concern in determining whether or not consolidated financial statements should be
prepared. The definitions of control fall into two categories: legal control and eco-
nomic control.
Definitions of control based on legal control look to specific objective conditions
that demonstrate the ability of the parent to control the subsidiary. Examples of legal
control include:
- Ownership of a majority voting interest in the subsidiary
- Ownership of a majority of the equity securities of the subsidiary
- Ability by contract, proxy, or otherwise, to appoint a majority of the subsidiary’s
board of directors
Economic control is a more subjective concept than legal control. Some examples
of economic control are:
- The control of legally independent entities by a mutually agreed system of cen-
tral and unified management - The right to direct the operating and financial policies of the enterprise through
either a controls contract or provisions in the enterprises’ Articles
This concept relies on a subjective determination of when the operation of a group
of entities is sufficiently unified to constitute economic control.
(b) Triumph of Full Consolidation. The full consolidation has emerged throughout
the world as the predominant method of accounting for investments in subsidiaries in
the primary financial statements. Accounting rule makers and regulators have come
to accept that the financial statements of a parent and its subsidiaries should report
the financial position, results of operations, and cash flows as if they were one legal
entity. Multiple subsidiaries may be formed for tax, legal, or other reasons, but they
function as a single economic unit and should report as one. Proponents of full con-
solidation recognize that members of the group may operate in a decentralized man-
ner and that management of the various subsidiaries may be given broad authority to
run their business with minimum supervision by the parent. The subsidiaries, how-
ever, operate for the benefit of the group and will be able to continue to operate in a
decentralized manner only as long as they serve the needs of the group. The parent
retains the power to control the subsidiaries whether they exercise it or not.
The alternatives to full consolidation, the equity method and the cost method have
become less acceptable over time, because they potentially obscure the nature and
extent of operations conducted by the subsidiaries and the parent’s control over them.
If the equity method is used, the parent reports its share of the subsidiary income or
losses but does not display the subsidiary assets or liabilities. In the United States, the
equity method is acceptable only when a company has significant influence over an-
other company but does not have control. When the cost method is used, the parent
does not report its share of the undistributed income and, of even greater concern,
does not report its share of subsidiary losses. The cost method thus provides a means
to conceal losses by transferring loss operations to existing or newly created sub-
sidiaries. In the United States the cost method is generally accepted accounting prin-
ciples (GAAP) only when a company invests in another company but neither has
control or significant influence. It is true that footnote disclosures can partially com-
18.5 ACCOUNTING FOR INVESTMENTS IN SUBSIDIARIES 18 • 5