Under the equity method of accounting for investments in associates, when is it used?

• A. When there is control over investee's board
• B. When there is significant influence (usually 20–50% ownership)
• C. When there is 100% ownership
• D. When shares are held as trading securities

Answer: (B)

The main concept here is significant influence. The equity method is used when the investor has enough influence over the investee to participate in policy decisions, typically evidenced by ownership in the 20%–50% range (and/or board representation or other indicators). Under this method you record the investment at cost and then adjust it each period for the investor’s share of the investee’s profits or losses, increasing the carrying amount by profits and decreasing it by losses. Dividends received reduce the investment account. This reflects the investor’s ongoing stake in the net assets of the investee.

If you have control (or 100% ownership), you consolidate rather than using the equity method. If the shares are held as trading securities, you measure them at fair value through net income, not by the equity method.