Equity Method

Loading the player...

What is the 'Equity Method'

The equity method is 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.

RELATED TERMS
  1. Operating Profit

    The profit earned from a firm's normal core business operations. ...
  2. Income Investment Company

    A money management firm whose primary investment goal is to generate ...
  3. Net Income - NI

    1. A company's total earnings (or profit). Net income is calculated ...
  4. Accounting Earnings

    The amount of money a company has earned during a given period, ...
  5. Discounted Future Earnings

    A method of valuation to estimate the value of a firm.
  6. Net Investment Income

    Income received from investment assets (before taxes) such as ...
Related Articles
  1. Investing

    Find Investment Quality In The Income Statement

    Use these key attributes to uncover top-level investments.
  2. Personal Finance

    Everything Investors Need To Know About Earnings

    We go over the concepts behind the excitement over the most important figure in the stock market.
  3. Managing Wealth

    Valuing Private Companies

    You may be familiar with publicly-traded companies, but how much do you know about privately-held firms?
  4. Investing

    How Do Accountants Use the Equity Method?

    The equity method is an accounting technique used by firms to assess the profits earned by their investments in other companies.
  5. Investing

    Valuing A Company Using The Residual Income Method

    Residual income is the income a company generates after accounting for the true cost of its capital, which is the cost of funds it uses to finance its business.
  6. Investing

    Explaining Market Value of Equity

    Market value of equity is the total value of all the outstanding stock as measured in the stock market at a particular time.
  7. Investing

    Accounting For Intercorporate Investments

    Understanding these investments is key to determining the value and future prospects of any business.
  8. Markets

    Calculating Economic Profit

    Economic profit is the difference between the revenue a firm earns from sales and the firm’s total opportunity costs.
  9. Investing

    Growth Investing

    Growth investing is a strategy where an investor seeks out companies demonstrating signs of high earnings that are well above the average rate compared to other firms in their industry and within ...
  10. Trading

    Valuing A Company Using The Residual Income Method

    Learn the underlying basics behind the residual income model and how it can be used to place an absolute value on a firm.
RELATED FAQS
  1. How does a company record profits using the equity method?

    Understand what the equity method of accounting is and what it's used for. Learn how a company record profits using the equity ... Read Answer >>
  2. What is the difference between private equity and venture capital?

    Learn the differences between private equity and venture capital, especially in terms of how these types of firms invest ... Read Answer >>
  3. How should I analyze a company's financial statements?

    Discover how investors and analysts use a company’s financial statements to evaluate a company's financial health and investment ... Read Answer >>
  4. What is the difference between earnings and income?

    See how earnings and income are different and when they are used in relation to personal finance versus a business' financial ... Read Answer >>
  5. What's the difference between an income statement and a balance sheet approach?

    Understand more about the principle purposes and primary differences between a company's income statement and its balance ... Read Answer >>
  6. Is maximizing stock price the same thing as maximizing profit?

    Simply put: yes. A company's stock price will factor in many different variables including the type of industry the firm ... Read Answer >>
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center