A company is considered a subsidiary of another if that second company, the parent, exerts substantial or total control over the subsidiary. The exact relationship and the accounting methods they use directly affect how the parent treats subsidiary dividends. The three applicable methods are the equity method, the fair-value reporting option of the equity method, and the consolidation method.
For individuals or companies with relatively small investments in other companies, the dividend payout is treated as income. The company receiving the payment books a debit to the dividends receivable account, and a credit to the dividend income account for the payout. The recipient records this transaction when it gains the rights to the payout. These rights stem from owning the stock on the record date. When the company receives the cash on the payment date, it records a debit to the cash account and a credit to the dividends receivable account for the payout.
The equity method applies when the parent company owns 20 to 50 percent of the subsidiary's common stock. The parent company must have substantial influence upon the subsidiary for the equity method to apply. The parent company books the purchase cost of the subsidiary's common stock by debiting the investment in the subsidiary account and crediting the cash account. When the subsidiary pays a dividend, the parent company reduces its investment in the subsidiary by the dividend amount. To do so, the parent company enters a debit to the dividends receivable account and a credit to the investment in subsidiary account on the business day after the record date. The parent company reports the effects of this transaction on its balance sheet.
Fair Value Option
The Financial Accounting Standards Board created the fair value option to the equity method in 2007. It has several accounting consequences, but most require the parent company to value its investment in a subsidiary at its current fair market value. That value is usually the trading price of the subsidiary's stock. For accounting purposes, the parent company reduces its investment in the subsidiary by the dividend amount, but does recognize the dividend as income. The parent company reports the effects of the dividend on its balance sheet and income statement.
The financial reports are consolidated when the parent company owns the majority of the subsidiary's stock. Consolidation is a complex accounting process that melds together all of the interaction between the parent company and the subsidiary. Under consolidated accounting, dividend payments are considered internal transfers of cash and are not reported on the public statements.