Which method must be used if ASC 810-10-65 prohibits full consolidation of a 70% owned subsidiary? Select one:
a. Equity method
b. The Liquidation value
c. Market value
d. The cost method
The correct answer and explanation is :
Correct Answer: a. Equity method
Explanation:
Under ASC 810-10-65, part of the Accounting Standards Codification (ASC) 810 – Consolidation, the Financial Accounting Standards Board (FASB) outlines the requirements for consolidating financial statements when one entity has a controlling financial interest in another. Typically, if a parent owns more than 50% of a subsidiary, it is required to fully consolidate that subsidiary into its financial statements. However, ASC 810-10-65 also provides guidance on exceptions to full consolidation.
If ASC 810-10-65 prohibits full consolidation of a 70% owned subsidiary, this usually means that the parent, despite its majority ownership, does not have effective control over the subsidiary. This situation could arise due to contractual agreements, legal restrictions, or other conditions that limit the parent’s ability to direct the activities of the subsidiary.
In such cases, the parent company cannot consolidate the subsidiary using the full consolidation method. Instead, it must use the equity method of accounting. Under the equity method, the parent does not combine the subsidiary’s assets, liabilities, revenues, and expenses with its own. Instead, the investment in the subsidiary is recorded as a single line item in the parent’s balance sheet, and the parent’s share of the subsidiary’s net income or loss is recognized in its income statement.
Why the Other Options Are Incorrect:
- b. Liquidation value: This is not a recognized accounting method for ongoing subsidiaries. It is typically used in bankruptcy or wind-down scenarios.
- c. Market value: This method is more relevant for investment securities rather than for accounting for investments in subsidiaries.
- d. Cost method: This is used when the investor has little or no influence (typically less than 20% ownership). It is not appropriate when the parent owns 70%, as that suggests significant influence, even if consolidation is restricted.
Thus, when consolidation is prohibited, but ownership is still significant (e.g., 70%), the equity method is the appropriate alternative.