The Equity Method in Investment Accounting

How does the equity method work in accounting for investments?

The equity method is a type of accounting used in investments to recognize the amount of influence an investor has on another company that is receiving investment. When a corporation acquires 20% or more of the voting stock of another firm, it is regarded as an affiliate, giving the investor the power to exert significant influence over the investee's decisions. The investor's asset account is credited for the cash paid, and a revenue account is debited for the investor's share of the investee's earnings. Similarly, the investor's asset account is debited, and a revenue account is credited for dividends paid by the investee. On the investor's balance sheet, the investment account is reported using the equity method as a single line item for all equity-method investments owned by the investor. This line item represents the carrying amount of all equity-method investments and should be reported in the non-current assets section of the balance sheet.

Calculating Book Value using the Equity Method

Red Co. holds a long-term investment with a significant influence in Ashton, Inc. Red acquired 3,000 shares, or 40%, of Ashton for $50,000. During the previous year, Ashton had $30,000 of net income, and in the current year, Ashton reported $40,000. No dividends were distributed in either year. Red will report book value of this investment on December 31 of the current year at $ __________