The debate over consolidating statements.

• Author: Pacter, Paul
• Position: Financial Accounting Standards Board's revised consolidation policy; includes related article

With the FASB's recent publication of a discussion memorandum, on "Consolidation Policy and Procedures," many executives will be debating how to prepare consolidated financial statements over the next several years.

The DM is step one in the FASB's complete reconsideration of the existing standards for preparing the consolidated financial statements of two or more business corporations. (The Board, however, is not addressing the question of applying the principles of consolidation to joint ventures partnerships, and not-for-profit organizations; the FASB plans to examine those matters in separate future projects.)

Unquestionably, the main issue in this DM is when is consolidation appropriate. Does control alone justify consolidation, with ownership an indicator of control? Or are control and ownership two separate and necessary conditions? What constitutes control? Should an investee company be consolidated if its parent is clearly in control but owns less than a majority of its voting stock? And, if so, how far below majority should the consolidation line be drawn?

ON THE BOOKS: ARB 51

The control-versus-ownership question in the DM is not a new one. The accounting profession has debated it for nearly a century, since the advent of consolidated statements. In 1959, 5 1, "Consolidated Financial Statements," was issued as a solution and remains in force today.

Like other accounting pronouncements of its day, ARB 51 was written in terms of presumptions, suggestions, and descriptions of practice rather than in the more prescriptive language of today's standards. In some cases, ARB 51 expressly sanctions alternative practices; some important consolidation issues are omitted, and others are not addressed conclusively.

Read below for paragraphs 1 and 2 of ARB 51:

"1. The purpose of consolidated statements is to present, primarily for the benefit of the shareholders and creditors of the parent company, the results of operations and the financial position of a parent company and its subsidiaries essentially as if the group were a single company with one or more branches or divisions. There is a presumption that consolidated statements are more meaningful than separate statements and that they are usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies."

"2. The usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule, ownership by one company, directly or indirectly, of over 50 percent of the outstanding voting shares of another company is a condition pointing toward consolidation

Although controlling financial interest is not defined, use of that phrase in paragraph 1 implies that the primary criterion for consolidation is control. Unfortunately, paragraph 2 muddies the waters by suggesting' that a controlling financial interest is usually conferred by owning a majority of voting stock without citing any other way that a controlling financial interest might be attained.

Consequently, under current accounting practice, an investee that is less than majority owned is seldom consolidated, even if there is no doubt about the investor's ability to control. The few exceptions tend to be foreign investees owned just a bit below the 50-percent level due to laws in the foreign country requiring majority local - in this case foreign-ownership, provided that the foreign owners are merely passive investors and not active in managing the foreign subsidiary.

Not only does control versus ownership as the basis for consolidation remain unsettled today, it looms as the single...