Dividends are a portion of a company's profits distributed to its shareholders, usually paid in cash or **. Dividends are an important part of shareholder returns and an important indicator of a company's financial health and profitability. So, how are dividends recognized and calculated when one company holds shares in another company? This involves an accounting method called the equity method.
The equity method means that when a company's investment in another company is able to exert significant influence or control over it, its share of the net assets and net profit of the investee company should be recognized according to its proportion of ownership in the investee company, and it should be included in investment income. The purpose of the equity method is to reflect the economic interests and risks of the investment company to the investee company, as well as the management rights and responsibilities of the investment company to the investee company.
So, how does the equity method recognize dividends? This article will analyze the following three aspects:
Conditions and scope of application of the equity method.
Recognition and calculation method of the equity method.
Considerations and recommendations for the equity method.
1. Conditions and scope of application of the equity method
According to China Accounting Standard No. 2 "Accounting Treatment of Business Combination and Purchase of Investees", when a company's investment in another company accounts for more than 20% but less than 50% of its voting rights, its investment income should be accounted for using the equity method. When a company's investment in another company accounts for more than 50% of its voting rights, it should be treated as a subsidiary and made consolidated statements. When a company's investment in another company accounts for less than 10% of its voting rights, the cost method should be used to account for its investment income.
It should be noted that the above ratio is only a reference for judgment, and in fact, whether to use the equity method depends on the actual influence and control of the investment company over the investee company. For example, when a company's investment in another company accounts for 15% of its voting rights, but through an agreement or other arrangement, it is able to have a significant impact on its operating policies and decisions, the equity method should also be used to account for its investment income. Conversely, when a company's investment in another company accounts for 25% of its voting rights, but it is unable to exert significant influence or control over it due to the presence of other shareholders, the cost method can also be used to account for its investment income.
2. Recognition and calculation methods of the equity method
When a company uses the equity method to account for its investment income in another company, it should follow these steps:
The first step is to confirm the cost of the investment. Investment costs refer to the cash or cash equivalents paid by the investment company to acquire the shares of the investee company, as well as other expenses directly related to the investment, such as intermediary fees, consulting fees, registration fees, etc. The cost of the investment should be recognized in a lump sum at the time of investment occurrence and as the initial carrying amount of the investment.
The second step is to confirm the net assets and net profit of the investee company. Net assets refer to the assets of the investee company minus liabilities, reflecting the equity of its owners. Net profit refers to the income of the invested company minus expenses, reflecting its profit and loss in a certain period. The net assets and net profit of the investee company should be adjusted according to its financial statements to ensure consistency with the investment company's accounting policies and reporting periods.
The third step is to calculate the investment company's share of the investee's net assets and net profits. The investment company's share of the investee's net assets and net profit shall be distributed in accordance with its ownership ratio in the investee company. For example, if the investment company's investment in the investee company accounts for 30% of its voting rights, the investment company's share of the investee's net assets and net profit will also be 30%.
The fourth step is to confirm the return on investment. Investment income refers to the investment company's share of the investee's net profit, reflecting its income from investment activities. Investment income shall be recognized at the same time as the investee company determines its net profit and shall be included in the profit and loss statement of the investment company. The formula for calculating investment income is:
Investment income = the share of the investment company in the net profit of the investee company - the dividend distributed by the investee company to the investment company
The fifth step is to adjust the book value of the investment. The book value of an investment refers to the performance value of an investment company's investment in the investee company on its balance sheet. The carrying amount of an investment should be adjusted to reflect the true value of the investment based on investment income and other factors. The formula for adjusting the book value of an investment is:
Book value of investment = investment cost + investment income - dividends allocated by the investee company to the investment company + other adjustment items
Among them, other adjustment items include the asset revaluation of the investee company, foreign currency exchange rate changes, merger adjustments, etc.
3. Precautions and suggestions for the equity method
The core of the equity method is to reflect the economic interests and risks of the investment company to the investee company, rather than the cash flow of the investment company to the investee company. Therefore, dividends distributed by the investee company to the investment company should not be regarded as part of the investment income, but should be regarded as a reduction in the carrying amount of the investment. This is because the payment of dividends will lead to a decrease in the net assets of the investee company and the share of the investment company in its net assets, thereby reducing the value of the investment.
The application of the equity method requires that the financial statements of the investment company and the investee company be comparable and consistent. Therefore, the investment company should make the necessary adjustments according to the financial statements of the investee company to eliminate differences in accounting policies, reporting periods, currency units, etc. At the same time, the investment company should obtain the financial information of the investee company in a timely manner so that the investment income can be recognized and calculated in a timely manner.
Conclusion
This paper analyzes how to recognize dividends and dividends by the equity method from three aspects: the applicable conditions and scope of the equity method, the recognition and calculation methods, and the precautions and suggestions. Through this article, we can understand that the equity method is an accounting method that reflects the economic interests and risks of the investment company to the invested company, and its core is to confirm the share of the investment company's net assets and net profit in the investee company according to the proportion of its ownership of the invested company, and include it in investment income. The application of the equity method requires that the financial statements of the investment company and the investee company be comparable and consistent, while noting that the payment of dividends will lead to a decrease in the book value of the investment.
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