A company may invest in another private or publicly traded company. The accounting for this investment depends on the level of control of the parent company in the subsidiary. The consolidated method of accounting applies when the parent company controls the subsidiary, which means it has direct operational control in the subsidiary's activities. Consolidated statements combine the income statements, balance sheets and statement of cash flows of the parent and subsidiary companies into a single set of statements.
Income Statement
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The consolidated income statement reports all transactions with entities external to the combined parent and subsidiary entities. For example, if company ABC acquires XYZ, then the combined income statement cannot include sales from ABC to XYZ, nor can it include payment for services from XYZ to ABC. However, if ABC or XYZ sells to an external business entity, then those revenues are part of the consolidated income statement. Similarly, raw material purchases from external suppliers and salaries are also part of the consolidated income statement.
Balance Sheet
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The consolidated balance sheet reports the assets, liabilities and shareholders' equity of the combined entities. If the parent acquires 100 percent of the subsidiary at book value, then the consolidated balance sheet does not have to account for positive or negative differences between the purchase price and the book value of the acquired company, which is the difference between its assets and liabilities. For example, if the parent company has $1 million in total assets and the acquired subsidiary has $500,000, then the combined assets are $1.5 million ($1 million + $500,000). The shareholders' equity section of the consolidated balance sheet would consist of the capital stock of the parent company and an entry for the investment in the subsidiary company.
Less Than 100-Percent Ownership
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If the parent controls less than 100 percent of the shares of a subsidiary, then the consolidated balance sheet must have a separate line showing the non-controlling interest, which refers to the ownership interest of shareholders other than the parent company. For example, if a company acquires 90 percent of a subsidiary at book value for $450,000, then the non-controlling interest is 10 percent, or $50,000 [$450,000 x (10 / 90)]. In this case, the consolidated balance sheet would show an investment in subsidiary account for $450,000 and a non-controlling interest amount of $50,000. The consolidated income statement must also show an adjusting entry for the non-controlling interest. If the parent does not control 100 percent of a subsidiary, it must subtract the non-controlling portion from the net income or loss.
Elimination Entries
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In addition to the elimination of inter-company sales, the preparation of consolidated statements requires certain other elimination entries to make the statements reflect a single corporate entity. For example, a company cannot own itself, which requires the elimination of inter-company stock ownerships. Similarly, a company cannot borrow from itself or owe itself money, which means the elimination of inter-company receivables and payables.
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Now, diving into the concepts presented in the article:
1. Consolidated Method of Accounting:
- This method applies when a parent company exercises direct operational control over a subsidiary, leading to the preparation of consolidated financial statements.
2. Consolidated Financial Statements:
- These statements combine the financial data of the parent and subsidiary companies, including income statements, balance sheets, and statements of cash flows.
3. Income Statement:
- The consolidated income statement includes transactions with external entities.
- Sales between the parent and subsidiary are excluded, but revenues from external sources, raw material purchases, and salaries are included.
4. Balance Sheet:
- The consolidated balance sheet reports combined assets, liabilities, and shareholders' equity.
- If the parent acquires 100 percent of the subsidiary at book value, no adjustments are needed for the purchase price.
5. Less Than 100-Percent Ownership:
- If the parent has less than 100 percent ownership, a separate line for non-controlling interest is added to the consolidated balance sheet.
- The non-controlling interest is calculated based on the percentage of ownership not controlled by the parent.
6. Elimination Entries:
- Certain entries are required to eliminate inter-company transactions that would distort the consolidated statements.
- Examples include the elimination of inter-company sales, stock ownership, and receivables/payables.
7. Adjusting Entry for Non-Controlling Interest:
- When the parent doesn't control 100 percent of the subsidiary, the consolidated income statement must include an adjusting entry for the non-controlling interest.
- The non-controlling portion is subtracted from the net income or added to the net loss.
8. Inter-Company Transactions:
- Elimination entries extend to transactions like stock ownerships, borrowing, and lending between the parent and subsidiary to present a true picture of a single corporate entity.
In conclusion, the consolidated method of accounting is a meticulous process crucial for providing an accurate representation of the financial health of a company with subsidiaries. It requires adept handling of various accounting principles, including those related to ownership percentages, elimination entries, and non-controlling interests.
