Module 7:
Intercorporate Investments
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Investment in Marketable Equity
Securities - Overview

Equity investments represent ownership of
another company’s outstanding common stock.
 Marketable equity investments are actively traded
on a public stock exchange.
 By owning shares of common stock, the investor
“owns” a part of the company, represented by the
percentage ownership.
 There are different accounting rules for:
(1) less than 20 percent ownership (passive).
(2) between 20 and 50 percent ownership
(significant influence).
(3) greater than 50 percent ownership (control).
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(1) Less than 20 % ownership.
If marketable securities, use the mark-to
market method.
 Carries securities on balance sheet at
market value.
 Revaluation at the end of each period
based on new market price
 Unrealized gains (or losses) are recognized
as the investment is valued up (or down).
 Treatment of the Unrealized G/L depends
on classification of security:
– (a) Trading securities.
– (b) Available-for-sale securities.

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(a) Trading Securities
Trading securities held for the short term,
with purpose of selling securities for profit.
 At purchase - record at cost to acquire.
 Activity during the year - record declaration
of cash dividends, and recognize “Dividend
Income” on the Income Statement:
Dividends Receivable
xx
Dividend Income
xx

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(a) Trading Securities
For securities on hand at the end of the
accounting period - revalue to market value
and record “Unrealized Gain/Loss” on
Income Statement.
 When sold - recognize “Gain/Loss on
Sale” on Income Statement for any
balance since the last revaluation.

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(b) Available-for-sale Securities
Available-for-sale (AFS) securities may be
held for the short term or for long term,
depending on management’s intentions.
 At purchase - record at cost to acquire.
 Activity during the year - record declaration
of cash dividends, and recognize
“Dividend Income” on the Income
Statement:
Dividends Receivable
xx
Dividend Income
xx

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(b) Available-for-sale Securities
For securities on hand at the end of the
accounting period - revalue to market
value and record “Unrealized
Gain/Loss” on Balance Sheet (as part of
Other Comprehensive Income in
Stockholders’ Equity).
 When sold - recognize “Gain/Loss on
Sale” on Income Statement for total
difference between original cost and
selling price.

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(2) From 20% to 50% Investment
Because investment represents significant
influence of investor, we cannot account for
investments the same way as Trading or
AFS.
 Specifically, we cannot recognize
“Dividend Income” as dividends are
declared, because the investor can control
dividend payout, and therefore control the
creation of income.

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(2) From 20% to 50% Investment
The equity method increases the
investment account and recognizes
investor’s portion of income as investee
earns it (as investee reports income to
investor).
 The equity method decreases the
investment account as investee declares
dividends to the investor.
 Note: additional complications from equity
method from cost exceeding fair value of
investment (e.g., goodwill) are not
addressed here for unconsolidated
investments.

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Basic Equity Method Journal Entries
On investor’s books:
1. When investment purchased:
L.T. Investment
xx
Cash, etc.
xx
2. When dividends declared to investor:
Dividends Receivable
xx
L.T. Investment
xx
3. When income reported by investee to
investor (from investee’s I/S):
L.T. Investment
xx
Income from Investment xx
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Illustration - Equity Method
Company P purchases 30% of the
outstanding common stock of Company S
on January 2, 2009 for $400,000 cash.
During 2009, Company S reported net
income of $300,000 to its shareholders, and
declared $100,000 dividends to its
shareholders.
Required:
Prepare all journal entries necessary (on
Company P’s books) to record this
investment using the equity method of
accounting.
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Journal Entries on P’s Books:
1.
Acquisition:
2.
Dividends declared (100,000 x 30%)
3.
Income reported (300,000 x 30%)
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Effects of Equity method

If the company had used the cost method and
recognized dividend income, the amount of
income would have been $30,000.
 Under the equity method, Company P
recognized $90,000 income.
 The equity method often yields higher
income, but the amount is less subject to
manipulation.
 The IRS recognizes income as the cash is
received (dividend income). This creates a
differential basis between tax and financial
accounting (more in Chapter 5, Part 2).
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Other Cautions Regarding Equity Method

The equity ignores market value for the investment
account. Instead the investment account
fluctuates as the investee’s equity fluctuates
(income in excess of dividends).
 20-50 percent is not always a valid indication of
significant influence.
 It generates off-balance sheet financing - one line
on the balance sheet may actually represent a
percentage ownership in a number of assets and
liabilities. (Consolidated investments show all the
detail of assets and liabilities, where
unconsolidated investments show only a net asset
amount.
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(3)Greater than 50% Investment
If an investor has majority control, the
investment is recorded using the equity
method, and a parent/subsidiary
relationship is established.
 At the end of the period, the financials of
the parent and subsidiary must be
combined, or consolidated, for external
financial reporting.
 Goodwill is recognized as a separate
asset in the consolidation.

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Comprehensive Problem
Prepare the following journal entries for Jackson
Company for 2007. Assume there were no other
investments prior to the following activities.
Feb. 17 - Purchased 500 shares of Medical Company
common stock for $20 per share (classified as trading
securities):
March 31 - Received a $1.20 per share dividend on
Medical Company stock:
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Comprehensive Problem
April 1 - Purchased 30,000 of the 100,000
outstanding shares of Olde Company common stock
at $10 per share.
Classification of Investment?
June 28 - Received a $1.00 share dividend on the
Olde Company stock:
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Comprehensive Problem
Oct. 1 - Purchased 2,000 of Alpha Company
common stock for $15 per share.
These shares are classified as available-for-sale.
Dec. 31 - Olde Company reported annual earnings
of $80,000 to its investors:
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Comprehensive Problem
Dec. 31 AJEs - At the end of the year, the following
market prices per share were reported:
Medical Co. (trading) $25 per share
Alpha Co. (AFS)
$12 per share
Olde Co. (equity)
$11 per share
AJE for Medical?
AJE for Alpha?
AJE for Olde?
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Comprehensive Problem
What total effect would the previous
transactions have on the income statement
for 2007?
What effect would the previous transactions
have on other comprehensive income for
2007?
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