Big Company owns a 20 percent interest in Little Company purchased on January 1, 2020, for $200,000.

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Question:

Big Company owns a 20 percent interest in Little Company purchased on January 1, 2020, for $200,000. Little then reports net income of $250,000, $300,000, and $400,000, respectively, in the next three years while declaring dividends of $50,000, $100,000, and $200,000. The fair values of Big's investment in Little, as determined by market prices, were $245,000, $282,000, and $325,000 at the end of 2020, 2021, and 2022, respectively.

			Accounting for BIG company under Fair value method			Accounting for BIG company under Equity method
Year	Income of Little Company	Dividends Little Company Declared	Dividend income	Fair-value change to income	Carrying the amount of investment	Equity in investee income	Carrying the amount of investment
	(1)	(2)	(3)	(4)	(5)	(6)	(7)
2020	250,000	50,000	10,000	45,000	245,000	50,000	240,000
2021	300,000	100,000	20,000	37,000	282,000	60,000	280,000
2022	400,000	200,000	40,000	43,000	325,000	80,000	320,000
TOTAL income recognized			70,000	125,000		190,000

Step 1: Fill out Income for Little Company in 2020, 2021, 2022 (Column 1)

Step 2: Fill out dividends declared by Little Company in 2020, 2021, 2022 (Column 2)

Step 3: Compute Dividend Income for Big Company for 2020, 2021, 2022 (Column 3), then get the total income recognized as dividend income in Column 3:

Dividends declared by Little Company x Percentage of ownership = ...............................................

	2020	2021	2022
Dividends declared	50,000	100,000	200,000
Multiply: percentage of ownership	20%	20%	20%
Dividend income	10,000	20,000	40,000

Step 4: Fill out the fair values of Big Company's investment in Little Company in 2020, 2021, and 2022 (Column 5)

	2020	2021	2022
Fair value ending	245,000	282,000	325,000
Less: carrying amount, beginning	(200,000)	(245,000)	(282,000)
Fair value change to income	45,000	37,000	43,000

Step 5: Compute Fair-value change to income for 2020, 2021, and 2022 (Column 4), then get the total income recognized as changes in fair value in Column 4:

The current carrying amount of investment (column 5) - Beginning balance =

2020: 45,000

2021: 37,000

2022: 43,000

Step 6: Compute equity in investee income for Big Company for 2020, 2021, and 2022 (Column 6):

Little Company income x percentage of ownership =

	2020	2021	2022
Income of Little Company	250,000	300,000	400,000
Multiply: % of ownership	20%	20%	20%
Equity in investee income	50,000	60,000	80,000

2020: 50,000

2021: 60,000

2022: 80,000

Step 7: Compute the Carrying Amount of Investment for Big Company (Column 7)

Carrying Amount = Original cost + Income recognized (Column 6) - dividend (Column 3)

2020: 240,000

2021: 280,000

2022: 320,000

	2020	2021	2022
Beginning Balance	200,000	240,000	280,000
Add: equity in investee income	50,000	60,000	80,000
Less: dividends	(10,000)	(20,000)	(40,000)
Ending balance	240,000	280,000	320,000

Example 2: Big Company owns a 20 percent interest in Little Company purchased on January 1, 2020, for $210,000. Little then reports net income of $200,000, $300,000, and $400,000, respectively, in the next three years while declaring dividends of $50,000, $100,000, and $200,000. The fair values of Big's investment in Little, as determined by market prices, were $245,000, $282,000, and $325,000 at the end of 2020, 2021, and 2022, respectively.

			Accounting for BIG company under Fair value method			Accounting for BIG company under Equity method
Year	Income of Little Company	Dividends Little Company Declared	Dividend income	Fair-value change to income	Carrying the amount of investment	Equity in investee income	Carrying the amount of investment
	(1)	(2)	(3)	(4)	(5)	(6)	(7)
2020
2021
2022
TOTAL income recognized