Many companies of all sizes have expanded into foreign markets, frequently by establishing subsidiaries and invest significant amount of capital in it.
Accounting rule makers and regulators are more and more focused on how to account for the investments in subsidiaries.
When one company owns a significant stake in another business -- generally defined as at least 20 percent -- it must account for that stake in its books using either consolidation or the equity method of accounting.
Which method to use depends on how much it actually owns.
A parent also combines 100 percent of the group’s income and expenses on the consolidated income statement.
All of the subsidiary company's assets and liabilities appear on the parent company's balance sheet, and all of the subsidiary company's revenue, expenses, gains and losses appear on the parent company's income statement.
A subsidiary is defined as an entity that is controlled by another entity.
Therefore, the definition of control is of primary concern in determining whether or not consolidated financial statements should be prepared.
The companies' financial results, therefore, are consolidated on a single set of statements.
Internally, the parent is free to treat the subsidiary as a completely separate entity, but it must consolidate its finances in statements prepared for outside observers, such as banks, regulators and potential investors.
Leucadia National Corporation, Time Warner, or Citigroup; as well as more focused companies such as IBM or Xerox.
These, and others, organize their businesses into national and functional subsidiaries, often with multiple levels of subsidiaries.
When a company owns a stake that is less than controlling but still allows it to exert significant influence over the business, it must use the equity method of accounting.
Accounting rules generally define a controlling stake as between 20 percent and 50 percent of a company.
Consolidated accounting is used to group the financial information of a parent company and one or more subsidiary companies.
A parent company owns the majority of voting shares of a subsidiary company or otherwise has contractual control of the subsidiary.