Accounting for liquidating dividend
Furthermore, the equity method of accounting meets the objectives of accrual accounting than does the cost method.
The cost method is generally followed for investments in noncontrolled corporations and unconsolidated subsidiaries.
Dividend is recorded as income and an adjustment is made for liquidating dividends (i.e dividends distributed by the investee exceed the investor's share of earnings since acquisition are treated as return of capital and recorded as reduction of the investment account).
: P Co acquired 20% stock of S Co on Jan 1, Year 1 and S Co's net income for year 1 was ,000. Liquidating dividends = ,300 - (20% of 10,000) = 0 Journal entry: Dr Cash ,300 Cr Dividend Income ,000 Cr Investment in S Co 0 Now, keeping the facts of the case same, try out the entries under the equity method and compare the end result.
I have explained this in more detail by charting a T account of "Investment Account". ( Codification 325 formerly referred as APB 18) - This method is applicable when the investor is not able to exercise significant influence over the investee and generally is evidenced by lack of ability to take policy decisions, temporary investment, holds non-voting preferred stock or ownership in voting stock is less than 20%.
You will notice that under both the methods Investment in S Co is reduced by the amount of liquidating dividend. Focus on how investment account and investment income account get affected by various transactions under Equity method.
Remember, investment and investment Income accounts are always reciprocal to each other except for when the dividend is received by the Investor.
When a company has more liabilities than assets, equity is negative and no liquidating distribution is made at all.
This is usually the case in bankruptcy liquidations.