Investments in Equity Securities

http://ccba.jsu.edu/accounting/EQUITYINV.HTML

A. The Cost Method

The accounting for investments is based on the amount of control the investor has on the company acquired. If the investor does not have significant influence (i.e, owns less than 20% of the stock), investments are accounted for using cost with year-end adjustements to fair value. Dividends received are recorded as dividend revenue.

Example:

On January 1, we acquire 10% of the stock of ABC, Inc. at a cost
of $100,000.  On December 31, ABC reports a net income of $40,000
and declares and pays a dividend of $20,000.  At December 31, our
investment is worth $110,000.

The following entries are required:

                                             Debit    Credit
                                            -------  -------

   1/1    Investment in ABC                 100,000
             Cash                                    100,000

   No entry for the net income


   12/31  Cash ($20,000 x 10%)                2,000
             Investment Revenue                        2,000

   The investment account would also be adjusted to its market value
   of $110,000 on December 31.

B. The Equity Method

The equity method assumes that the investor can exercise significant influence over the company. This is normally presumed when the investor owns more than 20% of the stock.

When the company reports their income/loss, the investor reports their share of the income/loss as an increase/decrease in the investment account. When the company declares a dividend, the investor reduces the amount of their investment account for the amount of the dividend. No fair-value adjustment is made at year end under the equity method.

  Example:

  On January 1, we acquire 30% of the stock of ABC, Inc. at a cost
  of $300,000.  On December 31, ABC reports a net income of $40,000
  and declares and pays a dividend of $20,000.

  The following entries are required:

                                             Debit    Credit
                                            -------  -------

   1/1    Investment in ABC                 300,000
             Cash                                    300,000

   12/31  Investment in ABC ($40,000 x 30%)  12,000
             Revenue from Investment                  12,000

   12/31  Cash ($20,000 x 30%)                6,000
             Investment in ABC                         6,000