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What is the equity method?

When a company purchases equity securities or invests in another company, there are three ways the investment can be reported: 1) Fair value option, equity method, and consolidation method.

The equity method is used when a company owns 20% to 50% of the outstanding stock of the investment and/or they have significant influence.

Under the equity method, the investment is recorded as an asset on the balance sheet based on the acquired cost (price paid). Subsequent to the initial recording, the investment balance increases when the investment reports net income, and decreases for any net losses or dividends paid by the investment.


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  • How to record the impact of net income and dividends under an equity method investment?

    As the visual below illustrates, net income increases the investment amount on the balance sheet, while dividends decrease the investment (since dividends are paid out of net income / retained earnings). You must take the total net income and dividends reported by the investee and multiply by the investors ownership % to get the investors share of net income and dividends to recognize. The investment rollforward below illustrates the change in carrying value from recognizing net income and dividends from an equity method investment. Example: At the beginning of the fiscal year, Boobaloo purchased 25% of Silicon Valley Robotics (SVR). for $550,000. At the end of the fiscal year, SVR reported net income of $65,000 and declared and paid cash dividends of $30,000. SVR uses the equity method of accounting. The balance at the end of the year would be $558,750.

  • What is the fair value option for reporting equity securities?

    When a company purchases equity securities or invests in another company, there are three ways the investment can be reported: 1) Fair value option, equity method, and consolidation method. The fair value method is used when ownership is less than 20% of the company’s outstanding shares and the investor does not have significant influence. When the fair value method is used, the company would classify the investment as “trading” or “available-for-sale”.