Definition
The equity method is a method of accounting for investments in associated undertakings where the investor initially records the investment at its cost. The carrying amount is adjusted in subsequent periods to reflect:
- The investor’s share of any profit or loss of the investee, net of goodwill amortization or write-off.
- The investor’s share of other comprehensive income (OCI) items or changes in the investee’s net assets.
Finally, the investor’s share of the associate’s results is typically included immediately after the group operating profit in the consolidated profit and loss account.
Examples
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Snapshot Media Ltd: If Snapshot Media Ltd. buys 30% of the shares in Tech Innovations Inc. for $1,000,000, they initially record the investment at cost. If Tech Innovations Inc. earns $200,000 net income and declares $50,000 dividends, Snapshot Media Ltd. will reflect their share (30%) of Tech Innovations Inc.’s results in Tech Innovations Inc.’s financials ($60,000 share of profit - $15,000 dividends received) and adjust their investment’s carrying amount on their balance sheet accordingly.
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Global Resources Inc.: Global Resources Inc. holds 25% of Energy Solutions Co. At year-end, Energy Solutions Co. reports a negative net change in OCI of $40,000 due to foreign currency translations. Global Resources Inc. will reduce its carrying amount of the investment by the share of OCI ($10,000, being 25% of $40,000) and detail the change in its financial statements.
Frequently Asked Questions
How is the initial investment recorded under the equity method?
The initial investment is recorded at cost, including identifiable goodwill arising from the purchase.
What happens to the investment’s carrying amount over time using the equity method?
The carrying amount is adjusted for the investor’s share of the net income or loss, OCI items, and other changes in the associate’s net assets.
How do you account for dividends received from the investee?
Dividends received from the investee reduce the carrying amount of the investment and are not recognized as income.
What is the relevant international accounting standard for the equity method?
The relevant International Accounting Standard is IAS 28, Investments in Associates and Joint Ventures.
How are the profits of associates presented in financial statements?
The share of the associates’ results is typically included immediately after the group operating profit in the consolidated profit and loss account.
Related Terms
Goodwill: The asset that captures the excess of the purchase price over the fair value of an acquired company’s identifiable net assets.
Amortization: The process of gradually writing off the initial cost of an intangible asset over its useful life.
Carrying Amount: The value at which an asset is recognized on the balance sheet after deducting any accumulated depreciation or impairment losses.
Net Assets: The total assets minus total liabilities of a company.
Financial Reporting Standard Applicable in the UK and Republic of Ireland (FRS 102): A financial reporting framework that provides detailed guidance on accounting practices in the UK and Ireland.
International Accounting Standard (IAS): Standards for financial reporting issued by the International Accounting Standards Board (IASB).
Online References
Suggested Books for Further Studies
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“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Covers detailed accounting methods including the equity method.
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“Financial Accounting: An Introduction to Concepts, Methods, and Uses” by Roman L. Weil, Katherine Schipper, Jennifer Francis
- Provides a comprehensive overview of accounting principles including investment accounting.
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“Advanced Accounting” by Debra C. Jeter and Paul K. Chaney
- Delves into advanced topics including the equity method of accounting for investments.
