In Lesson 1, we will discuss the overview of accounting for investment in equity securities. Companies often invest in equity securities of other companies, such as shares of common stock. The accounting for investment in shares of common stock of another company is based on the influence that the investor has over the investee. Influence is generally determined based on the percentage of ownership held. So, if the ownership is more than 50 percentages— in this specific case— the presumed influence is control, and the accounting method for initial recognition will be business combination, Accounting Standards Codification 805. The subsequent accounting will be consolidation, Accounting Standards Codification 810. If the percentage of ownership is between 50 and 20 percentages, the presumed influence is significant influence, but not control. The accounting method can be either: The equity method of accounting, Accounting Standards Codification 323, or the fair value option, Accounting Standards Codification 825. But if the percentage of ownership is less than 20 percentages— in this specific case— the investor has no influence or very little influence over the investee. Thus, the accounting method must be fair value through net income, Accounting Standards Codification 321. Under the equity method of accounting, the investor recognizes in its income statement its share in the earnings or losses reported by the equity method investee. Investor shares in the net income of the investee increases the equity income for the period. Thus, equity income is credited and equity investment account is debited. Exactly the opposite joint entry is recorded for the share in the net losses of the investee. In this case, equity income is debited and the equity investment account is credited. However—under the equity method of accounting— dividends received from equity method investee decrease the carrying amount of equity method investment account. So, the joint entry will be: Debit the cash received and credit the equity method investment account. Let's see the following example. On January 1, 2018, Company A acquired for $80 thousand, 30,000 shares out of a total of 100,000 outstanding shares of common stock of Company B. Company A did not elect the fair value option for this specific investment. In 2018, Company B reported net income of $50 thousand, and at the end of the year Company B declared and paid cash dividends of $20 thousand. So, let's take a look at this example in detail. First of all, we need to determine the accounting method for the investment in common stock of Company B. The accounting method is based on the influence that the investor has over the investee, and influence is based on the percentage of ownership. In our case, Company A holds 30,000 shares out of a total of 100,000 outstanding shares of common stock of Company B. So, 30,000 shares out a total of 100,000 outstanding shares will give us 30 percentage of ownership. In case of 30 percentage of ownership, the presumed influence is significant influence. In case of significant influence, two accounting methods are available. Option number one is the fair value option for the investment and common stock, and the second option is the equity method of accounting. In our example, it was indicated that the fair value option was not elected. So, we must apply the equity method of accounting for the investment in common stock of Company B. So, the following joint entry is recorded on January 1, 2018, the acquisition date. Company A paid $80 thousand to acquire the shares of common stock of Company B. So, we will credit cash for $80 thousand, and equity method investment account is debited for the same amount. Equity method investment. Also, $80 thousand. At the end of the year, at December 31, 2018— under the equity method of accounting— the investor must recognize its share in the net income or losses reported by the investee. In 2018, Company B recorded net income of $50 thousand. This was the net income of Company B in 2018. Company A has 30 percentage ownership in Company B. So $15 thousand is Company's A share in the net income report of Company B. So, we will credit equity income, and we will debit equity method investment account: $15 thousand. Also at the end of the year, Company B declared and paid $20 thousand of dividends. We know that under the equity method of accounting, dividends received recognizes a decrease in the investment account. So, $20 thousand of dividends were declared and paid by Company B. Company A share of it 30 percentages, so it's $6 thousand. Since Company A receive this cash, we will debit cash for $6 thousand, and we credit the equity method investment. Now, all the activity under the equity method of accounting was recorded, and we can find the investment account in the end of the year. So, in 12/31/2018's balance sheet, the equity method investment account is reported in following way. We initially recognize the investment of $80 thousand on the acquisition date. Then we increase the investment account for the sharing the net income reported by the equity method investee, and we decrease the investment account for the dividends received from the investee. So, the ending balance of the investment is $89 thousand. In the income statement-in 2018's income statement— equity income of $15 thousand is reported. Equity income is $15 thousand.
