Equity method
The equity method is an accounting procedure for accounting for investments in and relationships with associated companies and joint ventures in the individual and consolidated financial statements.
The basic idea of the equity method is to develop a mirror image of the carrying value in the balance sheet of the investor to the development of the proportionate equity in the companies involved. The method makes it possible to collect at the aperture of the realization principle gains from investments before they are realized.
In contrast to the assessment under the historical cost principle, the gains and losses of the associate have a direct impact on the consolidated or separate financial statements of the company involved. As such, the equity method of full consolidation of subsidiaries in the consolidated financial statements is similar and has features of a consolidation method (see also: Consolidated Financial Statements ). In contrast to the full or proportionate consolidation, the investment is shown as an asset or asset and evaluated. The individual assets of the associate are not included in the balance sheet of the investor. As such, the equity method is a method of valuation.
- 4.1 Accounting standards
- 4.2 Literature
- 4.3 External links
- 4.4 Notes and references
Scope
A company in which another company (investor) a significant but exerts a controlling influence and to which the investor holds shares, is considered by several accounting systems as an associate of the investor. Shares in associated companies and business relationships with these should account for the investor in its consolidated financial statements in the rule for using the equity method. The U.S. GAAP provide for the application of the equity method in the financial statements. While the IFRS accounting under the equity method already provide in the ability to exercise significant influence, the German Commercial Code, the latter also only with the actual exercise of significant influence.
An investor has a " significant influence " over another undertaking if he indeed has the opportunity to participate in decisions on the financial and operating policies of the company, but he can not control this company. To clarify this definition, several indicators have been developed to individually or together indicate that there is a significant influence. Common indicators are:
- The investor has a representative on the executive and / or supervisory body or a similar governing body of the investee,
- Exist between the investor and the investee companies significant business,
- The investor participates in the decision-making processes of the associated company,
- Between the investor and associated undertakings managers is replaced,
- The investor, the associate important technical information.
In the event that an investor holds at least 20% and less than 50 % of the voting rights in an associate is entitled, suspect all accounting systems that the investor has significant influence over the associate. Depending on the accounting system voting rights to be added, which are exercised through subsidiaries. Furthermore, ( 28.8 IAS) are counted also certain potential voting rights in the accounting under IFRS. Can prove to the investor that he still does not have significant influence, contrary to the presumption or to exercise, he needs the equity method is not applied. Even if the investor has less than 20% of the voting rights may exist, which can be demonstrated by the presence of one or more of the above indicators has a significant influence.
The application of the equity method to investments in joint venture will vary from one accounting system:
U.S. GAAP, do not know the proportionate consolidation method, the application of the equity method also demand to joint ventures to which the investor has significant influence. This practice was introduced by abolition of IAS 31 in the IFRS. The German Commercial Code provides, however, for joint venture proportionate consolidation before, but recognizes companies an option to opt for the equity method here.
Recognizing an interest under the equity method
As a rule sees the equity method of accounting for the shares on the asset side of the balance sheet as an asset or asset ago. A separate disclosure of assets and liabilities of the associate in the balance sheet as at the full consolidation or proportionate consolidation does not take place.
A distinction is made between the initial and subsequent measurement. The initial assessment is carried out typically at the time at which for the first time met the participation criteria of evaluation according to the equity method. Subsequent measurement is typically carried out at each subsequent quarterly and annual financial statements.
Initial
On initial recognition, investments in associates is performed with the original acquisition cost of the shares.
In the initial assessment, the investment is initially recorded at the book value, with whom she has also been recognized in the financial statements at the time of initial evaluation. Is the time of the initial evaluation at the time of acquisition of the investment agreement, the carrying value corresponds to the cost.
In addition to bills now in the carrying amount of the components pro rata equity, unrealized gains and business or goodwill is allocated. The values determined here are relevant to the subsequent accounting.
First, the value of the proportionate equity of the investor is determined in the associate. The value of the proportionate book value of equity on the balance sheet of the associate. The following is a difference between the proportionate book value of equity and cost of the investment is made.
