sition reflects the investor’s proportionate interest in the net assets of the investee as
a single amount, typically labeled “equity in net assets of investee,” and in which the
investor’s income statement reflects the investor’s proportionate interest in the net in-
come of the investee as a single amount, typically labeled “equity in net income of
investee.” As the investee earns income, the investor includes its proportionate share
in income and increases the balance of the investment (equity in net assets). As the
investee declares dividends the investor reduces the balance of the investment.
(d) Cost Method. This is a method of accounting for the investments in which the
investor’s statement of financial position reflects its investment in the investee at
original cost. The investor records income as the investee declares dividends out of
net accumulated earnings of the investee since the investor’s purchase of its invest-
ment. Dividends in excess of the net accumulated earnings are accounted for as a re-
duction of the investment.
(e) Comparison of Methods. The first three methods generally result in the same
shareholders’ equity and net income with minor exceptions but the presentation of the
financial statements is quite different, as illustrated in Exhibit 18.1. The cost method
results in different stockholders’ equity and net income, because the investor does not
record the investee’s undistributed income. For purposes of illustration, Exhibit 18.1
applies all four accounting methods to a single investment. In reality the four meth-
ods can not be used interchangeably in accounting for a single investment.
18.5 ACCOUNTING FOR INVESTMENTS IN SUBSIDIARIES
(a) Definitions of Control. A parent–subsidiary relationship is a prerequisite for the
preparation of consolidated financial statements. A subsidiary is defined as an entity
that is controlled by another entity. Therefore, the definition of control is of primary
18 • 4 CONSOLIDATED FINANCIAL STATEMENTS AND BUSINESS COMBINATIONSAssume that Parker International acquired 80% of the common stock of MNO Corp. on Jan-
uary 1, 2001 (at the beginning of the current year) for $800,000. On the date of acquisition,
the book value of the net assets of MNO was $800,000, which also equaled their fair value.
The first two columns in the solution are the Statement of Financial Position and the Income
Statement for Parker International and MNO Corp. as of December 31, 2001 and for the year
then ended. While this is an illustration of the four methods discussed above it must be re-
membered that the methods are not interchangeable. Specific conditions must be taken into
consideration when determining the method to be used. The investment in MNO is recorded
on the books of Parker International using the equity method.
Solution:
Observe that the Net income is the same under all the methods except the cost method. Since
no dividends were paid by MNO, Parker would not report any income from its investment in
MNO under the cost method. The minority interest is recognized on the statements when the
full consolidation method is used. Minority interest is not recognized when the proportionate
consolidation method is used as only the parent’s share of the assets and liabilities of MNO
are reported under the proportionate consolidation method.
Exhibit 18.1. Comparison of Methods of Reporting Investments.