A. The Cost Method

The accounting for investments is based on the amount of control the investor has on the company acquired. If the investor does not have significant influence (i.e, owns less than 20% of the stock), investments are accounted for using cost with year-end adjustements to fair value. Dividends received are recorded as dividend revenue.
Example:On January 1, we acquire 10% of the stock of ABC, Inc. at a costof $100,000. On December 31, ABC reports a net income of $40,000and declares and pays a dividend of $20,000. At December 31, ourinvestment is worth $110,000.The following entries are required: Debit Credit ------- ------- 1/1 Investment in ABC 100,000 Cash 100,000 No entry for the net income 12/31 Cash ($20,000 x 10%) 2,000 Investment Revenue 2,000 The investment account would also be adjusted to its market value of $110,000 on December 31.

The equity method assumes that the investor can exercise significant influence over the company. This is normally presumed when the investor owns more than 20% of the stock.


When the company reports their income/loss, the investor reports their share of the income/loss as an increase/decrease in the investment account. When the company declares a dividend, the investor reduces the amount of their investment account for the amount of the dividend. No fair-value adjustment is made at year end under the equity method.
Example: On January 1, we acquire 30% of the stock of ABC, Inc. at a cost of $300,000. On December 31, ABC reports a net income of $40,000 and declares and pays a dividend of $20,000. The following entries are required: Debit Credit ------- ------- 1/1 Investment in ABC 300,000 Cash 300,000 12/31 Investment in ABC ($40,000 x 30%) 12,000 Revenue from Investment 12,000 12/31 Cash ($20,000 x 30%) 6,000 Investment in ABC