Sunday, 4 March 2012

Equity Method of Accounting: Basic Principles

Investments in associates are accounted for using the Equity Method of Accounting. Equity method is also known as “One-line Consolidation”.
Under equity method of accounting:
· The equity investment is initially recorded on the investor’s Balance Sheet at cost.
· In subsequent periods, the carrying amount of the investment is adjusted for:
i. Investor’s proportionate share of the investee’s earnings or losses and these earnings or losses are reported in the investor’s Income Statement.
ii. Dividends or other distributions received from the investee reduce the carrying amount of the investment and are not reported in the investor’s Income Statement.

The current market value of the stock is ignored but the proportionate share of the earnings is added to the original investment and the proportionate share of the dividends is subtracted from the earnings i.e.
Total value of the investment = Original Investment + (earnings - dividends)

· If the investment value is declined to zero, the investor discontinues using equity method and does not record further losses. If in subsequent periods investee reports profits, the equity method is resumed only when the investor’s share of the profits equals the share of losses not recognized during the suspension of the equity method.
· Equity method investments are classified as Non-Current Assets on the Balance Sheet.
· The Equity method income is reported as Non-Operating Income.
· Goodwill is included in the carrying amount of the investment and is not reported separately. where, Goodwill = Cost of acquisition – investor’s share of the fair value of the Net Identifiable assets.

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