What is Equity Accounting?
514 reads · Last updated: December 5, 2024
Equity accounting is an accounting process for recording investments in associated companies or entities. Companies sometimes have ownership interests in other companies. Typically, equity accounting–also called the equity method–is applied when an investor or holding entity owns 20–50% of the voting stock of the associate company. The equity method of accounting is used only when an investor or investing company can exert a significant influence over the investee or owned company.
Definition
Equity accounting is the accounting process for recording investments in associated companies or entities. Typically, when an investor or holding company owns 20-50% of the voting shares of an associate company, equity accounting, also known as the equity method, is used. This method is only applied when the investor or investing company can exert significant influence over the investee company.
Origin
The origin of equity accounting can be traced back to the mid-20th century. As inter-company investment activities increased, traditional accounting methods could not accurately reflect the influence of investors on investee companies. Thus, the equity accounting method was developed to better reflect the financial position and operating results of investors.
Categories and Features
Equity accounting is primarily used for two types of investments: joint ventures and investments in companies where the investor has significant influence but not control. Its features include: the investor having significant influence in the investee company, recognizing investment income proportionally, and adjusting the book value of the investment according to changes in the investee's net assets.
Case Studies
Case 1: Microsoft's investment in LinkedIn. Microsoft acquired LinkedIn for $26.2 billion in 2016. Although it was a full acquisition, prior to the acquisition, Microsoft used the equity accounting method to record its investment in LinkedIn, reflecting its significant influence. Case 2: Coca-Cola's investment in Monster Beverage. Coca-Cola acquired a 16.7% stake in Monster Beverage in 2015, using the equity accounting method to record its investment due to its significant influence in Monster Beverage.
Common Issues
Common issues include: How to determine if an investor has significant influence? This is usually assessed through factors such as shareholding percentage, board seats, and participation in policy-making. A common misconception is that equity accounting applies to all 20-50% shareholdings, but it is only applicable when the investor can exert significant influence.
