Lesson 22 - Advanced Accounting Course

Lesson 22: Equity Method vs. Proportionate Consolidation

When a company has joint control or significant influence over another company, it must decide how to include that company’s financial information in its own financial statements.

There are two main methods:

1. ✅ Equity Method
   
   

2. 🔗 Proportionate Consolidation (used only in specific cases)
   
   

Let’s understand both—how they work, when they are used, and how they differ.

✅ 1. What is the Equity Method?

Under the equity method, the investor includes its share of the profit or loss of the investee (the company it owns a part of) in its own income statement.

📘 Used when:

• The investor has significant influence (usually 20–50% ownership)
  
  

• Or in joint ventures, as required by IFRS 11 and IAS 28
  
  

📊 How it works:

• Initial investment is recorded at cost
  
  

• Each year, adjust the investment value by:
  
  

  • ➕ Adding your share of the investee’s profits
    
    

  • ➖ Subtracting your share of losses or dividends received
    
    

📌 You do not include the investee’s individual assets or liabilities in your financial statements.

🧠 Example:

If Company A owns 40% of Company B:

• Company B makes $100,000 profit → Company A shows $40,000 in its income
  
  

• If B pays $10,000 dividend → A subtracts $4,000 (its 40%) from its investment account
  
  

🔗 2. What is Proportionate Consolidation?

Under proportionate consolidation, the investor includes its share of each individual item (assets, liabilities, income, expenses) of the joint operation in its own financial statements.

📘 Used when:

• The arrangement is a joint operation, not a joint venture
  
  

• As defined by IFRS 11
  
  

⚠️ This method is not used for joint ventures under IFRS anymore—only for joint operations

📊 How it works:

• You record your percentage of:
  
  

  • Assets
    
    

  • Liabilities
    
    

  • Revenues
    
    

  • Expenses
    
    

It’s like splitting everything line by line based on your ownership share.

🧠 Example:

If Company A is in a joint operation and owns 50%:

• The operation has assets of $1M → A reports $500k
  
  

• The operation earns $200k revenue → A reports $100k
  
  

• Liabilities, costs, profits—everything is shared proportionally
  
  

⚖️ Equity Method vs. Proportionate Consolidation: Key Differences

🛑 Important Notes

• IFRS no longer allows proportionate consolidation for joint ventures.
  Under IFRS 11, joint ventures must use the equity method.
  
  

• Joint operations, where partners share specific assets and obligations, still use proportionate consolidation.
  
  

• Always analyze the contractual arrangement and the substance of the relationship to decide the right method.
  
  

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