Equity method

What it means

The equity method is a way of valuing a stake in another company. Instead of acquisition cost, the stake is carried at the investor’s share of the investee’s equity. When the investee makes a profit, the value of the stake rises; when it makes a loss, the value falls.

It is used for stakes carrying significant or controlling influence, meaning subsidiaries and associates. Slovak accounting rules allow it when measuring long-term financial assets at the balance sheet date, and in consolidated financial statements associates are carried under it.

In the individual financial statements the change in the stake’s value is booked as a revaluation difference in equity, not in profit or loss. The parent therefore does not show the subsidiary’s profit as its own realised profit until it receives it, for instance as a dividend.

How it works in practice

In holding structures the equity method shows the real value of the parent company’s assets better than acquisition cost, especially where subsidiaries have been profitable for years and retained their earnings. The balance sheet becomes more informative for banks and investors.

To apply it, we need the subsidiaries’ financial statements as at the same date and, where accounting policies differ, adjustments. Dividends from a subsidiary reduce the value of the stake because they reduce its equity.

For tax, revaluation differences under the equity method do not enter the tax base. A gain or loss on the stake shows up for tax only when the stake is sold or a dividend is paid, under the rules for that income.

What to watch out for

A common mistake is confusing a revaluation difference with distributable profit. An increase in the stake’s value under the equity method is not cash and cannot be paid out as a dividend. It must be kept separate when deciding on a profit distribution.

The second risk is a subsidiary with negative equity. The value of the stake cannot fall below zero; further losses are tracked off the balance sheet or reflected in provisions if the parent guarantees the subsidiary.