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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. 

 

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