When is the equity method applied in accounting?

The equity method is applied in accounting primarily when an investor holds an investment in the voting stock of another company and has significant influence over that company. Significant influence typically means the ability to participate in the financial and operating policy decisions of the investee without controlling those policies outright. This is generally presumed to exist when an ownership interest is between 20% and 50% of the voting stock.

Under the equity method, the investor recognizes its share of the investee's profits or losses in its own financial statements. This approach differs from the cost method, where the investment is typically recorded at cost and leads to minimal recognition of the investee's financial performance. The equity method allows investors to better reflect their economic interest in the investee, incorporating the underlying performance in their financial results.

This method also aligns with the accounting principles that seek to provide a clearer picture of financial relationships and influence, making it a critical concept in financial reporting for entities involved in investment activities.