If your business invests in another business, keeping the books becomes even more complicated. If, say, you buy one of your suppliers, do you still report buying supplies as an expense?
Does the subsidiary count as an asset on your balance sheet? There are three accounting methods for this situation, cost, equity and consolidation. The one you use depends on how big a stake you have in the other business. Cost, Equity or Consolidation Cost is the simplest method of accounting for your investment. You record your acquisition as an asset on the balance sheet, setting the value as equal to the the purchase price. The only time you can use this approach is if you purchased 20 percent or less of the other company.
If you buy more than 20 percent, accounting rules treat you as a serious player — someone who can exert a lot of influence over the other business. Now you have to use the more complicated equity method.
The exception is if you can show your influence is limited: The other company filed suit or complained to regulators to block your investment. You signed an agreement reducing your shareholder rights. The majority owner ignores your opinions or wishes. The consolidated method of accounting kicks in when your investment is 50 percent or more.
At this level, you don't just have influence, you're running the show. When the second company announces earnings, you report 30 percent of the earnings as your own income. If, instead, the company reports losses, you adjust the asset's value down. If you control the other company, you have to draw up consolidated financial statements. These add the subsidiary's income, expenses and assets to your own. However, if you do any business with the subsidiary — contracting with it for services or supplies, for example — you have to eliminate those deals from your income statement.
Consolidated accounting doesn't count the sale as income, because you're really selling to yourself.