Investment in Securities with Controlling Influence

A long-term investment classified as equity securities with controlling influence Long-term investment when the investor is able to exert controlling influence over the investee; investors owning 50% or more of voting stock are presumed to exert controlling influence. implies that the investor can exert a controlling influence over the investee. An investor who owns more than 50% of a company’s voting stock has control over the investee. This investor can dominate all other shareholders in electing the corporation’s board of directors and has control over the investee’s management. In some cases, controlling influence can extend to situations of less than 50% ownership. Exhibit 15.7 summarizes the accounting for investments in equity securities based on an investor’s ownership in the stock.

EXHIBIT 15.7 Accounting for Equity Investments by Percent of Ownership

The equity method with consolidation is used to account for long-term investments in equity securities with controlling influence. The investor reports consolidated financial statements when owning such securities. The controlling investor is called the parent Company that owns a controlling interest in a corporation (requires more than 50% of voting stock)., and the investee is called the subsidiary Entity controlled by another entity (parent) in which the parent owns more than 50% of the subsidiary’s voting stock.. Many companies are parents with subsidiaries. Examples are (1) McGraw-Hill, the parent of J.D. Power and Associates, Standard & Poor’s, and Platt’s; (2) Gap, Inc., the parent of Gap, Old Navy, and Banana Republic; and (3) Brunswick, the parent of Mercury Marine, Sea Ray, and U.S. Marine. A company owning all the outstanding stock of a subsidiary can, if it desires, take over the subsidiary’s assets, retire the subsidiary’s stock, and merge the subsidiary into the parent. However, there often are financial, legal, and tax advantages if a business operates as a parent controlling one or more subsidiaries. When a company operates as a parent with subsidiaries, each entity maintains separate accounting records. From a legal viewpoint, the parent and each subsidiary are separate entities with all rights, duties, and responsibilities of individual companies.

Consolidated financial statements Financial statements that show all (combined) activities under the parent’s control, including those of any subsidiaries. show the financial position, results of operations, and cash flows of all entities under the parent’s control, including all subsidiaries. These statements are prepared as if the business were organized as one entity. The parent uses the equity method in its accounts, but the investment account is not reported on the parent’s financial statements. Instead, the individual assets and liabilities of the parent and its subsidiaries are combined on one balance sheet. Their revenues and expenses also are combined on one income statement, and their cash flows are combined on one statement of cash flows. The procedures for preparing consolidated financial statements are in advanced courses.

IFRS Unlike U.S. GAAP, IFRS requires uniform accounting policies be used throughout the group of consolidated subsidiaries. Also, unlike U.S. GAAP, IFRS offers no detailed guidance on valuation procedures.