The need to provide more adequate financial information has resulted in the formulation of several methods of accounting for the investments of undertakings. Under current UK (and IAS) GAAP, the cost-based method is only suitable when accounting for simple investments33 where the investor does not exercise significant influence over the investee or in certain circumstances when a subsidiary is excluded from consolidation. Investments are essentially recorded at cost in the balance sheet of the investor, with any related dividends reflected in the income statement.
The legal regulations and accounting standards referred to in the previous section ensure that the cost-method is no longer permitted when accounting for subsidiaries, associates, joint ventures or JANEs. In fact, the acquisition34method of consolidation is predominately used when accounting for subsidiaries. Consolidation entails combining the accounts of the parent and its individual subsidiaries as though a single entity were in existence. Amounts are aggregated on a line-by-line basis, with adjustments made for minority interests and inter-company transactions.
FRS 6 also allows for the use of the merger method35, on a restricted basis, which is much easier to apply and attractive in that generally, distributable reserves are greater. Unfortunately, prior to the promulgation of the Seventh Directive, the definition of a subsidiary was quite crude, based primarily on share ownership. This allowed companies to avoid fully-consolidating investments by maintaining holdings of equity under the 50% threshold. With the incorporation of the de facto control principle, the definition of a subsidiary was widened, with greater emphasis placed on voting rights and dominant influence.
FRS 2 strengthened consolidation requirements in this regard. In relation to associates and joint ventures, SSAP 1 advocated the use of the equity method, where "the investor's share of the investee's net assets is included as a single item in the investor's balance sheet"36. No minority interest is thus shown. This one-line method of consolidation may also be used to account for subsidiaries in the absence of dominant influence. Where significant influence is exerted, (which constitutes the existence of an associate), this method must be employed under FRS 9.
While this standard did not effectively alter accounting for associates, new measures were taken to emphasise significant influence over the traditional 20% ownership floor and in relation to joint ventures. The latter are thus accounted for under current UK GAAP using the gross equity method37, which, for disclosure purposes, differs only from the equity method when presenting turnover and the investment in investee. Paragraphs 8 and 9 of FRS 9 also make provision for JANEs. The standard requires the use of a "variation of proportional consolidation38",39 whereby only the group's share of the assets and liabilities is recorded.
The Seventh directive banned the use of this method when accounting for subsidiaries, and the ASB rejects its use with respect to joint ventures under FRS 940. In essence, the methods of accounting for investments in other companies under UK GAAP are quite complex and have evolved over time, reflecting changes in the macroeconomic environment and the need to provide sterner regulation in order to reduce the scope for circumvention. Yet, where do international standards differ?