Different types of business relationships are required to account for investments differently. The profits and losses of investments may or may not be allowed to be recorded with equity method accounting. Some companies are required to use it and others are required to consolidate financial statements and are not allowed to use equity method accounting.

Two of the different types of relationships are investors to affiliates and parent companies to subsidiaries. These two will be broken down later, but there are some main differences. An investing company owns some stock, but less than 50% of the company and may or may not have significant influence. A parent company owns at least 50% of the shares and has controlling interest.

An investing company can own varying amounts of stock and this ownership is generally connected to the amount of influence over the affiliate. At 20% ownership of shares, an investor usually has, what is called, a significant influence. This definition fluctuates with each affiliate, but some influences may be representation on the board of directors, input for managing employees, financial dispersion, and other operations of the business.

With 20% ownership and exercises significant influence, the investor is required to account for financial records with equity method accounting. This requirement is spelled out in IAS 28, Investments in Associates. If the stocks owned are less than 20%, the investor has a choice to use equity method accounting or not.

Using equity method accounting when less than 20% of the company is owned, is not recommended by most accountants, for the majority of investors. The main reason is because the profits from that small of investment are insignificant and may never be realized. However, if the recording of the investments is desired, the extra work can be done to show the profits of the stocks because there is no law preventing it.

A company that owns over 50% of another company’s shares is a parent company. A parent company has control of the subsidiary’s operations. These operations and business procedures may be conducted by the subsidiary, but ultimate control can be exercised by the parent.

In the parent to subsidiary relationship, the financial statements must be consolidated together. This one report shows the accounting numbers for the group of entities. Since the two companies are consolidated, equity method accounting is not applicable. In some countries, consolidation is not mandatory and this method can be used, but this is not the case in the United States.