{"id":16102,"date":"2022-02-25T09:14:56","date_gmt":"2022-02-25T09:14:56","guid":{"rendered":"https:\/\/seunkolade.com\/?p=16102"},"modified":"2025-04-02T08:43:35","modified_gmt":"2025-04-02T08:43:35","slug":"equity-method-of-accounting-for-investments","status":"publish","type":"post","link":"https:\/\/seunkolade.com\/?p=16102","title":{"rendered":"Equity Method of Accounting for Investments"},"content":{"rendered":"<p><img decoding=\"async\" class='wp-post-image' style='display: block;margin-left:auto;margin-right:auto;' src=\"https:\/\/www.bookstime.com\/wp-content\/uploads\/2019\/09\/QB_Advanced.png\" width=\"259px\" alt=\"equity method of accounting\"\/><\/p>\n<p>When an investee declares a dividend, the investor reduces the carrying amount of their investment by the dividend amount. This approach reflects that dividends represent profits already recognized in the investor\u2019s share of the investee\u2019s earnings. The cost method of accounting  is used when an investor owns less than 20% of the investee, holding a minority interest.<\/p>\n<p><img decoding=\"async\" class='aligncenter' style='display: block;margin-left:auto;margin-right:auto;' src=\"https:\/\/www.bookstime.com\/wp-content\/uploads\/2019\/09\/Hubdoc.png\" width=\"257px\" alt=\"equity method of accounting\"\/><\/p>\n<h2>Updated Carrying Amount Calculation<\/h2>\n<p>Company B reports a net income of $400,000 and declares dividends of $100,000 during the year. This  entry increases the carrying amount of the investment and recognizes the investor\u2019s share of the OCI in the equity section of the balance sheet. Equity method accounting can be complex, but analyzing real-world examples helps illustrate the key concepts. Here are some case studies and lessons learned from companies applying the equity method.<\/p>\n<h2>Equity Method of Accounting: Definition and Example<\/h2>\n<ul>\n<li>FASB considers a significant influence criterion based on the ownership of outstanding securities whose holders possess voting privileges.<\/li>\n<li>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.<\/li>\n<li>Any profit and loss should be recorded in a proportional amount to the percentage of shares, with dividends deducted from the account.<\/li>\n<li>The initial measurement reflects that there are basis differences of $300 in this transaction, consisting of $100 unrecorded intangible assets (customer relationship) and $200 goodwill.<\/li>\n<li>Indicators of impairment include significant financial difficulties faced by the investee, declining cash flows, or adverse market conditions.<\/li>\n<li>Significant influence can emerge, for instance, when an investor gains board representation and participates in policymaking by conducting substantial inter-company transactions or when the investee becomes technologically dependent.<\/li>\n<\/ul>\n<p>Company A sold shares, reducing its ownership to 10%, and the fair value of the remaining investment is $300,000. On the income statement, the <a href=\"https:\/\/www.bookstime.com\/articles\/equity-method-of-accounting\">equity method of accounting<\/a> investor&#8217;s share of the investee&#8217;s net income or loss is presented as a single line item called &#8220;Equity in Earnings\/Losses of Investee&#8221;. Under IFRS, the equity method is applied when the investor has significant influence over the investee. Significant influence is presumed with a shareholding between 20-50%, unless it can be clearly demonstrated not to exist. These practical illustrations reveal the beauty and intricacy of the equity method\u2014every entry tells a story of intertwined businesses, each dependent on the other for financial accuracy and success.<\/p>\n<ul>\n<li>Imagine you\u2019re on a financial seesaw; on one end is the equity method and on the other, different accounting treatments like the cost method or consolidation.<\/li>\n<li>Receive the latest financial reporting and accounting updates with our newsletters and more delivered to your inbox.<\/li>\n<li>This influence allows the investor to participate in the financial and operating policy decisions of the investee, distinguishing it from passive investments.<\/li>\n<li>Therefore, usually a difference exists between the investor\u2019s carrying amount of an equity method investment and its proportionate share of the investee\u2019s net assets.<\/li>\n<li>To further demonstrate the equity method of accounting, we will also provide examples of some of the more common accounting transactions that apply to an equity investment.<\/li>\n<li>The equity method applies when an investor has &#8216;significant influence&#8217; over the investee.<\/li>\n<li>As a result, the investor can exert significant influence over the investee\u2019s operational and strategic decisions.