[MochiBunni]

I’m having a lot of trouble with the Cost and Equity method. Under Equity Method, stock or cash dividend should not be recognized as dividend income/revenue. Then I ran into the below question:

__________

A owns 20% Preferred Stock and 40% Common Stock. A’s outstanding stock are:

10% cumulative preferred stock $100,000

Common stock 700,000

Net Income at year end is $60,000 and dividend paid $10,000 to its preferred shareholders. How much revenue should A record?

The calc. is 100,000 x 10% = 10,000 dividend x 20% = 2,000 dividend received

Common Stock:

Net Income: 60,000

Less: Pref. dividend <10,000>

50,000 x 40% = 20,000

__________

Why did they back out the dividend besides it’s not considered as income under the equity method, but how would I know to back it out?

[M.O.D.]

I believe Preferred stock is a hybrid between a bond and equity. Ie it pays a dividend like interest payment, but payment is not required. Also, because it is a “dividend” it is not tax deductible like interest is. However it is payed out like interest and thus reduces the income available to shareholders.

So if it were a bond, the investor would record the interest payment. Likewise it would deduct that from the investee income to recognize under the equity method.

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[Author]

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