Question

What is the Equity Method of accounting for an investment and what is the most important factor in determining if this method is appropriate?​

Answer 1

Equity Method of Accounting for an investment

Equity Method of accounting is used to account for an organization's investment in another entity (the investee). This method is only used when the investor has significant influence over the investee. Under this method, the investor recognizes its share of the profits and losses of the investee in the periods when these profits and losses are also reflected in the accounts of the investee. Any profit or loss recognized by the investing entity appears in its income statement. Also, any recognized profit increases the investment recorded by the investing activity, while a recognized loss decreases the investment.

The most important factor in determining if equity method is appropriate

The equity method is only used when the investor can influence the operating or financial decisions of the investee. If there is no significant influence over the investee, the investor instead uses the cost method to account for its investment. Therefore the significant influence is the most important factor in determining if equity method is appropriate.