Key Points
- The equity method replaces cost-based measurement with a carrying amount that moves in line with the investee's results each period.
- Dividends from an associate reduce the carrying amount of the investment rather than flowing through the investor's profit or loss.
- Implicit goodwill (the excess of cost over the share of net assets at acquisition) stays embedded in the carrying amount and is not amortised separately under IFRS.
- If the investor's share of losses exceeds the carrying amount, IAS 28.38 requires the investor to stop recognising further losses unless it has a legal or constructive obligation to fund the investee.
What is Equity Method?
A 30% stake in another company sits on the balance sheet as a single line item. Every period, that line moves up or down based on numbers the audit team often cannot verify directly because the investee has a different auditor, a different year-end, or both. When something goes wrong with an equity method investment, the file should tell a story about how the team got comfortable with figures it did not audit first-hand.
IAS 28.10 requires an investor with significant influence over an investee (or joint control under IFRS 11 ) to account for that investment using the equity method. At acquisition, the investor records the investment at cost. Each subsequent reporting date, IAS 28.11 adjusts the carrying amount for the investor's share of the investee's profit or loss (recognised in the investor's income statement) and for changes in the investee's OCI. Distributions received reduce the carrying amount under IAS 28.10 , not the income statement.
The difference between cost and the investor's share of the investee's identifiable net assets at acquisition constitutes implicit goodwill. IAS 28.32 prohibits separate recognition of this goodwill. It sits inside the single-line investment balance, subject to the impairment requirements in IAS 28.40 –43 rather than the annual test in IAS 36 . On the audit side, ISA 540.13 (a) requires the auditor to evaluate whether the entity's method for measuring the investment is appropriate. That means verifying the share of profit ties to the investee's audited (or reviewed) financial statements (FS), confirming that unrealised intercompany profits have been eliminated per IAS 28.28 , checking that the implicit goodwill calculation at acquisition was correct, and testing whether IAS 28.40 impairment indicators have been properly assessed.
Worked example: Henriksen Shipping A/S
Client: Danish maritime logistics company, FY2025, revenue EUR 140M, IFRS reporter. Henriksen holds 30% of the ordinary shares in a Norwegian port services operator, Nordvik Havn AS (revenue EUR 24M). Henriksen acquired the stake in January 2023 for EUR 9.6M. At acquisition, Nordvik's identifiable net assets were EUR 26M. At 31 December 2025, Nordvik reports net profit of EUR 3.8M for the year, OCI gains of EUR 0.4M (revaluation of property), and dividends declared of EUR 1.2M. The opening carrying amount of the investment at 1 January 2025 is EUR 10.9M.
Step 1 — Confirm significant influence
Henriksen holds 30% of voting rights, triggering the IAS 28.6 presumption. Henriksen has two of six seats on Nordvik's board and provides fleet coordination services under a long-term agreement. No other shareholder holds a controlling stake. The presumption is not rebutted.
Step 2 — Calculate implicit goodwill at acquisition
Henriksen's share of Nordvik's net assets at acquisition was EUR 7.8M (30% of EUR 26M). The cost of EUR 9.6M less the share of net assets of EUR 7.8M produces implicit goodwill of EUR 1.8M. Per IAS 28.32 , this goodwill is not separately recognised but remains within the investment balance.
Step 3 — Apply the equity method for FY2025
Henriksen recognises its share of Nordvik's profit: 30% of EUR 3.8M = EUR 1.14M (income statement). Henriksen recognises its share of Nordvik's OCI: 30% of EUR 0.4M = EUR 0.12M (other comprehensive income). Dividends received reduce the carrying amount: 30% of EUR 1.2M = EUR 0.36M. The closing carrying amount is EUR 10.9M + EUR 1.14M + EUR 0.12M - EUR 0.36M = EUR 11.8M.
Step 4 — Assess impairment indicators
Nordvik is profitable, has no going concern issues, and its net asset backing attributable to Henriksen (30% of approximately EUR 28.6M = EUR 8.58M) remains below the carrying amount of EUR 11.8M, meaning implicit goodwill of EUR 3.22M is embedded. However, no external indicators (market decline, operational deterioration, regulatory changes, or loss of key contracts) suggest the recoverable amount is below carrying amount. IAS 28.40 requires the investor to apply IAS 36 indicators but not a full annual impairment test.
