Accounting for Stock Investment Cost Method
Overview
When the company purchases a stock investment that is less than 20%, it will use the cost method to account for the investment. In this case, the company records the investment at cost and it only recognizes the revenue when it receives the cash dividend from the stock investment.
When the company sells back the stock investment, the cost of the investment will be used to compare with the net proceed from the sale. The net proceed is usually the total amount of sale deducting the brokerage fees.
Stock investment journal entry with the cost method
Under the cost method of accounting, the company can make the journal entry for stock investment on the first day of the purchase by debiting the stock investments account and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Stock investments | $$$ | |
| Cash | $$$ |
Afterward, when the company receives the cash dividend, it can make the journal entry to record the revenue from the investment by debiting the cash account and crediting the dividend revenue.
| Account | Debit | Credit |
|---|---|---|
| Cash | $$$ | |
| Dividend revenue | $$$ |
Example
For example, on September 1, 2020, the company ABC purchases 10,000 shares of XYZ Corporation common stock for $5 per share. The 10,000 shares only represent 10% of XYZ’s total shares. Later, on December 31, 2020, the company ABC receives a $0.2 per share dividend.
What is the journal entry for the stock investment:
- on September 1, 2020, when the company purchases the stock?
- on December 31, 2020, when the company receives the cash dividend?
Solution:
On September 1, 2020
When the company makes the stock investment on September 1, 2020, by purchasing 10% shares of XYZ Corporation, it can make the journal entry for the $50,000 (10,000 x $5) with the cost method of accounting as below:
| Account | Debit | Credit |
|---|---|---|
| Stock investments | 50,000 | |
| Cash | 50,000 |
On December 31, 2020
When the company receives the cash dividend of $2,000 (10,000 x $0.2) on December 31, 2020, it can make the journal entry to recognize the dividend revenue as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 2,000 | |
| Dividend revenue | 2,000 |
It is useful to note that the cost method accounting for stock investment is only used for the stock that the company holds less than 20%. If the company holds the stock from 20% to 50%, it will be deemed as having significant influence; hence, the equity method of accounting will be used instead.
For the stock holding that is more than 50%, the company will be deemed as having a significant control. In this case, the consolidation method of accounting will be used and the company that purchases the stock will be known as the parent company while the company that it purchases the stock from will be known as the subsidiary company.
