Many public companies have at least one large investor. This investor, often another company, can choose to buy a large share of 20 to 40 percent of the subject company's stock, making the target company a subsidiary to the investing company. This entitles the investing company to a portion of the subsidiary company's earnings, in addition to any dividends paid on the stock. Accountants must make several entries to properly record these transactions.
Recording the Investment
For the purposes of example, assume an imaginary company called InvestCo buys 40 percent of another fictional firm, TargetCo's common stock with voting rights, for a total purchase price of $1,000. InvestCo's accountant will debit, or increase, a balance sheet asset account titled "investment in affiliate" for $1,000. The offsetting entry consists of a credit, or reduction, in the cash account for the same amount.
If TargetCo reports $100 of net income, for example, InvestCo records its proportionate share of the $100 as equity income. The accountant debits, or increases, the investment in affiliate account on the balance sheet for $100 x 40 percent, or $40. She offsets this with a credit entry, or increase, in the income statement account labeled "equity income in affiliate."
If TargetCo announces that it will be paying a $20 dividend, in cash, to its shareholders, then the accountant records this entry with a debit, or increase, to the cash account for $20. The investment in affiliate account receives a credit entry, or reduction, for $20.
InvestCo will need to make some income tax entries to account for the income received. Assume InvestCo's corporate tax rate is 35 percent. Also, assume InvestCo must pay taxes on the dividends received in cash. InvestCo received $100 in income from TargetCo, but only $20, or 20 percent, of that money was paid in cash. The remainder still creates a tax liability, but the company must record it as a deferred tax liability. To record the income tax expense, the accountant debits, or increases, the income tax expense account by ($100 x 20 percent) x 35 percent = $20 x 35 percent = $7.
Offsetting Tax Entries
InvestCo's original tax debit entry is offset by two credit entries, which make up the current part of taxes due in cash, and the taxes due in the future, or the deferred tax liability. Cash is credited, or reduced, by ($20 x 20 percent) x 35 percent = $4 x 35 percent = $1.4. Finally, the deferred tax liability account is credited, or increased, by the following amount: [($100 x 20 percent) - ($20 x 20 percent)] x 35 percent = (20 - 4) x 35 percent = $5.6. These two entries together should equal the original income tax expense debit entry of $7.
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