An investor company with a 40% interest in an investee properly used the equity method to account for the investment. If the entries to the Investment account for the current year showed a debit of $45,000 and a credit of $22,000, the investee must have paid total dividends of:
A) $45,000
B) $55,000
C) $22,000
D) $100,000

Question

Quizplus · Accepted Answer

Under the equity method, the investor records its share of the investee's net income (or loss) and dividends as adjustments to the Investment account. A debit to the Investment account indicates a decrease in the value of the investment, while a credit indicates an increase. Since the Investment account had a net decrease of $23,000 ($45,000 debit - $22,000 credit), we know that the investee paid dividends during the period.

To calculate the total dividends paid by the investee, we need to determine the investee's total net income for the period. Since the investor's share of net income is accounted for through adjustments to the Investment account, we can find the investee's net income by multiplying the total adjustments by the investor's ownership percentage. In this case, the total adjustments are $23,000 / 40% = $57,500.

If we assume that the investee distributed all of its net income as dividends, we can calculate the total dividends paid by the investee as follows:

Total Dividends = Investee's Net Income - Investor's Share of Net Income 
Total Dividends = $57,500 - ($57,500 × 40%) = $57,500 - $23,000 = $34,500

However, we don't know for certain that the investee distributed all of its net income as dividends. It's possible that the investee retained some of its earnings for future growth. Therefore, we can only say that the investee paid at least $34,500 in dividends during the period. The closest answer choice to this amount is B ($55,000), so that is the best choice.

An Investor Company with a 40% Interest in an Investee