Brief Definition
The equity method is an accounting technique used by a company to record its investment in another company, typically when it owns 20-50% of the investee’s shares and can exert significant influence over it. Under the equity method, the investment is initially recorded at cost, and the investor adjusts the carrying amount of the investment to recognize its share of the investee’s profits or losses.
Further Explanation
The equity method is an accounting technique used by a company to record its investment in another company, typically when it owns 20-50% of the investee’s shares and can exert significant influence over it. Under the equity method, the investment is initially recorded at cost, and the investor adjusts the carrying amount of the investment to recognize its share of the investee’s profits or losses. Dividends received from the investee reduce the carrying amount of the investment.
Example:
If Company A owns 30% of Company B, and Company B earns $100,000 in profit, Company A would record $30,000 (30% of $100,000) as its share of the profit, increasing the carrying value of its investment in Company B. If Company B then pays a dividend, Company A reduces its investment by the amount of the dividend it receives.