Equity Method of Accounting for Investments in Associates
- Graziano Stefanelli
- Jun 19
- 2 min read
The equity method is applied when an investor exercises significant influence over an investee, typically indicated by ownership of 20% to 50% of voting stock. This accounting method ensures that the investor’s share of the investee’s profits and losses is reflected in the investor’s own financial results, capturing more than just dividends received. The equity method aligns reported asset values with economic reality, particularly when joint decision-making or board representation exists.
1. When to Apply the Equity Method
Significant influence is usually presumed with 20%–50% ownership, but other factors can demonstrate influence, including:
Board representation
Participation in policy-making
Material transactions between investor and investee
Interchange of managerial personnel
Provision of essential technical information
If significant influence is not present, the investment is usually accounted for using the cost or fair value method.
2. Initial Recognition
At acquisition, the investor records the investment at cost, including any directly attributable expenses. The investment is classified as “Investment in Associate” on the balance sheet.
Journal Entry:
Dr. Investment in Associate
Cr. Cash
3. Subsequent Measurement and Share of Earnings
Each period, the carrying amount of the investment is adjusted to reflect the investor’s share of the associate’s net income or loss after acquisition:
Formula:
Adjusted Carrying Value = Initial Cost + Investor’s Share of Associate’s Profits − Investor’s Share of Associate’s Losses − Dividends Received
Accounting Entry for Share of Profit:
Dr. Investment in Associate
Cr. Equity in Earnings of Associate (Income Statement)
Accounting Entry for Dividends Received:
Dr. Cash
Cr. Investment in Associate
Example:
30% stake in Associate Co.
Associate Co. earns $100,000 profit: Investor recognizes $30,000 income and increases investment carrying value.
Dividends of $10,000 received: Reduces investment carrying value by $3,000.
4. Goodwill and Fair Value Adjustments
If acquisition cost exceeds the investor’s share of the net fair value of associate’s identifiable assets and liabilities, the excess is treated as goodwill and included in the carrying amount of the investment.
Fair value adjustments related to the associate’s assets and liabilities at acquisition are also included in the investor’s share of net income (adjusted for additional depreciation or amortization).
5. Impairment Testing
At each reporting date, the investment is tested for indicators of impairment. If the carrying amount exceeds recoverable amount, an impairment loss is recognized:
Dr. Impairment Loss
Cr. Investment in Associate
Impairment losses cannot be reversed under US GAAP; limited reversal is possible under IFRS if circumstances change.
6. Disclosures
Required disclosures include:
Name, nature, and percentage of ownership in associates
Quoted market value, if available
Summarized financial information of significant associates
Investor’s share of net income, other comprehensive income, and dividends
7. Example Table: Equity Method Accounting
Year | Opening Balance | Share of Profit | Dividends | Closing Balance |
1 | $200,000 | $30,000 | $6,000 | $224,000 |
2 | $224,000 | $40,000 | $9,000 | $255,000 |
8. Standards Reference
US GAAP: ASC 323 “Investments—Equity Method and Joint Ventures”
IFRS: IAS 28 “Investments in Associates and Joint Ventures”
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