You use the equity method of accounting to record an investment in another company over which you have a significant influence. This typically occurs when you own approximately 20 to 50 percent of the investee company’s shares outstanding. Under this method, the investment’s value in your accounting records fluctuates based on your share of the investee’s dividends and income. When you sell the investment for an amount that is greater than the investment’s value in your books, you must record a gain on the sale, which increases your profit.
1. Determine the price for which you sold an investment and the investment’s equity method balance in your accounting records at the time of the sale, which is the investment’s book value. For example, assume you sold an investment for $100,000 and that the investment had a $60,000 book value in your accounting records.
2. Subtract the investment’s book value from the sale price to determine the gain on sale of the investment. In this example, subtract $60,000 from $100,000 to get a $40,000 gain.
3. Debit the cash account in a journal entry in your accounting records by the investment’s sale price. This increases the cash account by this amount. In this example, debit the cash account by $100,000.
4. Credit the account called “investment in equity method securities” in the same journal entry by the investment’s book value. This reduces the investment account by this amount. In this example, credit the investment in equity method securities account by $60,000.
5. Credit the account called “realized gain on sale of investment” in the same journal entry by the amount of the gain. This increases this account, which records the gain and increases your profit. Continuing with the example, credit the realized gain on sale of investment account by $40,000.
- PrinciplesofAccounting.com: Chapter Nine -- Long-Term Investments
- Accounting -- Concepts and Applications, 11th Edition; W. Steve Albrecht et al.
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