Equity investment and subsidiary dividends

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prodigal

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Hello All,
Here’s a question;
A buys 25% of B and is following Equity accounting. B has net income of 20000 and gives out 3200 in dividends. I thought 1/4 of those 3200 dividends go to A since A has 1/4 ownership. But according to example 5 in Intercorporate Investments CFAI, 3200/4 is deducted from calculation of investment in B as shown in A’s account. Can anybody explain?
I am probably not reading something properly but is there ever a case/accounting method where subsidiary’s dividend payout actually benefits the investor?
Thanks,
P
 
I could be off base, but if they are using the Equity Method and taking 1/4 of the Net Income of the subsidiary then it would make sense to remove 1/4 of the dividend payment from the Net Income number. The dividends that the subsidiary is paying out will not be there for you to add company A’s financial statements.
 
Correct. With the equity method, the investment account on the financial statement of company A should be increased by the proportionate amount of company Bs net income and subtract the appropriate percentage of any dividends paid.
 
The subsidiary’s benefit payout DOES benefit the investor… they are receiving cash. The investment goes down because it is assumed that if you are using equity method you have significant control over the sunsidiary (including its dividend policy) - the offset is that the firm receives cash. The prop. share of the Net Income is still reported on the IS, but the dividends take away from the balance of the investment.
Therefore, if you can influence dividend policy you should report those dividends as a return of your capital instead of an increase in your income from the investment.
 
Ok so if you have significant control, deduct dividends from NI and then take your share of residual.
If you do not have sinificant control how do you deal with NI and dividends?
P
 
Well, if you don’t have significant control, then I suggest you should read up on how to account for securities using either HTM, AFS, or HFT.
Sort of tongue in cheek, but if you dont have “significant influence” (i meant influence above not control, apologies. Consolidation is used when you have control) than you cant use equity method. In that case, you dont care about the net income but would report the dividends as income
 
kwalew wrote:
The investment goes down because it is assumed that if you are using equity method you have significant control over the sunsidiary (including its dividend policy)
Click to expand...
You mean significant influence…if it is significant control, then you consolidate.
 
Yes, Dreary. Thanks - Significant influence = equity method, Control = Consolidation
 
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