24.3 Equity Method Income, Dividends, and Impairment
Key Takeaways
- The equity method applies when an investor has significant influence over an investee but does not control it - presumed at 20% to 50% of voting stock but rebuttable by the facts.
- The investment carrying amount increases for the investor's share of investee net income and decreases for both investee net losses and dividends received.
- Dividends from an equity method investee are a return of investment that reduces the carrying amount, never dividend income.
- Basis differences between cost and the share of investee book value are assigned to identifiable assets and liabilities, with extra depreciation/amortization reducing equity-method income; any residual is equity-method goodwill embedded in the balance.
- An equity method impairment loss is recognized only when the decline in value is other than temporary, writing the investment down to fair value as the new basis.
Equity Method Income, Dividends, and Impairment
The equity method applies when an investor exercises significant influence over an investee but does not control it. FAR includes equity method investments in the investments group of balance sheet accounts. The 2026 blueprint tasks include identifying when the equity method applies and calculating the carrying amount with journal entries (the basic carrying-amount task excludes impairment). A production-quality study plan still covers impairment because it is a common judgment and links to broader investment measurement.
When the Equity Method Applies
Significant influence is presumed when an investor holds 20% to 50% of voting stock, but the presumption can be overcome in either direction. Evidence of influence: representation on the board, participation in policy decisions, material intercompany transactions, interchange of management, or technological dependency. Evidence against influence: an opposing majority owner, litigation between the parties, a standstill agreement, or legal/regulatory restrictions on the investor's rights.
| Investment situation | Usual accounting model | Key reason |
|---|---|---|
| Control of investee | Consolidation | Investor controls the entity |
| Significant influence, no control | Equity method | Participation in policy and operating decisions |
| Passive equity, readily determinable fair value | Fair value through net income | No significant influence |
| Passive equity, no readily determinable fair value | Measurement alternative (cost less impairment, plus/minus observable price changes) | No influence and no quoted price |
Carrying Amount Rollforward
The equity-method investment is a one-line substitute for the investor's share of investee net assets. Roll it forward:
- Begin with cost of the investment.
- Add the investor's share of investee net income.
- Subtract the investor's share of investee net loss.
- Subtract dividends received.
- Adjust for amortization of basis differences and intercompany profit deferrals.
- Reduce for impairment when required.
The income entry is debit Investment in Investee, credit Equity in Earnings of Investee. The dividend entry is debit Cash, credit Investment in Investee. Dividends are not income because the investor already recognized its share of investee earnings as the investee earned them; a dividend is the investee returning part of that already-recognized value.
Basis Differences
Cost often differs from the investor's share of the investee's book value. Assign the difference to identifiable assets and liabilities based on fair value differences; any residual is equity-method goodwill embedded in the investment balance.
Worked example. Investor buys 30% of Investee for $500,000 when 30% of book value is $440,000. The $60,000 excess is $40,000 attributable to undervalued equipment with a 10-year remaining life and $20,000 to goodwill. Each year, the investor reduces equity-method income by $4,000 ($40,000 / 10) of extra depreciation. The goodwill portion is not separately amortized or tested; it stays in the investment balance and is only addressed through overall impairment.
Intercompany Profit Effects
Transactions between investor and investee can create unrealized profit. If inventory sold between the companies remains unsold to outsiders at period-end, the investor defers its ownership share of the unrealized profit. This prevents recognizing income on profit not yet earned from the broader economic perspective; the deferral reverses when the goods reach an outside customer.
Impairment
An equity-method investment is reviewed for impairment when events suggest the carrying amount may not be recoverable. If the decline in fair value below carrying amount is other than temporary, the investor recognizes an impairment loss and writes the investment down to fair value, which becomes the new basis going forward. The write-down is not reversed if value later recovers.
Judgment factors: the severity and duration of the decline, the investee's financial condition and operating losses, liquidity problems, adverse legal or regulatory developments, and the investor's ability and intent to hold until recovery. A temporary market dip does not automatically create impairment.
Exam Traps
- Do not record dividend income for equity-method dividends - reduce the investment instead.
- Do not consolidate when significant influence exists without control.
- Do not ignore fair value basis differences created at purchase.
- Apply the investor's ownership share to the depreciation/amortization difference, not 100% of the investee's amount.
- Do not recognize impairment unless the decline is other than temporary.
Losses Exceeding the Investment and the Fair Value Option
When accumulated equity-method losses reduce the investment to zero, the investor generally stops recognizing further losses and does not record a negative investment, unless it has guaranteed investee obligations or committed to provide further financial support. Recognition resumes only after the investee returns to profitability and the investor's share of subsequent income exceeds the share of losses not previously recognized.
An investor may also elect the fair value option for an equity-method-eligible investment at initial recognition. If elected, the investor reports the investment at fair value with changes in net income and does not apply equity-method rollforward mechanics; the election is irrevocable for that instrument. Watch for fact patterns that mention this election - they change the entire accounting.
Change from Cost/Fair Value to Equity Method
If an investor's ownership rises to the significant-influence level (for example, from 10% to 25%), it adopts the equity method prospectively from the date of the increase. There is no retroactive restatement of prior periods; the carrying amount at the date of change plus the new purchase become the cost basis going forward.
Key Takeaways
Equity-method questions are rollforward questions. Start with cost, add income, subtract losses and dividends, adjust for basis differences and unrealized profits, then test for impairment. Stop recognizing losses at a zero carrying amount absent a guarantee, and switch to the equity method prospectively when influence is gained. If the fact pattern shifts from significant influence to control, stop using the equity method and move to consolidation analysis.
Investor owns 30% of Investee and has significant influence. Investee reports $200,000 of net income and pays $50,000 of dividends. Ignoring basis differences, what is the net increase in Investor's equity method investment account?
Which statement about dividends received from an equity method investee is correct?