Equity Method of Accounting ASC 323 for Investments and Joint Ventures

When Company A (the investor) has significant influence over Company B (the investee)—but not majority voting power—Company A accounts for its investment in Company B using the equity method of accounting. Company B is considered an unconsolidated subsidiary of Company A in such circumstances, from Company A’s perspective, but could be a freestanding, publicly traded corporation. A company is generally considered to have significant influence, but not control, when it owns 20% – 50% of the voting interest in the unconsolidated subsidiary. The company does not actually record the subsidiary’s assets and liabilities on its balance sheet. Rather, the Investment in Affiliate (or Equity Investment) non-current asset account on the balance sheet serves as a proxy for the Company A’s economic interest in Company B’s assets and liabilities. The equity method is a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets.

The companies each apply their ownership interest, 25%, to JV XYZ’s first year and second year losses to determine their proportionate share of losses to record in current period earnings. Each company’s share of the losses is $20,000 ($80,000 x 25%) for the first year and $30,000 ($120,000 x 25%) for the second year. This article discussed the fundamentals of the equity method accounting for investments. A comprehensive discussion of equity method accounting is beyond the scope of this article.

Equity accounting vs. other accounting methods

Entity B’s assets include real estate with a carrying amount of $20m and fair value of $35m and remaining useful life of 15 years. For other assets and liabilities, the carrying amount approximates fair value. Consequently, any eventual dividend received from Little is a reduction in the investment in Little account rather than a new revenue.

• An equity method investment is valued as of a specific reporting date with any activity related to the investment recorded through the income statement.
• For example, if a firm owns 25% of a company with a $1 million net income, the firm reports earnings from its investment of $250,000 under the equity method.
• On Big’s income statement for Year One, investment income—Little is shown as $80,000.
• It is used when the investor holds significant influence over the investee but does not exercise full control over it, as in the relationship between a parent company and its subsidiary.
• Consider an example where the investor has a 40% equity investment in a foreign entity, which has a book value of $4,600, and accounts for it based on the equity method.
• It would then also include an entry that deducted the portion of the business it didn’t own.
• When calculating its share of the investee’s profits, the investor must also eliminate intra-entity profits and losses.
• Investors may sell (downstream transactions) or purchase (upstream transactions) assets to or from investees.

In other words, there is an outflow of cash from the investee, as reflected in the reduced investment account. Profit and loss from the investee increase the investment account by an amount proportionate to the investor’s shares in the investee. It is known as the “equity pick-up.” Dividends paid out by the investee are deducted from the account. The balance sheet value would be written https://www.bookstime.com/articles/equity-method-of-accounting down to reflect the loss of a deferred tax asset, which would reflect the deduction the company could claim if it were to take the loss by selling the shares. On 1 January 20X0, Entity A acquires 25% interest in Entity B for $150m and accounts for it using the equity method. Entity B’s net assets as per its financial statements amount to $350m and this approximates their fair value.

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Any goodwill created in an investment accounted for under the equity method is ignored. This research project is designed to undertake a fundamental assessment of the equity method of accounting in terms of usefulness to investors and difficulties for preparers. During the first year and second years, JV XYZ has net losses of $80,000 and $120,000, respectively.

• A minority interest is the portion of a company’s stock that is not owned by its parent company.
• The equity method is a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets.
• The income statement would never show the 5% of Saks’ yearly profit that belonged to Macy’s.
• However, if the company produces net income of $5 million during the next year, you would take 40% of that amount, or $2 million, which you would add to your listed value, and record as income.
• These materials were downloaded from PwC’s Viewpoint (viewpoint.pwc.com) under license.
• We should note that these types of transactions often impact multiple periods until the transaction cycle is fully complete.

Equity investments are evaluated for impairment anytime impairment factors are identified that might indicate that the fair value of the asset is not recoverable. A capital call is when an investee requires its investors to make additional capital contributions. In some types of agreements, each investor has an obligation to the investee for a total amount of capital over a specific period of time. Subsequent contributions or capital calls increase the carrying value of the investment. Investors may sell (downstream transactions) or purchase (upstream transactions) assets to or from investees. ASC 323 requires that investors and investees engage in these activities as arm’s length transactions.