Equity Method of accounting

CFA Level II FRA
#1

Hi,

In Equity method, at initiation, we record investment at cost and report it as non current asset.

In subsequesnt period, proportionate share of the investee’s earnings increase the investment account on balance sheet and is recognized in investor’s Income statement.

My question is why earnings of investee should increase equity income in Income Statement and investment account( i.e. equity asset marked as non current asset on balance sheet) both?

Won’t this be a double counting of the income.?

The earnings which will come through income statement will be added in retained earning in later periods. So won’t the same earnings be accounted twice.? First at the investment account and then at retained earnings.

I know I am missing something very basic here. Thanks in advance.

#2

Not at all.

If you earn interest, you show it on the income statement as interest income, and you show the increase in cash as an asset on the balance sheet. Assets increase, equity (retained earnings) increases, everything’s in balance.

It’s the same here: you show the income on the income statement, and show the increase in the asset on the balance sheet. Assets increase, equity (retained earnings) increases, everything’s in balance.

#3

Oh i understood now.

May be the confusion was because of the one line consolidation in case of Equity method.

Since cash can not be increased here, Investment account on Balance sheet is increased instead.

I hope this understanding is correct.

Thank you very much. :slight_smile:

#4

You got it.

You’re very welcome.