The greatest factor that influences the equity method is the influence of the holding company over the associate company. It is very important to influence an associate’s operating or financial decisions for a holding company to control the investment in the associate company. If a company does not hold a significant share in an associate company, it can influence the management by increasing its stake in the associate company by buying its stocks. The holding company at least needs to buy
20% of the total stocks of the associate to control the financial and operating decisions, which will eventually affect the profit-making of the associate.
Influence over the following things is very important to control the investment in associate:
Influence over Board of Directors of an associate company.
Involvement in policymaking and decision-making.
Transaction between the holding company and the associate company.
Manpower exchange between the holding company and the associate company.
The proportion of ownership holding company holds in the associate company.
To exert influence over the associate, the holding company must acquire at least 20% of the voting share.
Exception To Equity Method
When a holding company has no influence over the associate company, it can yet control its assets and investment in the associate company. The holding company uses the costing method for accounting if it does not hold significant influence over the management of the associate company. Under the cost method, the cost of investment in the asset is recorded in historical cost. But the point to be noted here is that there is no change in the value of an asset due to a change in profit or losses of the associate company. The equity method makes time to time adjustments to the value of the asset on the holding companyâ€™s balance sheet because the holding company holds a significant portion of the associate company, at least
There is also a method called, consolidation method. It records investment in both companies. Holding company shows investment as an asset on the holding companyâ€™s balance sheet, and an associate companyâ€™s balance sheet records it as equity. Consolidated financial statements are prepared under this method, showing all the profit & losses, liabilities, and assets combined under one roof.
How To Identify An Associate Firm?
Holding firm should hold at least
20% of the voting share of the associate firm and must exert its control over the management of the associate firm. The holding company must:
Must hold at least
20% of the voting share.
Must influence the operating and financial decisions.
Holding company should influence the Board of Directors.
Holding Company should influence all the important decisions.
It should regularly interact and engage in activities with the associate company.
The holding company must share technological advancement with the associate company.
If a holding company satisfies these conditions, then it can be said that a company holds and influences the associate company and has the right to influence the investment decision-making of the associate company.
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