3.2 Equity Method

Question 1

Under the equity method, dividends from the investee are treated as

Answer 1

a return of an investment.

they decrease the investment balance but have no effect on the investor’s income.

Question 2

Chatham Co. owned 25% of the voting stock of Boyrum Co. Chatham applied the equity method to account for this investment. Boyrum reported income of $100,000 and paid $30,000 in cash dividends during the period. What amount should Chatham report as investment income?

Answer 2

$25,000

Under the equity method, the investor recognizes in income its share of the investee’s earnings or losses in the periods for which they are reported by the investee. Thus, Chatham’s equity income (investment income) for the period is $25,000. Under the equity method, dividends from the investee are treated as a return of an investment. They decrease the investment balance but have no effect on the investor’s income.

Question 3

Significant influence is presumed to exist when the investor holds

Answer 3

between 20% and 50% of the investee’s voting interests (shares of common stock)

Question 4

An equity method investment is initially recognized

Answer 4

at cost

Question 5

An investor uses the equity method to account for an investment in common stock. The investor’s equity in the earnings of the investee is affected by

• Cash dividends from investee: yes/no
• Change in fair value of the investee’s common stock: yes/no

Answer 5

• Cash dividends from investee: no
• Change in fair value of the investee’s common stock: no

Under the equity method, an investor debits an investment and credits revenue for its share of the investee’s earnings. The receipt of a cash dividend from the investee is treated as a return of an investment. Thus, it is credited to the investment but does not affect equity-based earnings. A change in fair value has no effect on an investment in securities accounted for under the equity method.