Equity Method Accounting: How It Works for UK Companies
The equity method is how an investor accounts for a stake in an associate or joint venture. You record the investment at cost, then adjust it each year for your share of the investee’s profit or loss. Dividends you receive reduce the carrying amount instead of counting as income. It applies when you have significant influence over the investee but not control. For many UK small companies it only matters once group accounts come into play.
TL;DR
Use the equity method when you have significant influence (usually a 20% or larger holding) but neither control nor joint control.
Start at cost, add your share of profit, subtract your share of losses and any dividends received.
It is “one-line consolidation”: one balance sheet line and one profit or loss line, not every asset and liability.
In the UK it is mainly a group accounts issue, and small companies may be exempt from group accounts altogether.
Influence is a judgement, not a percentage. Document your reasoning.
Table of Contents
When the equity method applies
The equity method accounts for investments where the investor has significant influence: the power to take part in the investee’s financial and operating policy decisions, without controlling it or sharing joint control. A holding of 20% or more of the voting power creates a rebuttable presumption of significant influence. Above 50% you are generally looking at control, which means a subsidiary and full consolidation.
Under international standards, IAS 28 requires the equity method for associates, and IFRS 11 requires it for joint ventures, with limited exceptions.
The 20% rule is a presumption, not a switch
Founders often treat 20% as a bright line. It is not. The same IFRS guidance points to evidence such as board representation, participation in policy-making, material transactions, interchange of managerial personnel and provision of essential technical information. So you can have influence below 20% if you hold a board seat. You can also hold 20% and have none if another shareholder dominates every decision.
Whichever way you land, write down why. Auditors challenge a rebutted presumption, and the paper trail is far easier to build at the time than two years later.
How the accounting works
The mechanics follow the IAS 28 approach:
Recognise the investment at cost on acquisition.
Each period, adjust the carrying amount for your share of the investee’s profit or loss, and include that share in your own profit or loss.
Deduct any dividends or distributions received from the carrying amount. They are not income.
Equity method journal entries: a worked example
The figures below are illustrative only. Suppose your company buys 30% of an associate for £300,000, and the associate’s net assets at that date are fairly valued at £1,000,000.
Event | Debit | Credit | Amount |
Acquire 30% stake | Investment in associate | Bank | £300,000 |
Associate earns £200,000 profit (your 30%) | Investment in associate | Share of profit of associate (P&L) | £60,000 |
Associate pays £50,000 dividend (your 30%) | Bank | Investment in associate | £15,000 |
The closing carrying amount is £300,000 + £60,000 − £15,000 = £345,000. Had the associate made a loss, you would reverse the first adjustment: debit share of loss in your P&L, credit the investment.
Don’t forget goodwill
If the price you pay exceeds your share of the fair value of the investee’s net assets, the excess is treated like goodwill and sits inside the carrying amount. A common mistake is to book the purchase price and never carry out or document the fair value assessment at the acquisition date. In the example above, your 30% share of net assets is £300,000, so there is no excess. Pay £340,000 instead and £40,000 is the goodwill element.
Equity method versus consolidation
Consolidation merges the investee’s assets, liabilities, income and expenses into the parent’s statements line by line. The equity method shows a single net investment on the balance sheet and a single net share of profit or loss in the income statement. That is why people call it one-line consolidation. It gives a cleaner picture, with less detail.
Equity method | Full consolidation | |
Typical stake | Significant influence, often 20% to 50% | Control, usually above 50% |
Balance sheet | One investment line | Line by line |
Profit or loss | Share of result, one line | All income and expenses combined |
Dividends received | Reduce the investment | Eliminated on consolidation |
If your position is near the 50% mark, control can exist below it. Our piece on IFRS 10 consolidation and document control, even below 50% walks through that judgement.
What this means under UK GAAP
Most UK private companies report under FRS 102 rather than IFRS. The equity method still appears there, but the context matters. Parent companies use it in consolidated financial statements for associates and joint ventures. The FRC’s summary of differences between FRS 102 and the IFRS for SMEs is the place to check how the treatment differs for an investor that is not a parent, where measurement at fair value may be the route instead.
That leads to the point many small businesses miss. Under the Companies Act 2006, a parent company must prepare group accounts unless it is exempt. If you qualify for the small companies regime, you may be exempt, and then equity accounting may not be needed until you outgrow the thresholds. Check the exemptions before spending time on complex workings. Our guide to small company thresholds in the UK covers the current limits, and the FRS 102 Section 1A changes are worth reading alongside it.
Even where equity accounting is not required, the law still expects disclosure. The 2008 accounts regulations set out how an interest in an associated undertaking and the profit or loss attributable to it must be shown.
Mistakes we see most often
Relying on the percentage alone. Using the equity method where simple measurement would do, or missing influence that really exists, both lead to the wrong treatment.
Booking dividends as income. Under the equity method they reduce the investment.
Skipping the fair value exercise at acquisition, so goodwill is never identified.
Forgetting to revisit the judgement when a board seat is given up or a shareholders’ agreement changes.
Assuming group accounts are needed without testing the small companies exemptions first.
Our view: judgement first, arithmetic second
The arithmetic of the equity method fits on a single page. The hard part is deciding whether you have significant influence, and that decision is where we spend our time with founders. Many of our team have worked with top firms in the UK and the Middle East, and the pattern is consistent: the file holds the percentage, but not the reasoning.
Our advice is to keep a short memo for each investment. Record the stake, the board rights, the shareholders’ agreement terms, who sets the budget, and your conclusion. Review it every year-end. Then check whether you are a parent that needs group accounts at all. That order saves most startups a great deal of unnecessary work.
— Shoaib
Getting it right with Keystone
If you hold a stake in another company and are unsure whether it needs equity accounting, consolidation or neither, we can help. We cover bookkeeping, accounts preparation, year-end reporting and audit readiness checks, plus specialist advisory on consolidation and IFRS. Our flexible accounting packages run at £99-£199 per month. See Keystone’s accounting services and talk to us before your next year-end. For the statutory side, our statutory accounts preparation guide is a good starting point.
FAQ
Is the equity method 20/50?
Broadly, yes, as a starting point. A holding of 20% or more of voting power creates a presumption of significant influence, and above 50% is generally control. Both are presumptions that can be rebutted on the facts, so the actual influence matters more than the number.
When should I use the equity method rather than the cost method?
Use the equity method when you have significant influence over an associate or joint venture and your framework requires it, typically in consolidated accounts. A cost or fair value approach may apply where you have no significant influence or where your framework restricts the equity method for non-parent investors. Check the relevant section of FRS 102 or your IFRS policy.
What is the difference between the equity method and consolidation?
Consolidation combines all of the investee’s assets, liabilities, income and expenses line by line because you control it. The equity method shows only one net investment line and one share-of-profit line because you influence the investee without controlling it.
Does a small UK company have to use the equity method?
Not necessarily. It is mainly a requirement for consolidated statements, and a parent that qualifies for the small companies regime may be exempt from group accounts. Check the Companies Act 2006 exemptions and your thresholds first.
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