investments/business combinations
Can somebody please tell me why one company would prefer recording at cost method vs equity method? are there any factors that would make one method more preferable than another for a company?
(maybe i should specify that its in a control situation where a parent acquires 100% of a subsidiary)
Thanks in advance
Cost method avoids having to take in a pro-rate share of the subsidiary's net income or net loss. So if the sub was losing money you'd prefer to have only a cost method investment to avoid having to record part of the loss. Using the equity method would cause you to record a pro-rata share of the loss.
But in your case the ownership is 100% which means 1) must use full equity method treatment (record 100% of sub's net income or loss) AND 2)must perform full consolidation of that sub with the parent.
Thank you so much for your help
could you please elaborate on why its a "must" that the equity method must be used here? is this the case even if the sub remains autonomous?
I think you have to ponder for a bit how being 100% owned goes along with being "autonomous". Can that sub merge with a company other than yours at its own choice? No. So sub is really not too "autonomous".
Anyway, ever since Enron, the accounting rules have been tough on ensuring that what is 100% owned is picked up as part of the consolidated total.
I suppose if management doesn't want the sub they can sell it. But right now they are the proud owners.
Originally Posted by blackeye2002
Single Member LLC as "Subsidiary"
zzyzx could extend his argument to LLCs with single owners (SMLLC). If the "Parent" company
owns a "subsidiary" in LLC form, the LLC is "disregarded as an entity separate from its
owner".
Hence the relationship of parent and subsidiary is in question. The LLC becomes an accounting
tool to separate financial accounting with a design towards economic analysis. Aforementioned
topic similar to distinction between department, division or subsidiary. Banks use the term "branch"
in the stead of department.
Example:
ExxonMobile decides to create 100 single member LLCs in Alaska. Each LLC will be 100%
owned by ExxonMobil. 100 Oil Carriers (Tankers) are transferred into 100 LLCs.
Are the 100 LLCs "subsidiaries" of ExxonMobil?
A: Federal Tax: No
B: State Tax in Alaska* or State of Delivery: No
C. Tort litigation in State Court: Maybe, depending on the amount of control retained or exercised over
the LLCs affairs - a question of defacto versus dejur autonomy.
*Alaska lacks a state income tax; though port delivery taxation, state securities taxation and
regulations fail to uniformly recognize federal SMLLC classification.
Last edited by Helse; 02-04-2010 at 09:51 AM.
Below are a few differences between the equity accounting method for investments and the cost accounting method for investments.
* The equity method of accounting is used when there is a significant influence or control, with the investment being between 20 to 50 percent of the total stock of the firm invested in. The cost method is preferably used for lesser investment percentages.
* The cost method of accounting has an advantage over equity method of accounting when there is no fair, easily determinable value for the investment.
* It is easier to calculate the return on investment and do other financial analysis of figures when the equity accounting method is used. As the cost method uses working paper and not the general ledger, all figures must be tracked there first.
* The cost method of accounting includes less paperwork than the equity method. On the other hand, being more comprehensive, the financial statements done using the equity method are more useful to the internal management for facilitating analysis.
* The best scoring point of the equity method over the cost method of accounting is that it has an easy self-checking feature, i.e., the consolidated financial statements should tally with certain parent figures and when they don't, the problem can be easily identified and corrected. The cost method of accounting has no such self-check feature.
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