CFA Practice Question

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CFA Practice Question

Western Manufacturing Company owns 40% of the outstanding common stock of Eastern Supply Company. During 2011, Western received a $50 million cash dividend from Eastern. What effect did this dividend have on Western's 2011 financial statements?

A. Total assets decreased.
B. Net income increased.
C. The investment account decreased.
Correct Answer: C

Under the equity method, the investment account is reduced by any dividends received from the investee.

User Contributed Comments 8

User Comment
YeahMe Isn't that investment account is part of total assets? please confirm, anyone
mtnn yes but the investee must have paid the 60% to outside entities.
Nancie For Western, their cash increased from the dividend received, but investment account decreased at the same time, so net effect for total asset is zero.
danlan2 Good comment, Nancie. Investment account decreased, but the investment revenue did not, investment revenue depends on the net income only, not the dividend.
vi2009 Cool danlan2, that is good clarification for me tq
quanttrader in equity method, only net income is recorded as investment revenue; div is deducted from the investment account.
Teeto dividend increased cash account and decreased the investment account so total assets did not change.

One may reason about dividend through an extreme case - the associate ceases to exists and repays all equity in the form of dividend to the shareholders. That would bring some cash out of the associate but then there will be no investment.
birdperson @nancie nailed it.
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