The equity method and joint arrangements

On 1 January 2026 Larkspur pays $900,000 for 30 per cent of the voting shares of Cedar Point Analytics, a private company that builds software for interpreting sensor data. Larkspur appoints two of Cedar Point's seven directors and licenses its sensor protocols to Cedar Point. Larkspur clearly has significant influence but not control. This lesson shows how Larkspur accounts for Cedar Point using the equity method, and then turns to joint arrangements, where two or more parties share control.

The logic of the equity method

Under the cost method, an investor recognizes income only when the investee declares dividends. If the investor can influence the dividend policy, it could time its income by deciding when the investee pays out. Fair value measurement, the alternative for passive holdings, ignores the investor's involvement in the investee's operations and can be hard to apply to private investees. The equity method answers both problems. It treats the investor's share of the investee's profit as the investor's own income as soon as the investee earns it, and treats dividends as a return of part of the investment rather than as income.

The basic entries are simple. The investment is recorded at cost. Each period, the investor increases the investment and recognizes income for its share of the investee's profit (or decreases both for a loss). It recognizes its share of the investee's other comprehensive income in its own OCI. When the investee pays a dividend, the investor debits cash and credits the investment, because the dividend converts part of the investment into cash.

IAS 28 requires the equity method for associates and joint ventures, with limited exemptions: an investor that is itself a subsidiary meeting certain conditions, and venture capital organizations, mutual funds and similar entities, which may elect to measure such investments at fair value through profit or loss under IFRS 9. Under ASPE Section 3051, a private enterprise may choose, as a policy for all significantly influenced investees, the equity method or the cost method; if it chooses cost and the shares are quoted in an active market, it must use fair value instead.

The acquisition differential

An investor rarely pays exactly its share of the investee's carrying amounts. The difference between the cost of the investment and the investor's share of the carrying amount of the investee's net assets is called the acquisition differential (Canadian textbooks) or basis difference (US practice). It is allocated, in memorandum records only, to the investor's share of the differences between fair values and carrying amounts of the investee's identifiable assets and liabilities, with any remainder treated as goodwill. Amounts allocated to depreciable or amortizable assets are amortized over those assets' remaining lives, reducing the investor's share of profit; amounts allocated to inventory are expensed as the inventory is sold; goodwill is not amortized but is part of the carrying amount tested for impairment.

Unrealized profits on transactions with the investee

When an investor and an associate trade with each other, part of the profit on goods still held by the buyer has not been earned from the group's point of view. Under both IFRS and US GAAP, the investor eliminates its share of unrealized profits and losses on such transactions, whether the sale is downstream (investor to investee) or upstream (investee to investor). Only the investor's percentage is eliminated, because the other owners of the associate are outside parties. The elimination is reversed in the period the buyer sells the goods to an outside party, when the profit is realized.

The IASB's equity method project, which published an exposure draft in September 2024, proposed recognizing the full gain or loss on all transactions with associates and joint ventures, both downstream and upstream, instead of eliminating the investor's share. As of September 2026 the IASB had completed its redeliberations and begun balloting a revised IAS 28, which it expects to issue in the first half of 2027 with an effective date of 1 January 2029. Until then, the current partial elimination applies.

# Equity method schedule for Larkspur's 30% investment in Cedar Point (illustrative)
cost, share = 900_000, 0.30
building_diff, life = 0.30 * 300_000, 20
years = [  # (year, investee profit, dividends, unrealized downstream profit at year end)
    (2026, 500_000, 150_000, 40_000),
    (2027, 560_000, 180_000, 25_000),
]
inv, prior_unreal = cost, 0
print(f"{'Year':>4} {'Share':>9} {'Amort':>7} {'Unreal adj':>11} {'Income':>9} {'Dividends':>10} {'Investment':>11}")
for yr, profit, div, unreal in years:
    s = share * profit
    amort = building_diff / life
    unreal_adj = share * (prior_unreal - unreal)   # realize last year's, defer this year's
    income = s - amort + unreal_adj
    inv += income - share * div
    print(f"{yr:>4} {s:>9,.0f} {amort:>7,.0f} {unreal_adj:>11,.0f} {income:>9,.0f} {share*div:>10,.0f} {inv:>11,.0f}")
    prior_unreal = unreal

Year     Share   Amort  Unreal adj    Income  Dividends  Investment
2026   150,000   4,500     -12,000   133,500     45,000     988,500
2027   168,000   4,500       4,500   168,000     54,000   1,102,500

In 2027 the profit deferred at the end of 2026 is realized when Cedar Point sells the goods, so Larkspur adds back $12,000 and defers 30 per cent of the new $25,000, a net adjustment of $4,500. Equity income for 2027 is $168,000 ($168,000 share, less $4,500 amortization, plus $4,500 net realization) and the investment rises to $1,102,500. The schedule shows how the equity method tracks the investee's growth year by year.

Losses, impairment and presentation

If an associate makes losses, the investor's share reduces the investment. When the investment reaches zero, the investor stops recognizing further losses unless it has guaranteed the investee's obligations or otherwise committed to provide further support. Under IFRS, the interest that absorbs losses includes long-term interests, such as loans to the associate that are in substance part of the net investment. If the associate later returns to profit, the investor resumes recognizing its share only after its share of profits equals the share of losses not recognized.

Under IAS 28, the investment as a whole is tested for impairment under IAS 36 when there is objective evidence that it may be impaired, such as significant financial difficulty of the associate or a significant or prolonged decline in fair value below cost. The recoverable amount is the higher of value in use and fair value less costs of disposal. Because goodwill is not separately recognized, an impairment loss is not allocated to it, and the loss can be reversed if the recoverable amount later increases.

The investor presents its share of profit of equity-accounted investees as a separate line in profit or loss. Under IFRS 18, which applies from 1 January 2027, income and expenses from associates and joint ventures accounted for using the equity method are classified in the investing category, below operating profit, so they no longer affect the new subtotal of operating profit. The investment is a non-current asset, and the cash flow statement shows dividends received and the acquisition cost as investing flows unless the entity's policy for dividends differs.

Joint arrangements

A joint arrangement is an arrangement of which two or more parties have joint control. IFRS 11 classifies joint arrangements as joint operations or joint ventures according to the parties' rights and obligations. In a joint operation, the parties have rights to the assets and obligations for the liabilities relating to the arrangement. In a joint venture, the parties have rights to the net assets of the arrangement. An arrangement not structured through a separate vehicle is always a joint operation. One structured through a separate vehicle, such as a corporation, is usually a joint venture unless its legal form, the contractual terms or other facts give the parties rights to the assets and obligations for the liabilities, for example when the parties are obliged to buy substantially all its output.

If instead Larkspur and its partner each owned an undivided half of a production line in Larkspur's plant and shared its output and costs directly, the arrangement would be a joint operation. Larkspur would recognize its share of the line's assets, any liabilities it incurred jointly, its revenue from selling its share of output and its share of expenses, in its own financial statements. Under ASPE Section 3056, a private enterprise may choose, as a policy, to account for interests in jointly controlled enterprises by the equity method, by the cost method (fair value if quoted) or by proportionate consolidation.