The equity method is a method of accounting whereby the investment is initially recorded at cost, identifying any goodwill/capital reserve arising at the time of acquisition. The carrying amount of the investment is adjusted thereafter for the post acquisition change in the investor’s share of net assets of the investee. The consolidated statement of profit and loss reflects the investor’s share of the results of operations of the investee.
From the definition, following broad conclusions can be drawn:
- In CFS, investment is to be recorded at cost.
- Any surplus or deficit in cost and net asset to be recorded as goodwill or capital reserve. Distributions received from an investee reduce the carrying amount of the investment.
- Any subsequent change in share in net asset is adjusted in cost of investment and goodwill/capital reserve.
- Consolidated Profit & Loss shows the investor’s share in the results of operations of the investee.
Circumstances under which Equity Method is followed
Equity method of accounting is to be followed by all the enterprises having significant influence on their associates except in the following cases:
- Control is intended to be temporary because the investment is acquired and held exclusively with a view to its subsequent disposal in the near future.
- The term ‘Near Future’ is expressed in ASI 8, explained above with AS 21.
Or it operates under severe long-term restrictions, which significantly impair its ability to transfer funds to the investor.
In both the above cases, investment of investor in the share of the investee is treated as investment according to AS 13.
An investor should discontinue the use of the equity method from the date that:
- It ceases to have significant influence in an associate but retains, either in whole or in part, its investment.
- The use of the equity method is no longer appropriate because the associate operates under severe long-term restrictions that significantly impair its ability to transfer funds to the investor.
From the date of discontinuing the use of the equity method, investments in such associates should be accounted for in accordance with AS 13, Accounting for Investments. For this purpose, the carrying amount of the investment at that date should be regarded as cost thereafter.
Application of the Equity Method
- Many of the rules followed under equity method for an associate is similar to consolidated financial statement rules as in case of subsidiary i.e. AS 21.
- Investment in an associate should be recorded as equity from the date when such relation comes in effect.
- Investment in the associate is recorded at cost and any difference in the cost and investor’s share in equity on the date of acquisition is shown as goodwill or capital reserve.