Cost and Equity Methods

Controlling interest in subsidiary

• REQUIRED to consolidate their F/S if parent owns 50.1%+ of subsidiary

Equity Method: REQUIRED if parent owns 50% or less of sub and has “significant influence” over
subsidiary
• 20-50% ownership: ASSUME significant influence unless evidence to the contrary exists
Cost Method: REQUIRED if parent owns 50% of less of sub and DOES NOT have “significant
influence” over subsidiary

“Significant Influence”
• Look for evidence such as parent on sub’s board, making policy decisions, parent is largest
single S/H, etc…
• 20% or more ownership of sub’s outstanding shares = equity method req because significant
influence is assumed unless otherwise stated!!!

Cost Method JE’s:

Investment in sub xx (@ cost)
Cash xx

• No entry required by parent to reflect the income/loss of the subsidiary

• Treat as Avail-for-sale security on parent’s B/S
• If sub pays parent dividend, JE as follows:

Cash xx
Dividend income xx

Cost Method: Liquidating Dividend example…

• Assume: Parent owns 5% of sub, and sub has 100K income
• Sub pays parent a 7K dividend
• WAIT: Parent is entitled to, at most, 5% of sub’s income
• Treat as return of capital (liquidating dividend)

JE: Cash 7000

Dividend Income 5000
Investment in S 2000

Equity Method Journal Entries:

Parent receives dividend from 20% owned sub: (sub pays 12K total div)
Cash 2,400 (20% * 12K)
Investment in S 2,400

*Dividends included in NI when declared, not paid

Parent automatically picks up portion of reported Net income/loss of sub SINCE THE
ACQUISITION (e.g. if buy sub’s shared 7/1/xx, only claim 50% of NI for the year * ownership %)
Investment in S 12K (20% * 60K)
Equity in S earnings 12K

Goodwill Impairment (permanent decline in market)

Goodwill impair xx
Investment in S xx

Preferred Dividends paid to Parent by Sub (acct for pref div’s using cost method)
Cash 60K
Dividend Revenue 60K

**Note: If selling investment accounted for under equity method, must apply up to date of sale

**When writing purchase price up to FMV, allocate excess to undervalued assets and AMORTIZE
over remaining useful life of assets

Example of Written-up asset amortization:

• FMV plant is 90K over BV, P bought 40% of S’s assets (traceable excess = 36K)
• Plant is depreciable over 18 years
• FMV of inventory is 10K over book, all inventory sold during the year (4K trace)

Plant adjustment:
Equity in S income 2,000 [90K*40% / 18 yrs]
Investment in S 2,000

Inventory adjustment:
Equity in S income 4,000 [amortize 100% * 4K since all was sold]
Investment in S 4,000

Step-by-Step acquisition (switch from cost method to equity method)

• Where it takes more than one stock purchase to gain “significant influence”
• Must retroactively apply equity method back to 1 purchase of stock!!!
st

• Base adjustments on ownership % at the time income was earned

COMCAST TICKET #: Cr191144014