Concept explainers
(a)
Cost method: It refers to an accounting technique used by an investor to determine the income earned on investments made in short-term equity securities of a company. Thus, the investor who own a non-significant interest by having less than 20% of ownership, accounts for investments in short-term equity securities under this method.
Equity method: It refers to an accounting technique used by an investor to determine the income earned on investments made in long-term equity securities of a company. Thus, the investor who owns a significant interest by having more than 20%, but less than 50% of ownership, accounts for investments in long-term equity securities under this method.
To Record: The stock transactions for the investment in Incorporation G for Company W using cost method.
(a)
Explanation of Solution
Record the purchase of common stock by Company W.
Date | Account Title and Description | Post Ref. |
Debit ($) |
Credit ($) |
January 1 | Stock Investments | 1,800,000 | ||
Cash | 1,800,000 | |||
(To record the purchase of stock investments.) |
Table (1)
Description:
- Stock Investments is an asset account. The amount has increased due to purchase of stock investment. Therefore, debit Stock Investments account with $180,000.
- Cash is an asset account. The amount has decreased because the stock investment is purchased for cash. Therefore, credit Cash account with $180,000.
Record the
Date | Account Title and Description | Post Ref. |
Debit ($) |
Credit ($) |
June 30, 2017 | Cash | 30,000 | ||
Dividend Revenue | 30,000 (1) | |||
(To record the receipt of dividend revenue.) |
Table (2)
Working Note:
Compute the amount of dividend received.
Description:
- Cash is an asset account. The amount has increased because interest is received; therefore, debit Cash account with $30,000.
- Dividend Revenue is a revenue account. Revenue increases
stockholders’ equity account. Therefore, credit Dividend Revenue account with $30,000.
Record the journal entry for the receipt of dividend revenue for Company W.
Date | Account Title and Description | Post Ref. |
Debit ($) |
Credit ($) |
December 31, 2017 | Cash | 30,000 | ||
Dividend Revenue | 30,000 (2) | |||
(To record the receipt of dividend revenue.) |
Table (3)
Working Note:
Compute the amount of dividend received.
Description:
- Cash is an asset account. The amount has increased because interest is received; therefore, debit Cash account with $30,000.
- Dividend Revenue is a revenue account. Revenue increases stockholders’ equity account. Therefore, credit Dividend Revenue account with $30,000.
(b)
To Record: The stock transactions for the investment in Incorporation G for Company W using equity method.
(b)
Explanation of Solution
Explanation
Record the purchase of common stock by Company W.
Date | Account Title and Description | Post Ref. |
Debit ($) |
Credit ($) |
January 1 | Stock Investments | 1,800,000 | ||
Cash | 1,800,000 | |||
(To record the purchase of stock investments.) |
Table (4)
Description:
- Stock Investments is an asset account. The amount has increased due to purchase of stock investment. Therefore, debit Stock Investments account with $180,000.
- Cash is an asset account. The amount has decreased because the stock investment is purchased for cash. Therefore, credit Cash account with $180,000.
Record the journal entry for the dividends recognized by Company W.
Date | Account Title and Description | Post Ref. |
Debit ($) |
Credit ($) |
June 30 | Cash | 30,000 | ||
Stock Investments | 30,000 (3) | |||
(To record the dividend received.) |
Table (5)
Working Note:
Compute amount of dividends received.
Description:
- Cash is an asset account. Since cash is received as dividends, cash amount has been increased. Therefore, debit Cash account with $30,000.
- Stock Investments is an asset account. Since Stock investment account is reduced, credit Stock Investments account with $30,000.
Record the journal entry for the dividends.
Date | Account Title and Description | Post Ref. |
Debit ($) |
Credit ($) |
December 31 | Cash | 30,000 | ||
Stock Investments | 30,000 (4) | |||
(To record the dividend received.) |
Table (6)
Working Note:
Compute amount of dividends received.
Description:
- Cash is an asset account. Since cash is received as dividends, cash amount has been increased. Therefore, debit Cash account with $30,000.
- Stock Investments is an asset account. Since Stock investment account is reduced, credit Stock Investments account with $30,000.
Record the journal entry for the equity on net income.
Date | Account Title and Description | Post Ref. |
Debit ($) |
Credit ($) |
December 31 | Stock Investments | 240,000 | ||
Revenue from Stock Investments | 240,000 (5) | |||
(To record the equity on the net income of the investee company.) |
Table (7)
Description:
- Stock Investments is an asset account. The asset is increased as the stock investment is increased. Therefore, debit Stock Investments account with $240,000.
- Revenue from Stock Investments is a revenue account. Revenue increases the value of stockholders’ equity account. Therefore, credit Revenue from Stock Investments account with $240,000.
Working Note:
Compute amount of income received.
(c)
To Prepare: A memorandum and explain each method, and show the account balance under each method at December 31, 2017 in a tabular form.
(c)
Explanation of Solution
Prepare a memo to the board of directors explaining the differences between cost and equity methods.
MEMORANDUM
Date: December 31, 2017
To: The Board of Directors, Company W
From: Miss S
Subject: Differences between cost and equity methods
Cost method: It refers to an accounting technique used by an investor to determine the income earned on investments made in short-term equity securities of a company. Thus, the investor who own a non-significant interest by having less than 20% of ownership, accounts for investments in short-term equity securities under this method.
Equity method: It refers to an accounting technique used by an investor to determine the income earned on investments made in long-term equity securities of a company. Thus, the investor who owns a significant interest by having more than 20%, but less than 50% of ownership, accounts for investments in long-term equity securities under this method.
The distinction between the cost and equity methods of accounting for investment in stocks is stated below:
Title: Distinguish between cost method and equity method | ||
Basis of Difference | Cost Method | Equity Method |
Type of stock investment | This method is used for accounting short-term investments or readily marketable investments. | This method is used for accounting long-term investments. |
Ownership interest | An investor has less than 20% of ownership interest in common stock of investee’s company. | An investor has more than 20% but less than 50% of ownership interest in common stock of investee’s company. |
Recognition of dividends reported by investee | Dividends are reported as revenue when cash dividends are received. | Dividends are reported as a reduction from the investment account. |
Recognition of net income of the investee | Investor does not recognize the net income or loss reported by the investee’s company. | Investor recognizes its share of revenue or losses from the net income or loss reported by the investee’s company. |
Table (8)
Account balances under cost and equity methods as at December 31, 2017.
Accounts | Cost Method ($) | Equity Method ($) |
Stock Investments | 1,800,000 | 1,980,000 (6) |
Dividend Revenue | 60,000 | 0 |
Revenue From Stock Investments | 0 | 240,000 |
Table (9)
Working Note:
Prepare Stock Investments account under equity method.
Stock Investments | ||||||
Date | Details |
Debit ($) | Date | Details |
Credit ($) | |
January 1 | Cash | 1,800,000 | June 30 | Cash | 30,000 | |
December 31 | Revenue from stock investments | 240,000 | December 31 | Cash | 30,000 | |
December 31 | Balance | 1,980,000 | ||||
December 31 | Total | 2,040,000 | December 31 | Total | 2,040,000 |
Table (10)
(6)
Thanking you,
Miss S
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