>> Equity securities with significant influence.
When an investor owns between 20 and 50 percent of a company,
it is assumed that they can significantly influence the investees decisions.
This influence may be helpful if
the investees and the investors businesses are somehow related.
These types of investments must be accounted for using the equity method.
As shown on the slide,
the investment is recorded at cost when acquired and
the investment account balance is adjusted for any dividends the investor receives,
and for the investor share of the investees net income or net loss.
In our example, Smart Touch Learning pays
400,000 to purchase 40 percent of the common stock of Kline,
Inc. Smart Touch Learning then refers to Kline as an affiliated company.
Smart Touch learning's entry to record the purchase of this investment, on January 6th,
2018 is a debit to Equity Investments-Kline,
Inc. for 400,000 and a credit to cash for 400,000.
Notice that the investor includes the name of the investee on
the equity investment account to signify that
Smart Touch Learning has significant influence over Kline, Inc.
When Kline Inc. declares dividends,
Smart Touch Learning will record it's proportionate part of the cash dividends.
Suppose the Kline declares and pays a cash dividend of $50,000 on June 30th, 2018.
Because Smart Touch Learning owns 40 percent of the stock,
It receives 40 percent of the dividend or $20,000.
Smart Touch Learning receives this dividend and debits cash for
20,000 and credits equity investment-Kline, Inc for 20,000.
The Equity Investment's account is credited for the receipt of the dividend,
because it essentially decreases the investor's investment.
In other words, the dividends are treated as if they were a return of capital,
which is the same as saying a return of Smart Touch's
original investment rather than being treated as dividend income.
Under the equity method,
the investor also must record annually each share of the investees net income.
The investor debits the equity investments account and credits
revenue from investments when the investee reports income.
As Smart Touch learning's equity incline increases,
so does the equity investments account on the investor's books.
Suppose Kline reported net income of $125,000 for the 2018 year.
Smart Touch Learning would record 40 percent of this amount,
which is $50,000 as an increase in the investment account.
The journal entry is a debit to equity investments-Kline,
Inc. for $50,000 and a credit to revenue from investments for $50,000.
After the preceding entries are posted,
Smart Touch learning's equity investments T-account shows it's equity in
the net assets of Kline as having an ending balance of $430,000.
Smart Touch learning would report the equity investments on
the balance sheet and the revenue from investments on the income statement.
When Smart Touch Learning decides to sell its investment in Kline, Inc.
It will lead to determine whether there is a gain or loss.
Suppose Smart Touch Learning sells 10 percent of
the client common stock for $40,000 on January 1st, 2019.
Smart Touch Learning will calculate the gain or
loss by starting with the cash they receive of
$40,000 less the book value of $43,000 on the date of disposal.
The book value is calculated by taking 10 percent
of the total ending book value of $430,000.
Many large corporations own controlling interests in other companies.
An investor owns a controlling interest when the investor
has legal control over the investee company,
and generally owns more than 50 percent of the investees voting stock.
This type of investment enables the investor to elect
a majority of the board of directors and thereby control the investee.
The corporation that controls the other company is called the parent company and
this company that is controlled by another corporation is called the subsidiary company.
