pensate for the deficiencies of the equity or cost method; however, information in the
footnotes commands less attention than the information contained on the face of the
financial statements. Further information in the footnotes generally is excluded from
financial statement databases.
Full consolidation, however, does not solve all of the problems. Creditors in the
individual entities in the consolidated group need separated financial statements to
reveal the resources that are available for the repayment of their loans. Consolidated
financial statements may also need footnote disclosure to explain restrictions on the
transfer of cash or other assets between the members of the group.
(c) Required Accounting for Investment in Subsidiaries. This section describes the
accounting requirement in the United States, Canada, the European Union, the
United Kingdom, Japan, and the requirements of International Accounting Stan-
dards.
(i) United States. The primary guidance in the United States is FASB Statement No.
94, “Consolidation of All Majority-Owned Subsidiaries. Statement No. 94 requires
the parent to fully consolidate all companies in which it “has a controlling financial
interest through direct or indirect ownership of a majority voting interest.” SFAS 94
contains two exceptions to this rule: (1) if control is likely to be temporary, or a long-
term investment position is not contemplated, such as when a majority interest is ac-
quired for the purpose of facilitating other business deals and not with a meaningful
commitment to the acquired company; and (2) if the control does not rest with the
majority shareholders. If the subsidiary is in legal reorganization or in bankruptcy,
control may not rest with the parent company management, but with fiduciaries, such
as bankruptcy trustees or creditors. Similarly, effective control of foreign subsidiaries
may rest with the foreign government, in cases where foreign exchange restrictions,
controls, or other governmentally imposed restrictions are so severe that they cast
significant doubt on the parent’s true ability to control the subsidiary. If the subsidiary
were not consolidated because control does not rest with the majority shareholders,
it would generally be accounted for by the cost method.
Rule 3A-02 of SEC Regulation S-X is substantially similar to Statement No. 94.
Rule 3A-02 differs in two respects:
1.It requires full consolidation of majority-owned “entities,” which includes non-
incorporated entities.
2.It notes that, in certain rare circumstances, it may be necessary to consolidate
an entity fully notwithstanding the lack of majority ownership, “because of the
existence of a parent-subsidiary relationship by means other than record own-
ership of voting stock.”In 1989, the SEC staff became increasingly concerned about special-purpose enti-
ties (SPEs):
Certain characteristics of those transactions raise questions about whether SPEs should
be consolidated (notwithstanding the lack of majority ownership).... Generally, the
SEC staff believes that for nonconsolidation... to be appropriate, the majority owner
(or owners) of the SPE must be an independent third party who has made a substantive
capital investment in the SPE, has control of the SPE, and has made a substantive cap-
ital investment in the SPE, and has substantive risks and rewards of ownership of the18 • 6 CONSOLIDATED FINANCIAL STATEMENTS AND BUSINESS COMBINATIONS