Equity accounting is a method used to account for investments in associate companies. An associate company is a company where the investor has significant influence but not control. This means that the investor can influence the associate's operating and financial policies but doesn't have the power to control them.
What is Equity Accounting?
Equity accounting is based on the principle of recognizing the investor's share of the associate's net income or loss in the investor's own financial statements. This is done by adjusting the investment balance to reflect the investor's share of the associate's profit or loss.
How to Calculate Equity Accounting:
- Determine the percentage of ownership: The first step is to determine the investor's percentage of ownership in the associate company. This is usually based on the number of shares owned by the investor.
- Calculate the share of net income or loss: The investor's share of the associate's net income or loss is calculated by multiplying the percentage of ownership by the associate's net income or loss for the period.
- Adjust the investment balance: The investment balance is adjusted to reflect the investor's share of the associate's net income or loss. This is done by adding the investor's share of net income or subtracting the investor's share of net loss.
Example:
Let's say Company A owns 30% of Company B. Company B reports a net income of $100,000 for the year.
- Investor's share of net income: 30% * $100,000 = $30,000
- Adjustment to investment balance: The investment balance in Company A's financial statements will be increased by $30,000.
Practical Insights:
- Equity accounting is used to provide a more accurate representation of the investor's financial position.
- It allows investors to recognize the economic benefits or losses associated with their investment in associate companies.
- Equity accounting is a common accounting practice for investments in associate companies.
Conclusion:
Equity accounting is a method of accounting for investments in associate companies where the investor has significant influence but not control. The method involves recognizing the investor's share of the associate's net income or loss in the investor's own financial statements.
