According to the case under discussion, Company F purchased 40% of Company K on June 30, 20XX. The primary question is how Company K should account for investments made to Company K. Before accounting for the costs of investment, dividends, and income of Company F, Company K should identify the appropriate accounting method. According to Tuovila (2021), when one company has a significant influence on the other company (owns between 20% and 50% of shares), the equity method should be applied. Under the equity method, the investment is initially recorded at historical cost, and adjustments are made to the value based on the investor’s percentage of ownership in net income, loss, and dividend payouts (Tuovila, 2021). This implies that Company F will need to record the initial investment as an asset and then make adjustments to this value due to the investor’s share in the company’s income or losses (Tuovila, 2021). Let’s assume that the initial investment of Company F was $4 million, and Company K reported $500,000 in net income and paid $100,000 in dividends. Then, the following entries should be made:
- Company F should record a debit to the asset account on June 30 for $4,000,000 as “Investment in Company K.”
- Company F should record a credit of $4,000,000 as to its cash value on June 30.
- On December 31st, Company F should record a debit of $200,000 (40% of Company K’s income) as “Investment in Company K” to the asset account.
- On December 31st, Company F should report a credit of $200,000 to Investment Revenue.
- Similarly, on December 31st, the company should record a credit of $40,000 (40% of Company K’s dividends) to cash.
- Additionally, on December 31st, Company F should report a credit of $40,000 from the asset account as “Investment in Company K.”
Thus, at the end of the year, investment recorded in the balance sheet will be $4,160,000 ($4,000,000 + $200,000 – $40,000). At the same time, the income statement will demonstrate a change in cash value by $3,960,000 ($4,000,000 – $40,000).
Reference
Tuovila, A. (2021). Equity method. Investopedia. Web.