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.

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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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RELATED FAQS
  1. How does a company record profits using the equity method?

    A company that invests in another company and has majority control of it would record profits using the equity method. This ... Read Full Answer >>
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    The equity and proportional consolidation accounting methods are distinguished from one another by how a company's balance ... Read Full Answer >>
  3. What is the accounting treatment for discontinued operations in IFRS and U.S. GAAP?

    Discontinued operations are company assets or components that have either been disposed of or are being held for sale. The ... Read Full Answer >>
  4. What are the sources of funding available for companies?

    Despite all the differences among companies, there are only a few sources of funds available to all firms. 1. They make ... Read Full Answer >>
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    All three of these terms refer to the degree of ownership that a parent company holds in another company. In most cases, ... Read Full Answer >>
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