Equity Method

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DEFINITION of 'Equity Method'

An accounting technique used by firms to assess the profits earned by their investments in other companies. The firm reports the income earned on the investment on its income statement and the reported value is based on the firm's share of the company assets. The reported profit is proportional to the size of the equity investment. This is the standard technique used when one company has significant influence over another.

BREAKING DOWN 'Equity Method'

When a company holds approximately 20-25% or more of another company's stock, it is considered to have significant control, which signifies the power that a company can exert over another company. This power includes representation on the board of directors, partaking in company policy development and the interchanging of managerial personnel. If a firm owns 25% of a company with a $1 million net income, that firm would report earnings of $250,000.

When the equity method is used to account for ownership in a company, the investor records the initial investment in the stock at cost, and then that value is periodically adjusted to reflect the changes in value due to the investor's share in the company's income or losses.

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