Equity Method

When Company A invests in 20% to 50% of outstanding stock of Company B, it normally indicates that Company A has significant influence over Company B and the investment is accounted for under equity method.

In equity method the investing company records the investment in associate initially at cost. Suppose Company A purchased 25,000 of the 100,000 outstanding shares of Company B at $10 per share on 1 Jan 2011. It records the investment at $250,000 which is the cost of investment (25,000 shares at $10 per share) as shown in the following journal entry:

Investment in Company B$250,000

In subsequent years it adds its share of the associate's profit to the cost of investment. If Company B's profit for the year ended 31 December 2011 is $100,000, it will add $25,000 to the cost of investment calculated as the product of net profit of the associate (Company B) and Company A's holding percentage in Company B (25,000/100,000).

Investment in Company B$25,000
Share in income of associate$25,000

Any dividends received from the associate is subtracted from the cost of investment. If Company B declared dividends of $60,000 in the financial year ended 31 December 2011, Company A will subtract $15,000 (its share in the dividend).

Investment in Company B$15,000

The investment in associate is reported as a non-current asset on the balance sheet at its carrying amount which is calculate as follows:

Carrying amount of investment at the beginning of the yearXXX
Add: share in profit of associateXXX
Less: dividends received from associateXXX
Carrying amount of investment at the year endXXX

Investment in Company B would appear on the balance sheet of Company A at $260,000 calculated as follows:

Investment in Company B as at 1 Jan 2011$250,000
Add: share in profit of Company for FY 2011$25,000
Less: dividends received from Company B in FY 2011$15,000
Investment in Company B as at 31 Dec 2011$260,000

by Obaidullah Jan, ACA, CFA and last modified on
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