Different ways like equity, cost and consolidated can be employed when accounting for investments. It’s the amount of ownership that decides the method of accounting. Here’ how a distinction is made between cost method Vs equity method. When the ownership is lower than twenty percent, cost method is employed but when the amount of ownership varies from twenty to fifty percent, we apply equity method. The consolidated method that combines the monetary statements of both the companies is employed when ownership is fifty percent or exceeds that amount.
Here we’ll give some examples to make more clear cost method vs equity method of accounting.
For recording the acquisition of shares in the other company, debit the equity investment and credit cash amounts. For instance when you purchase 100 shares (representing an ownership of less than twenty percent) of Intel @ 28/share, you need to credit cash and debit equity investment by 100X27=$2,800 each.
Take into account the dividends paid by the company by crediting earning through dividend and debiting cash account. In the above example if dividend from Intel comes to $0.25/share, you’ll need to credit income from dividend and debit cash by 100X.25=$25 each.
When accounting for the sale of shares of company, we adjust equity investment, cash and loss or profit from sales of investment account. To conclude the above example of cost method, on selling 100 shares of Intel @29.50/share, we credit gain from equity investment on sales of investment by 2950-2800=$150 and debit cash by 29.50X100=$2,950
Take into account purchase shares of other company in the same manner as in cost method that is credit cash and debit equity investment. Let us say that you purchase 100 shares of a company ABC @ $50/share, wherein 100 shares represent twenty to fifty percent of ownership. In this case you will credit cash and debit equity investment by 100X50=$5,000 each.
Take into account dividends from company by crediting equity investment while debiting cash. You’ll note this differs from cost method as in case of equity method we treated dividend as return (partial) on investment and not as earning. Let’s assume that in this case dividend from company ABC is $1/share. So, you’ll need to credit equity investment and debit cash by 1X100=$100 each.
Now take into account your part of the loss or net income from the company by regulating proceeds from investment and equity investment accounts. For finishing the example of equity method , let’s assume the company ABC announces a dividend of $1.5/share , you’ll need to credit income from investment and debit equity investment by 1.5X100=$150.
cost method vs equity method of accounting
The above illustrations should suffice to educate you on how to apply cost method vs equity method of accounting for investments in stocks.