Benefits and Drawbacks of Equity Method

01.07.2013

Parent companies employ equity method of bookkeeping to take into account profit from their other companies into their statement of account.  The parent company should necessarily have at least twenty percent stock and be capable of exerting considerable influence for following this method. This method has its own benefits and drawbacks. For instance, using this method, the company is in a position to cover up figures from public view and thus enabled to demonstrate more truthful margins of profit.

Advantages of Equity method

Accurate accounting:

An important advantage of using equity method is that it enables the parent company to have a more truthful balance of income. It indicates income from all its investments and not just from parent company. Since combined statements of subsidiaries and parent companies are not merged together, this system of accounting carries together their figures. This allows for boosting of companies’ number and demonstrates more profit than could be shown from the number of parent company only.

Hiding of numbers:

The other advantage of using equity method is that it enables the parent company to conceal critical figures from its investors. For example, if the parent company’s figure show a low profit, by including the figures of its subsidiaries companies, it could show improved profits, thus encouraging public and shareholders to continue investing or stay invested with the parent company and consider the company as having better worth. It also allows the parent company not to reveal subsidiary figures if the same could lower the worth of the parent company.

Drawbacks

Level of difficulty

One of the drawbacks of employing equity method is that it’s not so easy to comprehend and use.  Using this method consumes longer amount of time for gathering, comparing and reviewing figures of the principal company plus its subsidiaries. It’s important to get accurate fiscal data from various companies to be able to arrive at useful figures. Even if data obtained from one subsidiary is inaccurate, it could adversely affect the worth of principal company.

Dividends

Another drawback of following equity method is that rather than conveying dividends as income, it shows them as deductions. So, on using this method, dividends cause reduction of the amount of investments. These are not accounted as income. It should also be mentioned here that on following equity method, dividends from subsidiary companies don’t ever get transferred to parent company.

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