Question

When is the carrying value of the investment account reduced under equity-method reporting?

I would like to obtain an in depth explanation of this scenario.

Answer 1

The equity method is used to value a company's investment in another company when it holds significant influence over the company it is investing in. The investor records its initial investment in the second company's stock as an asset at historical cost. Under equity method, investment's value is periodically adjusted to reflect the changes in value due to investor's share in the company's income or losses. Adjustments are made when dividends are paid out to shareholders. Under equity method, a company reports the carrying value of its investments independent of any fair value change in the market. For example, when the investee company reports a net loss, the investor company records its share of the loss as 'loss on investment' on the income statement, which also decreases the carrying value of the investment on the balance sheet.

When the investee company pays a cash dividend, the value of its net assets decreases. The investor company receiving the dividend records an increase in its cash balance but reports a decrease in carrying value of its investment. Since investment is an asset, then any reduction in the value will likely increase another asset, in this case, cash. Hence, double entry will be:

Cash (Dividend received)               Dr

Carrying amount of investment       Cr