What Investments Would Normally Be Accounted Under the Equity Method?

by Lisa Bigelow

When an entity has at least 20 percent voting rights in a company, the entity must report the investment on its financial statements using the equity method. The International Accounting Standards Board Rule 28 describes the investor as having "significant influence" but not control, joint or otherwise. Investors don't always need IAS Rule 28, however; rules depend upon the type of investment over which the entity has significant influence.

Evidence of Association

According to IASPlus.com, there are several key points that identify a significant influence investor. If the investor is on the board of directors or has a similar position of authority and participates in company policy decisions, it's significant influence. Investments that the investor makes in the company should demonstrate materiality. If the company's management interchanges or if there is a technological dependency on the part of the investee, evidence of association exists.

IAS 28 Accounting

If the investor meets these criteria, then it must report the investment using IAS 28's rules. There are exceptions to IAS 28 in limited circumstances, and the equity method doesn't have to be used if the investor meets all four of the IASB's conditions. If the investor is a partially or wholly owned subsidiary of another company, and the company doesn't object to accounting for the investment in another way, then the investor doesn't have to use the equity method. If the investor doesn't have publicly traded debt or equity instruments of its own -- and doesn't plan to -- then IAS 28 doesn't apply. Finally, if the investor's parent company files consolidated financial statements that abide by international standards, then the equity method doesn't apply.

How it's Used

When the investor first reports the investment, it's reported at cost. Following this, the investor adjusts the value of the investment up or down depending upon the performance of the company. If the investor loses its money in the company, then it no longer has to apply the equity method on its financial statements, according to IASPlus.com. Also, if the investor loses significant influence in the investment, then it no longer has to report the investment under the equity method.

Proportional Share

Once the investor determines whether or not it has significant influence, it must report the proportional share of ownership on its own financial statements. Initially, the investment is recorded at cost; over time, the proportional share adjusts based on the company's performance. The investor records the proportional ownership value on a single line item on its own income (profit and loss) statement. If the investor owns more than 50 percent of the company's outstanding common stock, then the investor advances beyond significant influence to having control over operations.

About the Author

Lisa Bigelow is an independent writer with prior professional experience in the finance and fitness industries. She also writes a well-regarded political commentary column published in Fairfield, New Haven and Westchester counties in the New York City metro area.

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