In short
The equity method is used for investments that give significant influence (usually 20% to 50% of voting stock). The investor records its share of the investee's income as income and increases the investment; dividends received reduce the investment.
Key takeaways
- Any excess paid for depreciable assets above book value is depreciated through investment income.
- Dividends are not income under the equity method.
- Significant influence can exist below 20% (for example, board representation) or be absent above it.
Example
A 30% investor in a company earning $200,000 and paying $50,000 of dividends records $60,000 of income and a $15,000 reduction for dividends.
Where it's tested
FAR: Investments (Debt & Equity Securities) — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
An investor owns 30% of an investee and applies the equity method. The investee reports net income of $200,000 and pays dividends of $50,000. What is the net increase in the investment account?