Equity Method, Consolidation and Control
How a parent company accounts for another business it owns a stake in — folding in every line item versus reporting just a single net number — hinges entirely on whether it controls that business or merely influences it.
Prerequisites: Reading a Balance Sheet, Purchase Price Allocation and the Opening Balance Sheet
A company owns 25% of another business. It doesn't control it — it can't hire or fire management, can't set the budget — but it can put a board member on the seat and influence major decisions. Should the investor's financial statements show 25% of that business's revenue, expenses, and assets mixed into its own, or just a single line reflecting its ownership stake? The answer depends entirely on one question: control or influence?
If a company controls another entity (usually, but not always, defined by owning more than 50% of voting shares), it consolidates — every line of the subsidiary's income statement and balance sheet is added into the parent's, with a "non-controlling interest" line backing out the portion it doesn't own. If a company has significant influence but not control (the common threshold is 20–50% ownership), it uses the equity method — reporting only its share of the investee's net income as a single line, with no revenue, expenses, or gross assets added in.
Two very different pictures
Consolidation makes the parent's statements look bigger — it shows the full scale of operations the parent actually directs, even the portion it doesn't fully own, because control means the parent's decisions drive the whole entity's results. The equity method deliberately keeps the investee's operations out of the parent's top line, because the investor doesn't direct them day to day — it only has a claim on a share of the profit.
Worked example
A parent owns 80% of Subsidiary A (control — consolidated) and 25% of Company B (influence — equity method). Subsidiary A has $500 million revenue and $60 million net income. Company B has $200 million revenue and $20 million net income.
- Consolidation of Subsidiary A: the parent's income statement adds in the full $500 million of revenue and all of A's expenses, arriving at $60 million net income from A. Then, because the parent only owns 80%, it subtracts a $12 million () "non-controlling interest" deduction below the net income line, leaving $48 million attributable to the parent's own shareholders.
- Equity method for Company B: none of B's $200 million revenue appears anywhere on the parent's income statement. The parent recognizes a single line: , i.e. $5 million of "equity in earnings of affiliate."
The parent's reported revenue includes all $500 million from A and $0 from B, even though it has an economic claim on profits from both.
What this means in practice
Revenue and margin comparisons can be distorted by consolidation choices that have nothing to do with operating performance — two companies with identical economic exposure to a joint venture can report very different revenue depending on whether they cross the control threshold. Analysts check ownership footnotes to see which entities are consolidated, equity-accounted, or excluded entirely.
Control isn't always a clean percentage threshold — a company can consolidate an entity it owns less than 50% of if it holds effective control through contracts, board seats, or being the primary beneficiary of a variable interest entity, and conversely can avoid consolidating a majority-owned stake if genuine control sits elsewhere. Ownership percentage is a strong signal, not a guarantee.
Related concepts
Practice in interviews
Further reading
- FASB ASC 810, Consolidation
- FASB ASC 323, Investments — Equity Method and Joint Ventures