The formulas
Equity in earnings = ownership % × investee net income − basis difference amortization − intra-entity profit eliminated. Closing carrying amount = opening + investment + equity in earnings + ownership % × OCI − dividends received. The framework is ASC 323-10.
When to use it
Use it to recompute a client's investment balance and equity income, test the roll-forward in the audit file, or see how basis difference and unrealized profit change income.
Limits
It applies one ownership percentage for the year. It does not handle step acquisitions, changes in ownership, preferred stock, investee equity transactions, different fiscal year ends or the impairment assessment for the investment. The basis difference input should be the amount assigned to depreciable or amortizable assets only.
Illustrative figures only. Check the result against your firm's methodology before relying on it.
Common questions
How is the carrying amount rolled forward?
Ending carrying amount = beginning + additional investment + share of investee net income (or − loss) − basis difference amortization − intra-entity profit eliminated + share of OCI − dividends received. Dividends reduce the investment because they are a return of what the investor already recognized.
What is a basis difference?
The difference between the investor's cost and its share of the investee's book equity. The part assigned to depreciable or amortizable assets is expensed over their remaining lives through equity in earnings. Equity method goodwill is not amortized.
How is intra-entity profit treated?
The investor eliminates its share of profit on assets still held that were sold between the investor and the investee, and recognizes it when the asset is sold or consumed. The tool eliminates ownership percentage times the change in unrealized profit during the year.
What happens when losses exceed the investment?
The carrying amount is reduced to zero. The investor does not recognize further losses unless it has guaranteed the investee's obligations, committed to provide financial support, or holds other investments in the investee that absorb them. Later income is recognized only after it exceeds the losses not recognized.
When does the equity method apply?
When the investor can exercise significant influence over the investee's operating and financial policies without controlling it. Ownership of 20% or more of the voting stock creates a presumption of significant influence, and ownership under 20% creates a presumption against it. Both can be overcome.
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