What Is the IFRS Equity Method?
The IFRS equity method is a style of accounting used under for companies that own a significant amount of equity in another company. This method should be used when the company in question owns between 20 and 50 percent of another company through investment in its equity. As a result, International Financial Reporting Standards (IFRS) requires that such a company must account for any change in the fortunes of the company in which it has invested. If the IFRS equity method is used, the reporting company must claim a percentage of the other company's net income equal to the portion of the equity that is owned.
Corporations that are governed by IFRS must provide accurate financial statements as a part of their business obligations. In this way, potential investors and shareholders can benefit from the financial transparency. Part of doing business as a large corporation involves investing in other businesses, and there are certain rules that must be followed on those occasions. When the investment is significant enough that a company gains some decision-making power in the other business, the IFRS equity method comes into play.
It is necessary for a company to use the IFRS equity method when it owns between 20 and 50 percent of the equity of another firm. This usually means that the investing company has enough equity to have some authority on the future of the second company. If the amount of the investment is less than 20 percent, the investing company can use the cost method, simply reporting the amount of the investment and the dividends earned. An investment of more than 50 percent makes the investing company the parent company and the other its subsidiary, requiring consolidated financial statements.
To perform the IFRS equity method, a company must report a portion of the net income of the company in which it owns equity. This portion depends upon the percentage owned. For example, imagine Company A owns 25 percent of the common stock of Company B. In a year, Company B earns $1,000,000 US Dollars (USD) As a result, Company A must report 25 percent of that amount, or $250,000 USD, on its own income statement.
In the United States, a corporation may be obligated to follow another set of standards known as the General Accepted Accounting Principles (GAAP.) There are certain differences between IFRS and GAAP rules. Concerning the IFRS equity method, it is a bit more strictly applied to companies owning between 20 and 50 percent of another company compared to those following GAAP, which allows those companies some leverage to use the cost method.
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