Equity method accounting and intercompany transactions.

In their consolidated statements chapters, most advanced accounting texts include a presentation of the "full" or "complete" equity method from the standpoint of the parent company. Under this method, the parent company adjusts its accounts for intercompany transactions with the subsidiary,

in addition to accounting for its share of the subsidiary's net income and dividends (the "simple" equity method) and for differences between the price paid and its share of the underlying book value of the subsidiary (the "partial" equity method). In these texts, many entries made by the parent company to adjust its accounts for unrealized profits on intercompany transactions would require modification if the parent issued "parent only" statements, or if the subsidiary was not consolidated (or an investor/investee relationship instead of a parent/subsidiary relationship existed).

The purpose of this paper is to discuss and illustrate parent/investor accounting for these intercompany transactions when the parent/investor uses the full equity method, but does not consolidate. Although the advanced texts provide the correct consolidating working paper techniques and resulting consolidated statements, the parent company's need to issue "parent only" statements (a one-line consolidation) makes these issues important. This paper's modified approach is also important regarding an investor/investee relationship in which the investor has significant influence, but not control, over the investee. The paper could be useful for students in advanced accounting courses or in intermediate accounting courses where the equity method is introduced and covered in some detail.

INTRODUCTION

Accounting Principles Board (APB) Opinion No. 18 (APB 1971a), The Equity Method of Accounting for Investments in Common Stock, requires that the equity method of accounting for a common stock investment be used when an investor's ownership percentage, usually between 20 percent and 50 percent, provides the investor significant influence over the operating and dividend decisions of the investee. Common stock investments in corporate joint ventures also require the use of the equity method. The equity method is also required by APB Opinion No. 18 when control exists under a parent/subsidiary relationship but consolidated statements are not appropriate, and when the parent company is required to issue "parent-only" financial statements. Companies also use the equity method in accounting for an investment in a subsidiary, even though the subsidiary will be consolidated for external reporting purposes.