In group financial reporting, not every entity in which the group holds an interest is fully consolidated. The method applied depends on the nature of the relationship between the investor and the investee — specifically, whether the investor controls the investee, has significant influence over it, or merely holds a financial interest. Full consolidation applies to subsidiaries where control exists. The equity method applies to associates where significant influence exists without control. Getting this distinction right is one of the foundational requirements of accurate group reporting.
Full Consolidation vs the Equity Method
| Relationship | Typical ownership | Method | P&L presentation |
|---|---|---|---|
| Subsidiary (control) | >50% voting rights, or IFRS 10 control | Full consolidation | All revenue, expenses, assets, liabilities included line by line; intercompany eliminated |
| Associate (significant influence) | 20–50% (presumed significant influence) | Equity method | Single line: “Share of profit of associates” |
| Joint venture (joint control) | Typically 50/50 or joint control arrangement | Equity method (IFRS 11) | Single line: “Share of profit of joint ventures” |
| Financial investment (no significant influence) | <20%, no board participation | IFRS 9 financial instrument | Fair value gains/losses or dividend income |
The most important implication of the equity method for group reporting: an associate’s revenue does not appear in the consolidated revenue line. Only the investor’s share of the associate’s net profit flows into the group P&L — as a single line item below operating profit. A group whose associate generates $50M of revenue shows none of that in consolidated revenue; it shows only its proportionate share of the associate’s profit.
What “Significant Influence” Means in Practice
IAS 28 presumes significant influence when an investor holds 20–50% of the voting power of an investee. The presumption is rebuttable in both directions — a 25% holder may lack significant influence if it has no board representation and no involvement in policy decisions; a 15% holder may have significant influence through contractual arrangements that give it effective participation in decision-making.
The IAS 28 indicators of significant influence are:
- Representation on the board of directors or equivalent governing body
- Participation in policy-making processes including decisions on dividends and other distributions
- Material transactions between the investor and the investee
- Interchange of managerial personnel
- Provision of essential technical information
Finance teams must assess the substance of the relationship — not just the ownership percentage — to determine whether the equity method is appropriate. Shareholder agreements, board composition, and the day-to-day interaction between the investor and investee all feed into this assessment.
How the Equity Method Works — Journal Entries
Initial recognition
Acquisition of a 30% stake in Associate Co for $600,000
| Account | Debit | Credit |
|---|---|---|
| Investment in Associate | $600,000 | |
| Cash | $600,000 |
Subsequent measurement — recognising profit share
Associate Co earns profit of $200,000; investor’s 30% share = $60,000
| Account | Debit | Credit |
|---|---|---|
| Investment in Associate | $60,000 | |
| Share of profit of associates (P&L) | $60,000 |
Dividends — reduce the investment, not income
Associate Co pays dividend of $80,000; investor’s 30% share = $24,000
| Account | Debit | Credit |
|---|---|---|
| Cash | $24,000 | |
| Investment in Associate | $24,000 |
Investment carrying value roll-forward Opening investment (acquisition cost): $600,000
Add: share of profit (30% × $200,000): $60,000
Less: dividends received (30% × $80,000): ($24,000)
Closing carrying value: $636,000
In the group balance sheet, the investment in Associate Co appears as a single non-current asset at $636,000. In the group P&L, “Share of profit of associates” shows $60,000 — below operating profit, not in revenue.
The Loss Recognition Limit
If an associate makes sustained losses, the investor continues to reduce the carrying value of the investment by its share of losses — until the investment reaches zero. Once the carrying value is nil, the investor does not recognise further losses unless it has incurred legal or constructive obligations on behalf of the associate (such as guarantees of the associate’s debt or commitments to provide additional funding). If the associate subsequently returns to profit, the investor resumes recognising its share of profits only after its share of unrecognised losses has been recovered.
Common Errors in Applying the Equity Method
🚩 Recognising dividends as income: The most common error. Dividends from associates reduce the carrying value of the investment — they are a return of capital already recognised through profit pickup, not additional income. Recognising dividends as income double-counts the economic return and overstates group profit.
🚩 Failing to eliminate unrealised profits on transactions with associates: Where the investor sells goods to the associate (downstream) or the associate sells to the investor (upstream) and some of those goods remain in inventory at period end, the unrealised profit on those transactions must be eliminated to the extent of the investor’s interest. Omitting this elimination inflates group profit.
🚩 Classifying based on percentage alone: Ownership above 50% does not automatically mean consolidation if voting rights are restricted. Ownership below 20% does not automatically mean exclusion from the equity method if significant influence is demonstrated through board representation or policy participation. The economic substance governs, not the headline percentage.
Mixed Ownership Structures in Practice
Most real-world groups have a mix of fully consolidated subsidiaries, equity-accounted associates and joint ventures, and financial investments. Managing this combination consistently requires clear ownership classification at each entity level — and a consolidation process that applies the correct treatment to each without manual intervention at every close.
The practical challenges in a mixed structure:
- Tracking the carrying value of each equity-accounted investment across periods (profit shares, dividends, impairments, OCI movements)
- Applying the loss recognition limit when an associate makes losses
- Correctly presenting each method’s contribution in the group P&L — full consolidation revenue separately from equity method profit share
- Reassessing classification when ownership percentages change — stepping up from associate to subsidiary (acquiring control) or stepping down from subsidiary to associate (losing control)
BrizoConsol supports mixed ownership structures — with full consolidation for subsidiaries and equity method accounting for associates tracked within the same consolidation environment. Ownership classification drives the treatment applied, and changes in ownership percentage are reflected in the correct period without manual reclassification. Learn more or see it in action →