The consolidation method of accounting
Companies often do invest in other companies that they view to be profitable or that have a promising future. After acquiring stock in another company, it is essential to identify the suitable accounting technique to employ to be able to account for the investment. Depending on the investment amount, there are two types of accounting for the investment that could be effective. One is by using the consolidated method, and the other is by using the equity method.
The consolidation method of accounting can be utilized when the investing company possesses the company’s controlling shares. This is to mean that they have to have at least 50.1% of the voting rights. That is to means they have the controlling stake. In this method, the investing company will report the balances of the subsidiary alongside its balances. The subsidiary’s incomes and expenses will be listed in proportion to the percentage of participation in the income statement and balance sheet. If say a parent company X has a controlling stake of 50% in company Y, it would record half of its assets, liabilities, expenses, and consequently revenues. If the subsidiary Y was to make a revenue of $2 million, company X records an income of $1 million, which is half of it.
The equity method of accounting is utilized when a company does not have the controlling stake in the subsidiary company but holds considerable stock in the company. Companies with less than 50% but with more than 20% of the stock in the subsidiary company use this accounting method. Some companies with less than 20% in investment may also use the technique if they have considerable influence. In this method, an investor records its share of the investment earnings from the investment as revenue on the income statement. If a firm reports earnings of $1 million and the investing company has 30% ownership, then the earnings from the investment will be $300, 000.