Explanation Equity method: The equity method is used when the investor who owns a significant interest by having more than 20% or more voting rights in the investee corporation. The significant influence signifies that an investor can exercise considerable influence in the operating and financial policy decisions of the investee company. Prepare the journal entries to record the given transactions as follows: January 5, Year 1 – Purchase of Company B’s shares. Date Account Titles and Description Post Ref. Debit ($) Credit ($) January 5, Year 1 Equity method investment- Company B 200,500 Cash 200,500 (To record the purchase of Company B’s shares. Table (1) Equity method investment-Company B is an asset account, and it increases the value of assets by $200,500. Hence, debit the equity method investment –trading with $200,500. Cash is an asset account and it decreases the value of asset by $200,500. Therefore, credit the cash account for $200,500. August 1, Year 1 – Dividend received from Company B. Date Account Titles and Description Post Ref. Debit ($) Credit ($) August 1, Year 1 Cash (1) 21,000 Equity method investment-Dividend revenue 21,000 (To record the cash dividend received) Table (2) Cash is an asset account and it increases the value of asset by $21,000. Therefore, debit the cash account for $21,000. Dividend revenue is a component of owner’s equity (revenue), and it increases the value of equity by $21,000. Hence, credit dividend revenue account with $21,000. Working note: Calculate the dividend revenue received from Company B for the year 1: Dividends = ( Number of shares × Dividend per share ) = ( 20 , 000 × $ 1.05 per share ) = $ 21 , 000 (1) December 31, Year 1 – Earnings from equity method investment: Date Account Titles and Description Post Ref. Debit ($) Credit ($) December 31, Year 1 Equity method investment- Company B 20,500 Earnings from Equity method investment (2) 20,500 (To record the earnings from Equity method investment) Table (3) Equity method investment is an asset account and it increases the value of asset by $20,500. Therefore, debit the equity method investment account for $20,500. Earnings from Equity method investment is a component of owner’s equity (revenue), and it increases the value of equity by $20,500. Hence, credit Earnings from Equity method investment account with $20,500. Working note: Calculate the earnings from Equity method investment for the year 1: Earnings from long-term investment } = Principle × Rate × Time =$82,000 × 25 100 × 12 12 = $ 20 , 500 (2) August 1, Year 2 – Cash dividend received from Company B. Date Account Titles and Description Post Ref. Debit ($) Credit ($) August 1, Year 2 Cash (3) 27,000 Equity method investment-Dividend revenue 27,000 (To record the cash dividend received) Table (4) Cash is an asset account and it increases the value of asset by $27,000. Therefore, debit the cash account for $27,000. Dividend revenue is a component of owner’s equity (revenue), and it increases the value of equity by $27,000. Hence, credit dividend revenue account with $27,000. Working notes: Calculate the dividend revenue received from Company B for the year 2: Dividends = ( Number of shares × Dividend per share ) = ( 20 , 000 × $ 1

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Principles of Financial Accounting.

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Solution Summary: The author explains that the equity method is used when the investor owns a significant interest by having more than 20% or more voting rights in the investee corporation.

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