In the next step, the hidden reserves are calculated on the balance sheet of the associate and proportionately allocated to the investor. However, this is only up to the maximum amount of the difference. If the difference is higher than the share of the hidden reserves, the remaining amount is to be regarded as business or goodwill. In the calculation of the share of equity, potential voting rights are to be disregarded in all accounting systems, see, for example, IAS 28.12.
Subsequent measurement
At each subsequent balance sheet date, the chosen value of the investment in the associate is modified by increases or decreases. The increases or decreases include the following facts:
/ - Share of profits or losses of associated companies
- Distributions to investors
/ - Other changes in proportional equity interest
- Depreciation of hidden reserves, which were revealed at the acquisition date
- If necessary. Updating a business or goodwill
/ - If necessary. Impairment of the carrying value and reversal
- Eliminations of intercompany profits
Increase the canceled upon the investor " share profits and losses of the associate " or reduce the carrying value in the period in which they are shown in the associated company. In this period, they are shown as equity income or loss in the profit and loss account of the investor.
Distributions to the investor reduce the carrying value of the shares of the associated company, without a change in earnings is shown in the consolidated financial statements or financial statements of the investor. If the distribution shown as equity income in the separate financial statements of the investor, this is to be eliminated in preparing the consolidated financial statements.
Other changes in shareholders' equity are shown in the associated company profit or loss, also lead to an earnings-neutral changes in the interest value of the associate.
Determined at the time of the initial hidden reserves are amortized in the income statement. Therefore, the carrying amount of the associated company diminishes in favor of the expense of the investor. The amount of depreciation depends on the depreciation of the assets to which the hidden reserves relate.
In some accounting systems (eg under the German Commercial Code), a value determined in the initial goodwill value is amortized over its useful life.
In other accounting systems ( eg IFRS and U.S. GAAP ) of the business or goodwill or goodwill is not amortized from the initial valuation. Under IFRS, the investment takes place only in the context of impairment tests also an indirect continuation of the business or goodwill. A separate impairment test of the goodwill value is in accordance with U.S. GAAP.
Impairment of the carrying value and write-up:
The determined under the equity method carrying amount of the investment as a whole is subject to an impairment test.
Requirements for the completion of the associate
For the valuation of the shares of the investor in the associated company, the financial statements of the associate is fundamental. Two problems may arise:
1 The financial statements should be possible on the date of the investor.
2 The financial statements should be prepared in accordance with accounting policies of the investor.
In principle, the underlying financial statements of the associate should be on the date of the initial evaluation or the closing date of the investor. Deviates from the reporting date of the associate of the reporting dates, as interim financial statements of the associate should be applied. However, it may be difficult for the investor to get these interim financial statements or to create. In these cases, a conclusion will be based on its effective date deviates up to three months from the date of the investor. Under IFRS, this conclusion is, however, to significant business transactions that occur between the reporting date of the financial statements and the date of the investor to modify. Notwithstanding this, it is sufficient according to U.S. GAAP, if those transactions are only given in the Appendix. Under German GAAP, it is even necessary only when the last available financial statements of the associated company is used without modification.
It is also necessary that the financial statements of the associate are prepared in accordance with the accounting rules of the investor. If the investor, for example, its financial statements according to IFRS rules, so the underlying financial statements of the associate should also be set up according to the rules of IFRS. The IFRS also require that for like transactions and the accounting and valuation methods of the investor be applied (IAS 28.26 ). This does not require the U.S. GAAP. If only one using accounting rules and methods as imputed completion is available, this should be modified accordingly ( IAS 28.27 ) before it can be used for applying the equity method.
Some accounting systems, as IFRS or U.S. GAAP, are characterized by Wesentlichkeitsgedanken. Therefore, the investor needs the above-required modifications to the financial statements of associates there, only to the extent to make, such as the impact on its financial statements are material.
Additional items to consider when using the equity method aspects
- Elimination of intercompany profits from deliveries between reporting entities and associating companies
- Method with a negative book value
- Deferred taxes
- Additional disclosures in the notes and the balance sheet