1. Understand the equity method
The equity method is an accounting method used to deal with the accounting treatment of long-term equity investments held by investment enterprises. Under the equity method, an investment enterprise is required to adjust the carrying amount of its long-term equity investment based on changes in the owner's equity of the invested enterprise. This method is mainly applicable to situations where the investing enterprise has significant influence or joint control over the investee enterprise.
2. Scope of application of the equity method
The equity method is mainly applicable in the following situations:
1.The investment enterprise has a significant influence on the invested enterprise, that is, the investment enterprise can exert significant influence on the business decisions and financial policies of the invested enterprise.
2.There is joint control between the investment enterprise and the investee enterprise, that is, the investment enterprise and other investors jointly control the invested enterprise.
3.Other situations in which the investment enterprise does not have control over the investee enterprise, but needs to be accounted for according to the equity method.
3. Steps for equity method entry
1.Determine the initial investment cost
The investment enterprise should determine the initial investment cost based on the actual cost at the time of obtaining the long-term equity investment. The actual cost includes the cash paid by the investment enterprise to obtain the long-term equity investment, the fair value of non-cash assets, and the liabilities assumed.
2.Recognition of investment returns
Under the equity method, the investment enterprise should recognize the investment income based on the net profit or net loss realized by the investee enterprise. The investment enterprise shall calculate the investment income based on the audited annual financial statements of the investee enterprise.
3.Adjust the book value of long-term equity investments
The investing enterprise should adjust the book value of the long-term equity investment according to the changes in the owner's equity of the invested enterprise. Changes include changes in the net profit or net loss realized by the invested enterprise, cash dividends distributed by the invested enterprise, and other comprehensive income of the invested enterprise.
4.Record equity method adjustment entries
The investment enterprise should record the equity method adjustment entries in the accounting books. Equity method adjustment entries mainly include the following:
Borrow: Long-term equity investment (the amount adjusted according to the change in the owner's equity of the invested enterprise).
Credit: Investment income (income recognized based on the net profit realized by the investee enterprise).
Other comprehensive income (the amount adjusted according to the change in other comprehensive income of the investee company).
5.Long-term equity investments are measured at the end of the period
The investor should measure the value of the long-term equity investment at the end of the period. The value of a long-term equity investment should be determined based on the initial investment cost plus an equity method adjusted amount.
4. Precautions
1.For long-term equity investment under the equity method, detailed accounts should be set up to record investment costs, profit and loss adjustments, and other comprehensive income.
2.Under the equity method, the investee should pay close attention to the financial status and operating results of the investee enterprise, and adjust the book value of the long-term equity investment in a timely manner.
3.When disposing of long-term equity investments under the equity method, the balance of the corresponding detailed accounts shall be transferred to investment income or other comprehensive income.
The equity method is an important accounting method used to deal with the accounting treatment of long-term equity investments. By determining the initial investment cost, recognizing investment income, adjusting the carrying amount of long-term equity investments, recording equity method adjustment entries, and measuring long-term equity investments at the end of the period, investors can ensure that the accounting treatment of long-term equity investments complies with relevant regulations.