Firms buy stock in other companies as either an investment or to fulfill a strategic positioning. For example, a computer manufacturing firm may buy ownership in a hard drive manufacturer for strategic positioning. To account for the purchase of stock in another company, the firm must use either the cost method, the equity method or consolidation. The method used depends on the percent of stock ownership and the amount of control a firm has in the subsidiary.
Choosing Between Equity Method and Consolidation for External Reporting
Internal reporting of financial statements does not need to be consolidated. If a firm owns more than 50 percent of another company, the firm must consolidate externally, but internally may choose between the equity method or the cost method.
When choosing between the equity method and consolidation look at the control a company can influence over another company. Generally speaking if a firm owns between 20 percent and 50 percent of another company then the firm should use the equity method to account for the subsidiary. If a firm owns more than 50 percent of a company, the firm should consolidate the financial statements.
Choosing Between Equity Method and Consolidation for Internal Reporting
Stock ownership is a general rule of thumb. An accountant must also consider other influences the firm currently has. For example, a firm may own 40 percent of stock, but not exert influence. In situations like an impending bankruptcy, the firm only intends to keep the stock for a short time, or only one person owns the other 60 percent of the company are situations where the firm meets the general rule of thumb of stock ownership, but cannot exert control.
Consolidating the financial statements involves combining the firms' income statements and balance sheets together to form one statement. The equity method does not combine the accounts in the statement, but it accounts for the investment as an asset and accounts for income received from the subsidiary.
The Fair Value or Equity Method
When an investor purchases stocks, he either plans to sell them to other investors at a higher price, or he is buying...
Cost & Equity Method in a Consolidated Financial Statement
A company that holds more than 50 percent of another business, or investee, must consolidate its financial statements with the investee's accounting...
Equity Method Vs. Proportional Consolidation
The accounting treatment of two companies who are partners in a joint venture plays out in either the equity or proportional consolidation...
Differences Between Cost Method & Equity Method
An investor's level of influence over an investee is the primary determinant of the method used to account for investments in common...
Joint Venture Accounting Methods
A joint venture is a temporary partnership between two or more firms in any particular business venture for a short period of...
Accounting Consolidation Methods
When a company owns another company, or subsidiary, it must adjust and combine information from the financial statements of both companies in...