Equity Method of Accounting
Equity accounting is a method used by companies to record the undistributed profits earned by their investments in other companies. The income earned from the investment is reported on the investing company's income statement based on the percentage of the other company that it owns. In many cases, the corporation never actually receives the profits from the company that's owned.
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Equity
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This accounting method generally is used when the investing company owns between 20 percent and 50 percent of another company, allowing for the exertion of influence over management's decision-making processes. The investing company records the equity as an asset.
Stocks
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This form of accounting is associated with publicly traded companies. The equity accounting method for common stock reflects the value, or economic substance, of owning common stock in another company. Many public and private companies invest in the stock market as a way to put excess money to work. Sitting on piles of cash that's not earning interest is the same as losing money.
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Investments
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Over time, money decreases in value. Inflation subsequently decreases each dollar in terms buying power. But inflation can be offset by investing in other companies and earning a higher interest rate on the invested cash. These earnings are recorded through equity accounting in common stock.
Consolidated Statements
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Once an investing company has acquired a significant percentage of a company's common stock and has the power to exert control over the decision-making process, a consolidated set of financial statements are required. The consolidated financial statements are a representation of how the investing company is doing overall, factoring in the investments. The consolidated statements provide a true and fair view of the financial standing of the company.
Legal Entities
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Consolidated financial statements are not an indication that the two separate legal entities have been consolidated into one. Only certain financial data is consolidated for the appropriate representation of a company's value and performance. Even if 100 percent of the invested company is owned, the two companies still will move forward as two separate legal entities.
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