In the case of an investment in equity securities where the investor does n and the investment is carried at fair value, a dividend from the investee is
A) a reduction of the carrying amount of the investment.
B) income to the investor in the period of declaration.
C) an expense to the investor in the period of declaration.
D) a direct increase to retained earnings of the investor to offset the retained earnings of the investee.
The correct answer and explanation is:
The correct answer is B) income to the investor in the period of declaration.
When an investor holds equity securities classified as fair value investments, any dividends received from the investee are treated as income in the period in which the dividend is declared. This treatment is consistent with the accounting standards for financial instruments, specifically for investments in equity securities that are not classified as part of a significant influence or control relationship.
Under fair value accounting, the carrying amount of the investment is adjusted based on the fair market value of the securities at the reporting date. However, dividends are not considered a reduction in the carrying amount of the investment, nor are they an expense to the investor. Instead, they are recognized as income in the period the dividend is declared or paid.
This method contrasts with the equity method of accounting, where dividends may reduce the carrying value of the investment in the investee. However, under the fair value method, dividends are recognized directly in the income statement as income, reflecting the investor’s return on investment.
Thus, the key point is that the dividend is recorded as income to the investor, which increases their revenue for that period, and the carrying value of the investment is not directly impacted by the dividend. This treatment helps ensure the accuracy of financial reporting by reflecting the economic benefits received from the investment separately from changes in the market value of the securities.
In conclusion, dividends from equity securities held at fair value are income to the investor in the period of declaration and are reflected in the income statement, rather than affecting the carrying amount or retained earnings.