On December 31, 2008 Company P invests $5,000 in Company S in exchange for 25% of the company. During 2009, Company S earns $2,000 and pays a dividend of $500. If Company P uses the equity method of accounting, what values will be reported on the balance sheet and income statement? How much cash will be recognized from the investment?
Balance Sheet Income Statement Cash A) $5,500 $0 $0 B) $5,375 $125 $125 C) $5,375 $500 $125
The answer was C, however, what i don’t understand is how the reported Income amount was 500, instead of the full NI. I thought that the equity method implies reporting the full NI amount on the investors balance sheet, same treatment with NI under the Acquisition Method…
Anyone know why only 500 of NI was reported instead of the full 2000 NI under equity method?
Because under the Equity Method you only report the % of income from the investment in associate that you owe (25%* 2000 = 500) on your income statement (not balance sheet). Under the acquisition Method you report all of it with a line of the minority ni (i.e the proportion not owed)
So basically when reporting NI under equity method, I should report 100% of NI in the Balance sheet, but only the proportional ownership of NI in the Income statement?
NI is shown on the Income Statement as a line item not on the Balance Sheet - It is added to the Balance Sheet when you are valuing the investment in associate.
Company A buys 20% of Company B for $10,000 and company B has NI of $1,000 - consequently Company A reports 20% of $1,000 ($200) on its Income Statement (Not Balance Sheet). Company B pays 0 dividends
If Company A wants to know the value of its investment in Company B at the end of the year, it will report on its balance sheet:
Initial investment + % of NI - % of Dividends
$10,000 + $200 - $0
So on the balance sheet the investment is worth $10,200
So I found a question from one of the FRA topic tests that contradicts the Qbank question i posted originally on how to treat Net Income using equity method. If you refer to FRA - Turner topic test, for question 1, it asks me to calculate the contribution of the equity portfolio to Foster’s Net Income.
In the Darnell Inc. Investement, it is an investment associates classified ownership (40%), so we use equity method. However, in the answer, it shows the FULL net income being included in the Income effect. I do not understand why… I thought that it was the proportional amount of ownership (40%*(NI-Dividends) = contribution to Income effect).
Does anyone know why? In schweser notes, it explains that NI should be reported at 100% under other both equity method and acquisition method. I feel like im missing some sort of distinction on when to include 100% NI vs. %ownership*(NI-Div)…
Ignore what you find in Schweser or BPP and go with what you find in the CFAI curriculum.
Maybe you should send a message to S2000… he can clear this up. But i am 100% sure under the equity method you report %ownership * NI form associates on the Income Statement a nd deduct %ownership * Dividends from assets on the Balance Sheet
I use schweser and I can tell you with certainty that schweser tells you only to report the proportionate share of Net Income. The proportionate share of net income increases the balance sheet investment account and then it is reduced by the proportionate share of dividends - nothing outside of the investors proportion is included with equity method. The net income is also recognized in the income statement and I am pretty positive that the dividends are NOT included in the income statement (disclaimer: I could be wrong about the dividends)
I just looked at the Turner topic test and $15,000 was included because it was listed as “the proportionate share of Darnell’s net income” … This alone ascertains that only the proportionate share should be included. If you look at the last row in the table this distinction is given in the Turner case.