purchase
The investment continues to be carried at its original cost until the time of sale
Income from the investment is recognized as dividends are declared by the investee
Recognition of investment income before a dividend declaration is inappropriate

ABC Company acquires 20 percent of XYZ Company’s common stock for $100,000 at the beginning of the year but does not gain significant influence over XYZ. During the year, XYZ has net income of $60,000 and pays dividends of $20,000. ABC Company records the following entries:

Dr:Investment in XYZ Company Stock    100,000
Cr:Cash                                                              100,000
      Record purchase of XYZ Company stock.
Dr:Cash    4,000
Cr:Dividend Income        4,000
      Record dividend income from XYZ Company stock: $20,000 x 0.20.

Declaration of dividends in excess of earnings since acquisition
Liquidating dividends: Dividends declared by the investee in excess of its earnings since acquisition by the investor from the investor’s viewpoint
The investor’s share of these liquidating dividends is treated as a return of capital, and the investment account balance is reduced by that amount.
These dividends usually are not liquidating dividends from the investee’s point of view.

Acquisition at interim date
Does not create any major problems when the cost method is used.
Potential difficulty: liquidating dividend determination

Changes in the number of shares held
Changes resulting from stock dividends, stock splits, or reverse splits receive no formal recognition in the accounts of the investor

Purchases of additional shares
Recorded at cost similar to initial purchase
New percentage ownership is calculated to determine whether switch to the equity method is required

Sales of shares
Accounted for in the same manner as the sale of any other noncurrent asset