Question

Linx Ltd has acquired 70% of shares of Digital Ltd, and 35% of the shares of Innex Ltd. If Linx Ltd was not a parent and therefore did not prepare consolidated financial statements, discuss what the differences would be in the equity accounting for Innex Ltd. (Assume 35% does not constitute control).

Answer 1

Equity method in accounting is the process of treating investments in associate companies. Equity accounting is usually applied where an investor entity holds 20–50% of the voting stock of the associate company. The investor records such investments as an asset on its balance sheet. The investor's proportional share of the associate company's net incomeincreases the investment (and a net loss decreases the investment), and proportional payments of dividends decrease it. In the investor’s income statement, the proportional share of the investor’s net income or net loss is reported as a single-line item.

Equity accounting is usually applied where the entity holds 20–50% of voting stock, since this implies significant influence on the decisions of the associate by the holding company. Equity accounting may also be appropriate where the holding falls outside this range and may be inappropriate for some entities within this range depending on the nature of the actual relationship between the investor and investee. Control of the investee, usually through ownership of more than 50% of voting stock, results in recognition of a subsidiary, whose financial statements must be consolidated with the parent's. They ownership of less than 20% creates an investment position, carried at historic book or fair market value (if available for sale or held for trading) in the investor's balance sheet.