An investor must consider the substance of a transaction as well as the form of an investee when determining the appropriate accounting for its ownership interest in the investee. If the investor does not control the investee and is not required to consolidate it, the investor must evaluate whether to use the equity method to account for its interest. The flowchart below illustrates the relevant questions to be considered in the determination of whether an investment should be accounted for under the equity method of accounting. The debit entry increases the balance sheet carrying value of the investment by the share of net income. The credit entry reflects the income in the income statement of the investor.

The cost and equity methods of accounting are used by companies to account for investments they make in other companies. Here’s an overview of the two methods, and an example of when each could be applied. Investees reflect the DTAs and DTLs resulting from temporary differences between the carrying amounts of their pre-tax assets and liabilities and their tax bases in their financial statements. Therefore, they make all their DTA and DTL adjustments for inside basis differences before publishing their financial statements. Using Q&As and examples, KPMG provides interpretive guidance on equity method investment accounting issues in applying ASC 323. This November 2023 edition incorporates updated guidance and interpretations.

Equity transactions of associate or joint venture

The FASB has made sweeping changes in the last two decades to the accounting for investments in consolidated subsidiaries and equity securities. However, it has left the accounting for equity method investments largely unchanged since the Accounting Principles Board released APB 18 in 1971. When an investor exercises full control over the company it invests in, the investing company may be known as a parent company to the investee.

• The difference is that it’s only for this minority stake and doesn’t represent all the shareholders in the other company.
• However, the amount is subsequently adjusted to account for your share of the company’s profits and losses.
• By using the equity method the investor reflects any earnings, dividends and changes in the value of the investee as they arise in the investment account.
• Lion receives dividends of $15,000, which is 30% of $50,000 and records a reduction in their investment account.
• When the investee company pays a cash dividend, the value of its net assets decreases.
• This ~3% ownership percentage is much lower than the normal 20% required for the equity method of accounting.

Entity A recognises the change in net assets attributed to its holding in its P/L. Exchange differences that arise when translating an investee’s financial statements into the investor’s presentation currency are recognised in OCI (IAS 21.44). This research project is designed to undertake a fundamental assessment of the equity method of accounting in terms of usefulness to investors and difficulties for preparers. This ~3% ownership percentage is much lower than the normal 20% required for the equity method of accounting.

What are the Other Possible Accounting Methods?

These assets include real estate with a carrying amount of $20m and a fair value of $35m, with a remaining useful life of 15 years. For other assets and liabilities, the carrying amount is roughly equivalent to their fair value. When considering the questions in the decision tree, an investor must take into account the specific facts and circumstances of its investment in the investee, including its legal form. The two red circles in the decision tree highlight scenarios in which the equity method of accounting would be applied. Some of the more challenging aspects of applying the equity method of accounting and accounting for joint ventures are discussed next.

• When considering the questions in the decision tree, an investor must take into account the specific facts and circumstances of its investment in the investee, including its legal form.
• The carrying value of the investment shown on the balance sheet is summarized as follows.
• As such, there are questions an investor should ask to make this determination.
• Consider an example where the investor has a 40% equity investment in a foreign entity, which has a book value of $4,600, and accounts for it based on the equity method.