Investment in associates
Overview
When the company purchases a certain number of shares of the common stock of another company that represents from 20% to 50%, it can record the purchase as an investment in associates. In this case, the company needs to make various journal entries for the investment in associates, such as the acquisition of associate journal entry, income from associate and cash dividend from associate journal entry, etc.
When the company owns between 20% and 50% of the common stock of the investee company, it is presumed that the company has significant influence over the financial and operating activities of the investee. In this case, the company needs to recognize the investment as the investment in associates and follow the equity method of accounting when it records transactions relating to such investment.
For example, under the equity method, the company needs to record its share of the investee’s net income as an increase in investment in associates, and at the same time, it needs to recognize it as an income or revenue from investments (even though there is no cash received at all). Meanwhile, when it receives a cash dividend from the associates, it needs to record it as a decrease in investment as the cash dividend here will decrease the investee’s net asset.
Investment in associates journal entries
Acquisition of associate journal entry
The company can make the journal entry for the acquisition of associates by debiting the investment in associates account and crediting the cash account
| Account | Debit | Credit |
|---|---|---|
| Investment in associates | 000 | |
| Cash | 000 |
Investment in associates account is an asset account on the balance sheet. Likewise, its normal balance is on the debit side of the trial balance.
Income or loss on investment in associates journal entry
At the end of the period, the company can record the income from associates with the journal entry of investment in associates account on the debit side and the income from investments account on the credit side.
Income from investment in associates
| Account | Debit | Credit |
|---|---|---|
| Investment in associates | 000 | |
| Income from investments | 000 |
As the investment in associates follows the equity accounting, the company needs to record income from associates that result from the net income of the investee company as an increase in the investment in associates account on the balance sheet.
On the other hand, if there is a loss in the investee company, the company will need to record the loss as a decrease in the investment in associates account as in the journal entry below.
Loss on investment in associates
| Account | Debit | Credit |
|---|---|---|
| Loss on investments | 000 | |
| Investment in associates | 000 |
Dividend received from associates
When the company receives the cash dividend from the associates, it can make the journal entry by recognizing the cash received as a decrease in the investment in associates as in the journal entry below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Investment in associates | 000 |
The company records the cash dividend received from associate as a decrease in investment in associates because when the investee company makes the dividend payment, it results in the reduction of its net asset.
Investment in associates example
For example, on January 1, 2020, the company ABC acquires 30% shares of the common stock of the XYZ corporation for $240,000. At the end of 2020, XZY corporation reports a net income of $150,000. And at the same time, it also declares and pays the cash dividend of $60,000 to its shareholders.
What are the journal entries for the investment in associates above on January 1, 2020, and December 31, 2020?
Solution:
On January 1, 2020
As the 30% share of the common stock of XZY corporation represents the investment in associates, the company ABC can make the journal entry for the acquisition of associate for $240,000 on January 1, 2020, as below:
| Account | Debit | Credit |
|---|---|---|
| Investment in associates | 240,000 | |
| Cash | 240,000 |
On December 31, 2020
Income from investment in associates
When the XZY corporation reports the net income of $150,000 on December 31, 2020, the company ABC can record its shares of income of $45,000 ($150,000 x 30%) as income from investments and as an increase in the investment in associates in the journal entry below:
| Account | Debit | Credit |
|---|---|---|
| Investment in associates | 45,000 | |
| Income from investments | 45,000 |
Dividend received from associates
On December 31, 2020, after XYZ corporation declares and pays the cash dividend of $60,000 to its shareholders, the company ABC can record $18,000 ($60,000 x 30%) as a decrease in investment in associates account as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 18,000 | |
| Investment in associates | 18,000 |
After the above journal entries, the balance of investment in associate of XYZ corporation will be $267,000 ($240,000 + $45,000 – $18,000) as at December 31, 2020.