Question

With equity method of accounting, equity investment means there is controlling ownership and revenue increased the investment account and didvidends reduce the equity account. How does this relate with consolidation?

Answer 1

Equity method of accounting is used to account for an organisations investment in another company. here the investor has significant control over the books of investee. Investor recognises the share of profits and losses of investee andand these effect the accounts of the investee. It will make that any adjustments in profits/losses of the investee will effect the investment made by the investing company.

Actually by investing in investee company we will have ownership depending on our share in their investments, if the investor holds more than 20% of holdings in investee company then investor will have ownership rights on the books of investee company. By having control over the books we have to prepare consolidated books of accounts which is very tough task. Actually there were three accounting treatments for the situation they wew cost, equity and consolidation.

Suppose you buy 40 percent of the stock in a $1 million company – a $400,000 expense. Under equity accounting, you report the $400,000 acquisition as an asset on the balance sheet. When the second company announces earnings, you report 40 percent of the earnings as your own income. If it reports $300,000 of net income for the year, you report $120,000 of that – 40 percent – as earnings on your income statement. The value of the asset on your balance sheet increases by $120,000. If, instead, the company reports losses, you adjust the asset's value down.

If you control the other company, you have to draw up consolidated financial statements. These add the subsidiary's income, expenses and assets to your own. If, say, your company generates $300,000 in revenue and the subsidiary brings in $160,000, you report income of $460,000. However, if you do any business with the subsidiary – contracting with it for services or supplies, for example – you have to eliminate those deals from your income statement. Consolidated accounting doesn't count the salf.

As above said when we have control over the subsidiary company we should prepare consolidated financial statements and while calculating you should eliminate all those subsidiary incomes while preparing consolidated financial statements. Thus if t generates income then such income will be shown in our books as income if any loss generated from such investment then such loss should be reduced from such investments.

By having more investments the dividends generated from such investments will be reduced due to dividend per share will depend on the number of equity held in such subsidiary company.