Question

(Investment Accounted for under the Equity Method) On July 1, 2018, Fontaine Company purchased for cash 40% ofthe outstanding common stock of Knoblett Company. Both Fontaine Company and Knoblett Company have a December 31 year-end.

Knoblett Company, whose common stock is actively traded in the over-the-counter market, reported its total net income forthe year to Fontaine Company and also paid cash dividends on November 15, 2018, to Fontaine Company and its other stockholders.

Instructions

How should Fontaine Company report the above facts in its December 31, 2018, balance sheet and its income statement for theyear then ended? Discuss the rationale for your answer.

Short answer

Income from investment is reported in the income statement.

Step-by-step solution

Definition of equity method

The equity is the portion of funds of company which are invested by the owners of the company.

Treatment of investment revenue

The share of the income is reported in the balance sheet under the head of shareholder’s equity. On the other hand, the dividend received increases the cash. It is recorded in the income statement under the authority of additional income; the dividend decreases the investment's carrying value.