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If a reporting entity determines it does not meet the criteria to consolidate a legal entity, it should next determine if the equity method of accounting is appropriate. The equity method of accounting is an approach for an investor to measure investments in common stock or other eligible investments in an investee entity (i.e., investments considered to be “in-substance” common stock, such as certain preferred stock investments) by recognizing its share of the net assets underlying those investments. It also requires the investor to recognize, in net income, its share of the investee’s earnings for each reporting period.
The equity method of accounting is required when an investor or a company is able to exercise significant influence over the operating or financial decisions of an investee.
The equity method of accounting guidance also addresses many other items, including:
  • An investor’s accounting for subsequent investments in an investee after suspending equity method loss recognition
  • Stock-based compensation granted by an investor to employees of the investee, exchanges of equity method investments
  • The determination of when limited partnerships and limited liability companies should be subject to the equity method
  • The receipt of an equity method investment for the contribution of nonfinancial assets
See EM for details on the equity method of accounting.
Only after a reporting entity has determined that its financial relationship with an entity does not give rise to a controlling financial interest or an equity method investment, would it look to other accounting guidance to determine the appropriate accounting for that relationship. Other guidance that may be applicable includes the accounting for receivables (ASC 310), debt securities (ASC 320), equity securities (ASC 321), other investments (ASC 325), contingencies (ASC 450), guarantees (ASC 460), collaborative arrangements (ASC 808), derivatives (ASC 815), and other industry-specific guidance.
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