Definition
The Gross Equity Method is an accounting technique used to record investments in associated undertakings — those in which the investor holds significant influence but not control. Unlike the more common equity method, which represents net assets and net income, the gross equity method requires the investor to show its share of the gross assets and liabilities of the investee on the balance sheet and account for its share of the turnover in the profit and loss account.
Examples
Company A and Company B:
- Suppose Company A invests 30% in Company B. Using the gross equity method, Company A will report 30% of the gross assets and liabilities of Company B on its balance sheet. Additionally, it will record 30% of Company B’s revenue (turnover) on its profit and loss account.
Investment in a Joint Venture:
- If Company X holds a 40% stake in a joint venture, applying the gross equity method, Company X shows 40% of the joint venture’s gross assets and liabilities on its balance sheet. It also records 40% of the venture’s turnover in its profit and loss statement.
Frequently Asked Questions
Q1: What differentiates the gross equity method from the net equity method?
A1: The gross equity method involves reporting the investor’s share of the gross assets and liabilities of the investee, whereas the net equity method records the net assets and net income only.
Q2: When is the gross equity method typically used?
A2: The gross equity method is less common and is primarily used in specific jurisdictions or under certain accounting frameworks which mandate its use.
Q3: How does the gross equity method affect financial ratios?
A3: The gross equity method can inflate total assets and liabilities compared to the net equity method, thereby potentially impacting financial ratios like the debt-to-equity ratio and return on assets.
Q4: What is an associated undertaking?
A4: An associated undertaking is an entity in which an investor holds significant influence, typically indicated by ownership of 20% to 50% of the voting shares, but not full control.
Related Terms
Equity Method: An accounting method where the investment is initially recorded at cost and subsequently adjusted for the investor’s share of the net income or loss of the investee.
Balance Sheet: A financial statement that presents the assets, liabilities, and equity of an entity at a specific point in time.
Profit and Loss Account: Also known as an income statement, this financial document summarizes revenues, costs, and expenses incurred during a specific period.
Turnover: Revenue generated from the normal business activities of a company, often used interchangeably with sales.
Online Resources
Suggested Books for Further Studies
- “Intermediate Accounting” by J. David Spiceland, Mark W. Nelson, Wayne Thomas
- “Financial Accounting: An Introduction to Concepts, Methods, and Uses” by Roman L. Weil, Katherine Schipper, Jennifer Francis
- “Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, Donald E. Kieso
Accounting Basics: Gross Equity Method Fundamentals Quiz
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