Equity Method of Accounting Dividends are those delightful distributions of cash you receive from your shares of stock and mutual funds. Corporations also can receive dividends by owning dividend-paying stock of other corporations. The accounting method an investor corporation uses to record dividends received from an investee -- the business in which it has invested -- depends on how much investee stock the investor owns.
Control The equity method assumes that the investor has some control over the actions of the investee. However, the investor may avoid the equity method if it can prove to the satisfaction of the Internal Revenue Service that such control is an illusion.
For example, the investee might regard the investor with hostility and disregard the investor's advice. The investor may even formally agree to give up voting rights on the investee stock to assert that it lacks influence. Dividends Corporations distribute dividends from the equity account called retained earnings, which records the accumulated profits of the company.
Dividends are not tax deductible to the payer; they represent the conversion of corporation equity to investor income. This conversion reduces the total equity of the corporation, which reduces the value of each share of common stock. A corporation using the equity method would not. Every quarter, corporations announce their income or losses for the period. An investor corporation adjusts the carrying value of its investment by its proportionate share of investee profits and losses.
The investor records the gain on its income statement and reports the new carrying value of its investment on its balance sheet. Dividend Treatment Investors do not treat dividends as revenue under the equity method.
Instead, the investor subtracts the cash dividend amount from the investment carrying value. This treatment recognizes that the value of the investment has decreased by the cash distribution. Since the investor immediately records this effect on its balance sheet, it would constitute double counting to also book the dividend as revenue. Should the investor sell sufficient shares to drop its investment percentage below 20 percent, it could adopt the cost method or fair value method.
The investor would then book dividends as revenue. If the investor increases its ownership percentage above 50 percent, it would treat the investee as a subsidiary and use a consolidated accounting treatment.