Equity Method Investments
The equity method is used to account for investments where the investor has significant influence (typically 20-50% ownership) over the investee, recognizing the investor's share of the investee's income and adjusting the investment balance.
Explanation
Under the equity method, the investment is initially recorded at cost. The investor then adjusts the carrying amount for its share of the investee's net income (increasing the investment) and dividends received (decreasing the investment). The investor also amortizes any excess of cost over the investor's share of the investee's net assets (basis differences) over the useful lives of the underlying assets.
Significant influence is presumed at 20% or more of voting stock, though this is rebuttable. The equity method is sometimes called "one-line consolidation" because the investor reports its share of the investee's results in a single line on the income statement and a single line on the balance sheet. Intercompany profits on transactions between investor and investee must be eliminated proportionally.
Key Points
- •Significant influence presumed at 20-50% voting ownership
- •Investment adjusted for share of income (increase) and dividends (decrease)
- •Basis differences amortized over useful lives of underlying assets
- •Intercompany profits eliminated proportionally
Exam Tip
Know the journal entries: debit investment for share of income, credit investment for dividends received. Basis difference amortization reduces investment income.
Frequently Asked Questions
Related Topics
Consolidations
Consolidation is the process of combining the financial statements of a parent company and its subsidiaries into a single set of financial statements, eliminating intercompany transactions and balances.
Financial Instruments
Financial instruments include cash, equity investments, debt investments, derivatives, and other contracts that give rise to financial assets and financial liabilities.
Intercompany Transactions
Intercompany transactions are transactions between related entities within a consolidated group that must be eliminated in consolidation to avoid double-counting revenues, expenses, assets, and liabilities.
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