Equity Method
An accounting approach for investments with significant influence (typically 20-50% ownership), recording initial investment at cost and adjusting for proportionate share of earnings.
Equity Method
An accounting approach for investments where the investor has significant influence but not control over the investee, typically applied when ownership interest ranges from 20% to 50%, recording the initial investment at cost and subsequently adjusting for the investor’s share of the investee’s earnings or losses.
For example, if Company A purchases a 30% stake in Company B for $3 million, it initially records the investment at $3 million. When Company B later reports $500,000 in quarterly earnings, Company A increases its investment account by $150,000 (30% of $500,000) and recognizes $150,000 in investment income. If Company B pays $200,000 in dividends, Company A reduces its investment account by $60,000 (30% of $200,000).
The equity method reflects economic reality by showing the investor’s stake in the investee’s changing net assets, unlike the cost method which only recognizes dividend income. The investor’s proportional share of investee earnings increases the investment account, while its share of losses and dividends decreases it. This approach applies to investments with significant influence, presumed when ownership is 20-50% absent evidence to the contrary, and sometimes applied outside this range based on governance structures or contractual arrangements.