Equity and Cost Methods in Accounting Essay Example | Topics and Well Written Essays - 250 words

Equity and Cost Methods in Accounting - Essay Example The cost method, therefore, shows a bigger value for the investment than the equity method. Since dividends under the cost method are a form of revenue, they create taxable income. For example, if the Investee Corporation pays out $1.50 per share in dividends in 2011, Investor Corporation’s income is $12,000. In the 25 percent tax bracket, its tax liability would be $4,000. The equity method affects income greatly and hence has an effect on income taxes. Suppose Investee Corporation records income of $100,000 in 2011. Investor Corporation would record income of $20,000. The tax liability would $5,000. Income is more volatile than the dividend yield hence the equity method is more likely to affect the Investor Corporations tax liability. Since earnings of the investee corporation keep changing from year to year, it would be recommendable that the Investor Corporation should use the fair value method. That would help it avoid reporting the share of the investee’s earnings and losses that it bears. The changes in earnings of the Investee over the years will, therefore, have little effect on the value of the investment over