<\/li>\n<\/ul>\n<h2>Cost Method<\/h2>\n<p><img decoding=\"async\" class='aligncenter' style='display: block;margin-left:auto;margin-right:auto;' src=\"https:\/\/www.bookstime.com\/wp-content\/uploads\/2019\/08\/info-7.png\" width=\"253px\" alt=\"equity method of accounting\"\/><\/p>\n<p>The investor must compare the investment\u2019s carrying amount to its fair value, which may involve valuation techniques such as discounted cash flow models. If the fair value is less than the carrying amount, an impairment loss is recorded in the investor\u2019s income statement. This ensures the investment\u2019s book value reflects its fair market value, offering stakeholders a transparent view of the investor\u2019s financial position. Conversely, if the investee incurs a $100,000 net loss, the investor would record a $30,000 reduction in <a href=\"https:\/\/www.youtube.com\/results?search_query=retained+earnings\">retained earnings<\/a> the investment\u2019s carrying value. If cumulative losses reduce the carrying value to zero, further losses are generally not recognized unless the investor has guaranteed obligations or made additional commitments to support the investee.<\/p>\n<p><img decoding=\"async\" class='aligncenter' style='display: block;margin-left:auto;margin-right:auto;' src=\"https:\/\/www.bookstime.com\/wp-content\/uploads\/2019\/12\/QBooks.png\" width=\"253px\" alt=\"equity method of accounting\"\/><\/p>\n<ul>\n<li>Special dividends or non-cash distributions, such as stock dividends, may require additional analysis to determine their impact on the investment\u2019s carrying value.<\/li>\n<li>This entry increases the carrying amount of the investment and recognizes the investor\u2019s share of the OCI in the equity section of the balance sheet.<\/li>\n<li>In this article, we\u2019ll cover how and when to use the equity method of accounting for an investment.<\/li>\n<li>If impairment exists, the investor must calculate its share of the impairment loss and record an impairment charge to reduce the carrying amount of the investment.<\/li>\n<li>When indicators of impairment are present, the investor must assess whether the carrying amount of the investment exceeds its recoverable amount.<\/li>\n<li>It makes periodic adjustments to the asset\u2019s value on the investor\u2019s balance sheet to account for this ownership.<\/li>\n<\/ul>\n<p>Technological dependency occurs when the investee relies on the investor for essential technology, intellectual property, or proprietary processes. This dependency can create a situation where the investee\u2019s operations are significantly influenced by the investor\u2019s technology and expertise. As a result, the investor can exert significant influence over the investee\u2019s operational and strategic <a href=\"https:\/\/www.pinterest.com\/pin\/1129770256525059495\/\">Grocery Store Accounting<\/a> decisions. The exchange of managerial personnel between the investor and the investee is another indicator of significant influence.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>When an investee declares a dividend, the investor reduces the carrying amount of their investment by the dividend amount. This approach reflects that dividends represent profits already recognized in the investor\u2019s share of the investee\u2019s earnings. The cost method of accounting is used when an investor owns less than 20% of the investee, holding a [&hellip;]<\/p>\n","protected":false},"author":34583,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[70],"tags":[],"class_list":["post-16102","post","type-post","status-publish","format-standard","hentry","category-bookkeeping"],"_links":{"self":[{"href":"https:\/\/seunkolade.com\/index.php?rest_route=\/wp\/v2\/posts\/16102","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/seunkolade.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/seunkolade.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/seunkolade.com\/index.php?rest_route=\/wp\/v2\/users\/34583"}],"replies":[{"embeddable":true,"href":"https:\/\/seunkolade.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=16102"}],"version-history":[{"count":1,"href":"https:\/\/seunkolade.com\/index.php?rest_route=\/wp\/v2\/posts\/16102\/revisions"}],"predecessor-version":[{"id":16103,"href":"https:\/\/seunkolade.com\/index.php?rest_route=\/wp\/v2\/posts\/16102\/revisions\/16103"}],"wp:attachment":[{"href":"https:\/\/seunkolade.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=16102"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/seunkolade.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=16102"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/seunkolade.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=16102"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}