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Companies often earn by investing in other companies. Accounting technique that is employed by organizations to find out the amount of profit that they have earned in other companies is referred to as equity method.
The organization reports this profit in the income statements. The value that is reported is based on the share that the organization has on the assets. The profit that is reported is equal to the equity investment size.
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Getting a detailed understanding of equity method
When one company employs a certain technique and influences another organization, it is referred to as equity method. It can only do so if it owns about 20-25% shares of the other organization. The power that this company can exert includes representation in board of director meetings.
This company can also participate in meetings that are related to developmental policies of the organization. With the help of this equity method technique, investor first tries to find out the initial investment cost and then adjust the value depending on the share of investor in the company’s profits or loses.
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How to adjust investments by earnings?
The method that is used to find out influence that one company exerts on another is referred to as substantive economic relationship between these two organizations. If Investor Company is able to influence financial and operational results of Investee Company, then it will also be able to directly influence value of investee organization. If holding of investor is more than 20% then investor definitely records value of its investments.
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How to adjust investments by loses?
In case an investee company suffers a loss then it lets Investor Company know about it. This definitely decreases investment carrying value. An organization uses equity method to find out and report carrying value of the investment. This is definitely different from fair value in market.
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