Companies frequently buy the stock of other companies. The size of an investment in another company dictates your accounting treatment. The dividing line between the two motivations is 20 percent of outstanding shares, according to generally accepted accounting principles. If you own less than 20 percent of the investee shares, you use the cost method to record equity method investment journal entries investment.
If you own between 20 percent and 50 percent of the shares, you normally use the equity method. You use the cost method when you make a passive but long-term investment in another company. You record the stock on a balance sheet account as a non-current asset at its historical purchase price. For example, if you purchase 10 percent of UVW Corp.
10 million, that amount would be the balance sheet value of the shares. You normally do not update this amount unless you purchase additional shares or sell shares. You book any dividends you receive on the shares as income. If you hold at least 20 percent of the investee’s shares, use the equity method unless you can prove you have no influence over the investee — for example, if the investee treats you hostilely or ignores your advice. Under the equity method, you book the stock purchase as you would under the cost method.
However, you must adjust this balance to account for your share of the investee’s profits and losses. For example, suppose your company purchases 30 percent of XYZ Corp. 150,000, which you add to the balance of XYZ Corp. You subtract losses in the same way. You treat dividends as a return of investment by posting to a contra-asset account linked to XYZ Corp. You do not book dividends as income.