Equity Method
The equity method is an accounting technique used by a company to record the profits earned through its investment in another company. With the equity method of accounting, the investor company reports the revenue earned by the other company on its income statement, in an amount proportional to the percentage of its equity investment in the other company.
Definition: The equity method is an accounting technique used to record the profits obtained by a company through its investment in another company. Using the equity method, the investing company reports the income earned by the investee company on its income statement in proportion to its equity investment.
Origin: The origin of the equity method can be traced back to the early 20th century when the accounting community began exploring ways to more accurately reflect inter-company investment relationships. With the increase in mergers and investment activities, the equity method gradually became a standard accounting treatment.
Categories and Characteristics: The equity method is mainly applicable to situations where the investing company has significant influence but not control over the investee company. Its characteristics include: 1. The investing company recognizes its share of the investee company's net profit or net loss based on its ownership percentage; 2. The investing company adjusts the carrying amount of the investment on its balance sheet to reflect the performance changes of the investee company; 3. The investing company reports its share of the investee company's profit or loss on its income statement.
Specific Cases: Case 1: Company A holds 30% of the shares of Company B. Company B achieves a net profit of 1 million yuan in a certain year. According to the equity method, Company A should recognize an investment income of 300,000 yuan on its income statement and increase the carrying amount of the investment by 300,000 yuan on its balance sheet. Case 2: Company C holds 25% of the shares of Company D. Company D incurs a net loss of 400,000 yuan in a certain year. According to the equity method, Company C should recognize an investment loss of 100,000 yuan on its income statement and decrease the carrying amount of the investment by 100,000 yuan on its balance sheet.
Common Questions: 1. In what investment situations is the equity method applicable? The equity method is applicable to investment situations where the investing company has significant influence but not control over the investee company, typically when the ownership percentage is between 20% and 50%. 2. How to handle dividends from the investee company? When the investee company pays dividends, the investing company should reduce the carrying amount of the investment rather than recognize dividend income.
