When a company owns another company, or subsidiary, it must adjust and combine information from the financial statements of both companies in order to prepare consolidated financial statements that present financial information for the group as a single economic entity. Accountants choose one of three methods of consolidation, depending on the percentage of ownership involved. If a company owns to 20 percent of a subsidiary, the company should use the cost method. If a company owns between 20 percent and 50 percent, it should use the equity method. If a company owns over 50 percent, the acquisition method is used.
The cost method records the investment at cost. Only dividends from the company are treated as income. For marketable securities, the investment account is adjusted to fair market value at the end of the year.
The equity method records the investment at cost. The subsidiary’s earnings increase the investment in the company and dividends decrease the investment in the company. The subsidiary’s earnings are treated as income; its dividends have no income effect.
The acquisition method consolidates the companies’ financial statements. The parent company eliminates the subsidiary’s stockholders' equity, creates a non-controlling interest account, adjusts the subsidiary’s balance sheet to fair market value and records goodwill or gains. The financial statements are then presented as one statement.
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