A company that holds more than 50 percent of another business, or investee, must consolidate its financial statements with the investee's accounting reports. If the equity holding is less than 50 percent, the company must either use the cost method or the equity method of consolidation, depending on the stake level.
Financial Statement Consolidation
To consolidate financial statements, accountants add a company’s operating data with the accounting information of affiliated companies. Accounting report consolidation often enables financial managers to explore -- and demystify, when appropriate -- deep-rooted financial orthodoxies. These include the notion that an investor must hold a substantial investment in a company to control it, the idea that subsidiaries automatically fall under the control of a parent company, and the perception that a company generating income in several currencies -- say, 40 or 50 -- might find it hard to consolidate data. In the latter scenario, the business first must convert its performance data into a single currency -- usually the parent company’s domestic currency -- before consolidating the information. Consolidation methods include cost, equity and outright combination, which happens when a business owns more than 50 percent of another company’s equity.
A consolidation process typically covers all financial accounts, running the gamut from assets and expenses to revenue items, equity and liabilities. The process also applies to four types of accounting reports. These include a statement of financial position, a statement of profit and loss, a statement of cash flows and a statement of retained earnings. Financial commentators use the terms “statement of financial position” and “balance sheet” interchangeably.
A business uses the cost method when it owns less than 20 percent equity stake in another company and doesn’t have significant influence in the investee’s operations. There’s no financial statement consolidation in the cost method. The investing company reports its holding at the initial cost, also called historical cost. If the investments pertain to available-for-sale or marketable securities, the organization records them at market value.
The equity method applies to a company that owns corporate equity ranging from 20 percent to 50 percent. The investing business does not consolidate its financial statements with the performance data of associates, unless it wields substantial clout in the way associates operate. The equity method mandates that a business increase its equity stake when the investee declares net income, decreasing it when the investee posts negative results. Other items decreasing an investing company’s equity include dividend payments and year-end equity distributions.