Some years ago, Japan’s finance ministry issued a directive requiring the 600 largest Japanese companies to produce consolidated financial statements. The previous practice had been to use parent-company-only statements. The change was intended to put a stop to the practice of “window dressing” the parent company financial results by shoving losses onto the subsidiaries. When a parent company needed to show a bigger profit, it might sell its product to subsidiaries at an inflated price. Or the parent company might charge higher rent to a subsidiary company renting space from the parent.
Could a parent company follow these practices and achieve window dressing in its parent-only financial statements if it used the equity method of accounting for its intercorporate investments? Explain.