What Is Equity Accounting?

Equity accounting is an accounting process for recording investments in associated companies or entities. Companies sometimes have ownership interests in other companies. Typically, equity accounting–also called the equity method–is applied when an investor or holding entity owns 20–50% of the 澳洲幸运5开奖号码历史查询:voting stock of the associate company. The equity method of accounting is used only when an investor or investing company 💧can exert a significant influence over the investee or owned company.

Understanding Equity Accounting

The investee company will record a profit or loss for the period in its own income statement. Under the 澳洲幸运5开奖号码历史查询:equity method, an investing company will recognize it's share of the investee company profit or loss for the period in its own 澳洲幸运5开奖号码历史查询:income statement. The share it recognize♔s will💮 be it's percentage ownership in the investee company.

The initial investment amount in the company is recorded as an asset on the investing company's 澳洲幸运5开奖号码历史查询:balance sheet. The investing company records its share of 🧸profit or loss in the income statement for the year; at the same time the profit increases the investment value, while losses would decrease the investment amount on the balance sheet.

Equity Accounting and Investor Influence

Under equity accounting, the biggest consideration is the level of investor influence over the operating or financial decisions of the investee. When there's a significant amount of money invested in a company by another company, the investor can exert influence over the financial and operating decisions, which ultimately impacts the financial results of the investee.

🉐While no precise measure cꦫan gauge an exact level of influence, several common indicators of operational and financial policies include:

• Board of directors representation, meaning a seat on the board of the owned company
• Policy-making participation
• Intra-entity transactions that are material
• Intra-entity management personnel interchange
• Technological dependence
• The proportion of ownership by the investor in comparison to that of other investors

When an investor acquires 20% or more of the voting stock of an investee, it is presumed that, without evidence to the contrary, that an investor maintains the ability to exercise significant influen♚ce over the investee. Conversely, when an ownership position is less than 20%, there is a presumption that the investor does not exert significant influence over the investee unless it can otherwise demonstrate such ability.

Interestingly, substantial or even majority ownership of an investee by another party does not necessarily prohibit the investor from also having significant influence with the investee. For instance, many sizable institutional investors may enjoy more impli✨cit control than their absolute ownership level would ordinarily allow.

Equity Accounting vs. Cost Method

If there is no significant influence over the investee, the investor instead uses the cost method to account for its investment in an associated company. The cost method of accounting records the cost of the investment as an asset at its historical cost and the investor does not recognize earnings of the investee. Instead, it recognizes dividend income when the investee distributes dividends. The carrying amount remains at historical cost, unless the investee's value declines permanently. In this case, this value is written down.

On the other hand, the equity method makes periodic adjustments to the value of the asset on the investor's balance sheet since they have a 20%-50% controlling investment interest in the investee.

The Bottom Line

The equity method is an accounting technique for reporting financials when one company invests in another. If the investing company has a significant stake, the company will report the value and profits of the investee on its own financial statements.