Equity Method

[CFA_silverbullet]

Hi,
the equity method states that the investment is initially reported on balance sheet at cost and subsequently the profits/losses are reported in income minus dividends.
is the initial investment a negative item in balance sheet since it says it’s reported at cost? if possible, could someone please give a simple example, showing how the investment recorded on balance sheet and income statetion?
example:
company X bought 30% of company Y’s equity for 3 millions on 1/1/2013. company Y earned 1 million in 2013 and 2 millions in 2014. in addition, it paid 100,000 dividends in 2013 and 200,000 dividends in 2014. how’s company X’s balance sheet and income statement look like?
thanks.

 

[S2000magician]

CFA_silverbullet wrote:Hi,
the equity method states that the investment is initially reported on balance sheet at cost and subsequently the profits/losses are reported in income minus dividends.
is the initial investment a negative item in balance sheet since it says it’s reported at cost? if possible, could someone please give a simple example, showing how the investment recorded on balance sheet and income statetion?
example:
company X bought 30% of company Y’s equity for 3 millions on 1/1/2013. company Y earned 1 million in 2013 and 2 millions in 2014. in addition, it paid 100,000 dividends in 2013 and 200,000 dividends in 2014. how’s company X’s balance sheet and income statement look like?
thanks.

No. It’s no different than saying that when you buy a truck it’s reported at cost. Cash decreases (credit), Investment in Affiliate increases (debit).
When the affiliate earns net income, our share appears as a Revenue (credit) and an increase in Investment in Affiliate (debit). The Revenue increase becomes an increase in equity (credit) when net income is closed out to the balance sheet (Retained Earnings).
When the affiliate pays a dividend, Cash increases (debit) and Investment in Affiliate decreases (credit).

 

[CFA_silverbullet]

S2000magician wrote:

CFA_silverbullet wrote:Hi,
the equity method states that the investment is initially reported on balance sheet at cost and subsequently the profits/losses are reported in income minus dividends.
is the initial investment a negative item in balance sheet since it says it’s reported at cost? if possible, could someone please give a simple example, showing how the investment recorded on balance sheet and income statetion?
example:
company X bought 30% of company Y’s equity for 3 millions on 1/1/2013. company Y earned 1 million in 2013 and 2 millions in 2014. in addition, it paid 100,000 dividends in 2013 and 200,000 dividends in 2014. how’s company X’s balance sheet and income statement look like?
thanks.

No. It’s no different than saying that when you buy a truck it’s reported at cost. Cash decreases (credit), Investment in Affiliate increases (debit).
When the affiliate earns net income, our share appears as a Revenue (credit) and an increase in Investment in Affiliate (debit). The Revenue increase becomes an increase in equity (credit) when net income is closed out to the balance sheet (Retained Earnings).
When the affiliate pays a dividend, Cash increases (debit) and Investment in Affiliate decreases (credit).

Hi S2000magician,
why is Cash decreases a credit and Investment in Affiliate increases is a debit? i read the artilcle that you wrote, but i am still not very clear. could you please explain a bit more? thanks.

 

[S2000magician]

Assets normally have debit balances, as do expenses.
Liabilities, equity, and revenues normally have credit balances.
That’s just how double-entry accounting works.
So when Cash (an asset) increases, you debit Cash; when it decreases, you credit Cash.
When Investment in Affiliate (an asset) increases, you debit Investment in Affiliate; when it decreases, you credit Investment in Affiliate.
Debits always equal credits; every time you have a transaction that you record in the journal, you have debits and credits, and they balance for every transaction.