Next video:
Loading the player...

Equity method is an accounting term describing how a company accounts for its ownership interest in another company’s stock when that ownership interest is above 20% of the voting shares, but less than 50%.

Under the equity method of accounting, if a corporation owns more than 20% of a company, it is presumed that the corporation is able to exert some control, even though a less than 50% interest in a company is technically referred to as a non-controlling interest.  This is often due to the corporation having a seat on the owned company’s board, or significant transactional interdependence between the two companies.

When the equity method is used, the owning company will include a proportionate share of the owned company’s profits in its own income.  In addition, it will increase the value it carries for that owned company by that same amount on its accounting books.

For instance, Conglomo owns 25% of ABC, Inc.  Conglomo purchased its share in ABC for $50 million, which is the historical cost amount Conglomo shows for ABC on its balance sheet.  Conglomo exerts control over ABC because some of its corporate officers sit on ABC’s board.  If ABC earns $20 million for the year, Conglomo will have a line item in its income statement titled “Earnings From Controlled Corporation,” and will report $5 million in income on that line (25% of $20 million.)  In addition, Conglomo’s balance sheet account for its ABC investment will increase by $5 million to $55 million. 

 

Related Articles
  1. Insights

    How a Recession Affects a Business

    Ever wonder what happens to a big business during a recession? Consider the plight of the fictitious corporation Conglomo.
  2. Small Business

    What Happens in a Carve-Out?

    A carve-out happens when a corporation isolates part of its business and shares those profits with a third party.
  3. Insurance

    How to Calculate a Combined Ratio

    Combined ratio is a formula used in the insurance industry to measure the performance of an insurance company.
  4. Investing

    The Impact Of Share Repurchases

    Share repurchases can impact investors and companies in different ways.
  5. Investing

    What is the Price-to-Sales Ratio?

    The price-to-sales ratio is an indicator of the value placed on each dollar of a company’s sales or revenues.
  6. Investing

    What is an Impaired Asset?

    An impaired asset is one where the fair market value of the asset is less than the historical cost (or book value) of the asset.
  7. Small Business

    What's Capitalization?

    Capitalization has different meanings depending on the context.
  8. Small Business

    Why Do Companies Go Offshore?

    The term offshore simply means to be located or based outside of a nation’s boundaries.
  9. Investing

    Calculating Book Value of Equity Per Share (BVPS)

    Book value of equity per share compares the total shareholder equity, as stated in the company’s balance sheet, to the total number of shares outstanding.
  10. Investing

    What's Share Capital?

    Share capital, also called equity financing, is the total amount of money and property a company has received for selling its shares to shareholders.
Hot Definitions
  1. Leveraged Buyout - LBO

    The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. ...
  2. Current Assets

    A balance sheet account that represents the value of all assets that can reasonably expected to be converted into cash within ...
  3. Tax Liability

    The total amount of tax that an entity is legally obligated to pay to an authority as the result of the occurrence of a taxable ...
  4. Preferred Stock

    A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares ...
  5. Net Profit Margin

    Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage ...
  6. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
Trading Center