Question

Explain the rationale for the equity method recording dividends received as a reduction in the investment account and not as dividend income.

Answer 1

Equity method to record investment in shares of another company is used when purchasing company has significant influence on the other company. In equity method the value of investment security is adjusted for net income for the year and dividend paid during the year. Net income would increase the value of investment and dividend paid would decrease the value of investment. Dividend received is deducted from investment account as dividend paid by another company reduces its shareholder's equity and thus the percentage share held in other company also reduces. This is adjusted by deducting the value of dividend received in the purchaser book so to reflect the correct percentage of share held.