The equity method carrying amount of EUR 11.8M is defensible. The share of profit ties to the investee's audited results, dividends are correctly deducted from the carrying amount rather than recognised as income, the implicit goodwill is identified and tracked, and the impairment indicator assessment addresses the embedded goodwill.
Why it matters in practice
Dividends from associates are sometimes recorded as income in the investor's profit or loss instead of as a reduction in the carrying amount. IAS 28.10 is explicit on this point: distributions reduce the investment balance. Recording them as income double-counts the return (once through the share of profit, once through dividend income) and overstates both revenue and the investment carrying amount.
Teams frequently skip the elimination of unrealised profits on transactions between the investor and the associate. IAS 28.28 requires the investor to eliminate its share of unrealised gains on upstream and downstream transactions. When the associate sells goods to the investor (upstream) at a margin, the investor's share of that unrealised profit must be removed from the equity method income. Omitting this step overstates the share of profit and the carrying amount.
In our experience, the equity method section of the file is where ticking and bashing breaks down. The team agrees the investee's FS to the carrying amount schedule, checks the arithmetic on the share of profit, and moves on without asking the harder questions: did anyone read the investee auditor's report for qualifications, did anyone verify the elimination of intercompany margins, has the reporting date gap been properly adjusted, and does the implicit goodwill figure still make sense three years after acquisition? These are the questions reviewers ask, and discovering the answers are missing at the review stage is genuinely painful for everyone involved.
Equity method vs. full consolidation
| Dimension | Equity method ( IAS 28 ) | Full consolidation ( IFRS 10 ) |
|---|---|---|
| When it applies | Investor has significant influence (typically 20%–50%) or joint control | Investor has control (power, variable returns, and the link between them) |
| Balance sheet presentation | Single line: "Investment in associate/joint venture" | Line-by-line aggregation of all assets and liabilities of the subsidiary |
| Income statement presentation | Single line: "Share of profit of associate/joint venture" | Full inclusion of subsidiary revenue, expenses, and a separate NCI allocation |
| Intercompany elimination | Investor eliminates only its share of unrealised profits per IAS 28.28 | All intercompany balances, transactions, and unrealised profits eliminated in full |
| Goodwill treatment | Implicit goodwill embedded in the investment balance, not separately tested annually | Goodwill recognised separately and tested annually for impairment under IAS 36 |
The distinction matters when an investee's classification shifts. If an investor acquires additional shares in an associate and obtains control, IAS 28.22 requires discontinuation of the equity method and IFRS 3 applies to the resulting business combination. The previously held interest is remeasured at fair value, and any difference hits profit or loss.
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Frequently asked questions
What happens when the equity method investment goes negative?
IAS 28.38 requires the investor to stop recognising its share of further losses once the carrying amount reaches zero (including any long-term receivables that form part of the net investment). The investor only continues recognising losses if it has incurred legal or constructive obligations or made payments on behalf of the investee. Resumption of profit recognition occurs only after the unrecognised losses have been absorbed.
Do I apply the equity method to joint ventures as well?
Yes. IFRS 11.24 requires a joint venturer to account for its interest in a joint venture using the equity method under IAS 28. The distinction matters because a joint operation (the other form of joint arrangement under IFRS 11) requires the operator to recognise its share of assets, liabilities, revenues, and expenses directly, not through a single investment line.
How do I audit the equity method when the associate's year-end differs from the investor's?
IAS 28.33–34 permits using associate financial statements with a different reporting date, provided the gap does not exceed three months. Adjustments are required for significant transactions between the two dates. The auditor checks that management has made these adjustments and that the time lag is consistently applied each period.
When does the equity method stop applying?
IAS 28.22 requires the investor to discontinue the equity method when significant influence is lost. The retained interest, if any, is remeasured at fair value on the date influence ceases. Common triggers include dilution below the 20% threshold without other indicators of influence, loss of board representation, withdrawal from participation in policy-making decisions, or a contractual change that removes participation rights.