Skip to main content
/2 min read

Equity Method Accounting

Equity Method Basics

When to Use

Investor owns 20-50% of investee with significant influence.

Initial Recording

Investment recorded at cost on the balance sheet.

Periodic Updates

Investor's share of investee's net income flows to investor's income statement.

Dividends

Reduce the investment account on receipt; not income.

Master Financial Modeling at Noble Desktop

Noble Desktop's Financial Analyst Training Program covers financial modeling, valuation, accounting, and Excel for finance.

Learn about the equity method, a technique used to assess a company's investment in another company when significant influence is held, understanding the 'significant influence' threshold, and how adjustments are made to the investment value based on the investor's percentage ownership in net income, loss, and dividend payouts.

  • The equity method is used to value a company's investment in another company when it holds significant influence over the company it is investing in
  • The threshold for "significant influence" is commonly a 20-50% ownership
  • Under the equity method, the investment is initially recorded at historical cost, and adjustments are made to the value based on the investor's percentage ownership in net income, loss, and dividend payouts
  • Net income of the investee company increases the investor's asset value on their balance sheet, while the investee's loss or dividend payout decreases it
  • The investor also records the percentage of the investee's net income or loss on their income statement
Infographic titled 'Equity Method Accounting' showing three steps: (1) When buying between 20% and 50%, record the investment as a long-term asset at full price, (2) Include the proportion of net income in the consolidated income statement, and (3) Reduce the balance sheet investment when dividends are paid, while cash balance increases.

Example:

Tiger Inc. Purchases 30% of Panther Corp for $500,000. At the end of the year, Panther Corp reports a net income of $100,000 and a dividend of $50,000 to its shareholders.

When Tiger makes the purchase, it records its investment under “Investments in Associates/Affiliates”, a long-term asset account. The transaction is recorded at cost.

Tiger receives dividends of $15,000, which is 30% of $50,000 and records a reduction in their investment account. The reason for this is that they have received money from their investee. In other words, there is an outflow of cash from the investee, as reflected in the reduced investment account.

Finally, Tiger records the net income from Panther as an increase to its Investment account.

The ending balance in their “Investments in Associates” account at year-end is $515,000. It represents a $15,000 increase from its investment cost.

This reconciles with their portion of Panther’s retained earnings. Panther reports a net income of $100,000, which is reduced by the $50,000 dividend. Thus, Panther’s retained earnings for the year are $50,000. Tiger’s portion of the amount is $15,000.