Power Generation Corp. owns 38% of Electric Limited. Net income for Electric Limited for the year ending December 31, 2020, is $450,000. The journal entry prepared by Power Generation Corp. on December 31, 2020, includes a:
A) credit to Long-Term Investment for $171,000
B) debit to Cash for $171,000
C) debit to Long-Term Investment for $171,000
D) debit to Long-Term Investment for $450,000

Question

Quizplus · Accepted Answer

When a company owns less than 50% of another company, it is considered an investment in equity securities and accounted for using the equity method. Under this method, the investor's share of the investee's net income is recorded as an increase in the investor's investment account. In this case, Power Generation Corp. owns 38% of Electric Limited and therefore, its share of Electric Limited's net income of $450,000 is $171,000 (38% x $450,000). Hence, the correct journal entry prepared by Power Generation Corp. on December 31, 2020, would be a debit to Long-Term Investment for $171,000 to record its share of Electric Limited's net income.