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How the Equity Method Relates to Consolidated Financial Statements

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How the Equity Method Relates to Consolidated Financial Statements

As we'll see, the equity method is in many ways a partial consolidation.

If a company acquires more than 50% of the voting stock of another company, it's said to have a controlling interest, because by voting those shares, the investor actually can control the company acquired. The investor is referred to as the parent; the investee is termed the subsidiary. For reporting purposes (although not legally), the parent and subsidiary are considered to be a single reporting entity, and their financial statements are consolidated. Both companies continue to operate as separate legal entities and the subsidiary reports separate financial statements. However, because of the controlling interest, the parent company reports consolidated financial statements.
p. 645 Consolidated financial statements combination of the separate financial statements of the parent and subsidiary each period into a single aggregate set of financial statements as if there were only one company - combine the separate financial statements of the parent and the subsidiary each period into a single aggregate set of financial statements as if there were only one company. This entails an item-by-item combination of the parent and subsidiary statements (after first eliminating any amounts that are shared by the separate financial statements).28 For instance, if the parent has $8 million cash and the subsidiary has $3 million cash, the consolidated balance sheet would report $11 million cash.

Consolidated financial statements combine the individual elements of the parent and subsidiary statements.Two aspects of the consolidation process are of particular interest to us in understanding the equity method. First, in consolidated financial statements, the acquired company's assets are included in the financial statements at

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