[Kodiak]

I’m having some difficulty understanding why the equity method (20%-50%) accounting method is treated as such. I’m okay on the cost method and the consolidations but wrapping my head around this is challenging.

Becker used the analogy of a “checkbook” to account for dividends received. Why does receiving a cash dividend reduce the carrying amount of the investment on the balance sheet of the investor? Is it just to balance the entry of (Dr) cash and (Cr) investment?

I guess what I’m trying to ask is: if I own shares in another company, why would receiving cash dividends REDUCE my investment in said company?

Thanks.

AUD - Pass
FAR - Pass
BEC - Pass
REG - Nov

[littlenumberrobot]

I just got passed that sections myself. Think of it like the your investment as a return of your investment. That helped me.

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Ethics 90%

[porschify]

It is treated as a “return” of your original investment because you have “significant influence” over the company and could use that influence to declare more dividends than a much more prudent company would, had they not of had such influence.

REG- 81
BEC- 72,76
AUD- 67,88
FAR- 78

Done!

[Givemesleep]

And Dividends received go inthe operating section of the cash flow statement – sorry just showing off here.

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Aud 02/28/2012 - 81
Bec 05/31/2012 - 78
Far 08/31/2012 - 83 Do you believe in Miracles, YES !!!

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Givemesleep

[Kodiak]

Thanks for the responses. That does make sense that somebody with a controlling influence and a significant investment would account for dividends differently. But what's the reasoning behind reducing the investment amount? If I received a $25 dividend on a $100 investment (which I owned > 20%, significant influence), it would reduce my investment down to $75. Well if I received the same dividend for the next 3 years it would reduce my investment down to 0… right? I'd still have $100 of dividend income but I guess I'm not understanding the reasoning for the reduction, too.

AUD - Pass
FAR - Pass
BEC - Pass
REG - Nov

[surfer4life949]

Here's how i think of it. Dividends would reduce the retained earnings of the company being invested in, so since you own a significant portion of THEIR equity, a reduction in their equity (i e dividend) would reduce your investment in them.

B-85 OCT 2012
A-84 NOV 2012
R-90 JAN 2013
F-89 AUG 2012
Ethics-92 (3rd try)

I am DONE BABY!!!
Used Roger 2012 + Wiley + NINJA Notes

[Anonymous]

I had the same exact question when going through F3 last night.

Surferdude got it right — the investment in sub account, under the equity method reflects the equity of the investee.

i.e. when the investee pays out dividends, their equity is reduced; hence, your investment account (which is a reflection of investee's equity) is also reduced

[Anonymous]

Kodiak, if you received $25 cash dividend for 4 years your Investment In account shouldn't be 0. Remember, your Investment In account will have been increased by the net income of the company you're invested in (multiplied by your ownership %).

[Kodiak]

Thanks again for the responses. It makes perfect sense now the way you have explained it.

AUD - Pass
FAR - Pass
BEC - Pass
REG - Nov

[Author]

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