Subsidiary

Definition

A subsidiary is a company that is controlled by another company, known as the parent company, through majority ownership of its voting shares. The parent company typically consolidates the financial statements of the subsidiary into its own, meaning the results of the subsidiary are combined with those of the parent. This relationship is important for understanding changes in reporting entities, particularly when acquisitions or mergers occur.

5 Must Know Facts For Your Next Test

1. Subsidiaries can be fully owned by the parent company or partially owned, but the parent must hold more than 50% of the voting shares to have control.
2. When a parent company acquires a subsidiary, it often leads to a change in reporting entity, requiring specific disclosures in the financial statements.
3. Financial results from a subsidiary are combined with those of the parent through consolidation, affecting both revenue and expenses reported.
4. If a subsidiary operates in a different industry than its parent, it may require separate financial reporting and analysis to reflect its unique operations.
5. Changes in control over a subsidiary can lead to re-evaluations of its fair value on the parent’s balance sheet, impacting overall financial reporting.

Review Questions

• How does the relationship between a parent company and its subsidiary affect financial reporting?
  • The relationship between a parent company and its subsidiary significantly impacts financial reporting because the parent must consolidate the financial results of the subsidiary into its own statements. This means that all revenues, expenses, assets, and liabilities of the subsidiary are reflected in the parent's financial reports. Such consolidation provides a comprehensive view of the overall financial health of the parent company and allows stakeholders to assess performance across all entities under common control.
• Discuss how changes in ownership or control of a subsidiary influence reporting entities and financial disclosures.
  • Changes in ownership or control of a subsidiary directly influence reporting entities as they can trigger a reassessment of how financial information is presented. When control shifts, for instance during an acquisition or divestiture, it requires proper disclosures regarding the change in reporting entity. This ensures transparency for investors and regulators by highlighting how these changes impact consolidated financial statements and overall corporate governance.
• Evaluate the implications of accounting for subsidiaries on the decision-making process within corporate structures.
  • Accounting for subsidiaries has significant implications on decision-making within corporate structures as it affects resource allocation, performance evaluation, and risk management strategies. Understanding how subsidiaries contribute to overall profitability and operational efficiency is essential for executives making strategic decisions. Furthermore, accurate accounting practices ensure that potential investors receive a true picture of financial health, enabling informed investment decisions which can impact future funding and growth opportunities.

Related terms

parent company: A parent company is an entity that owns enough voting stock in another company to control its policies and oversee its management.

consolidation: Consolidation refers to the accounting process of combining the financial statements of a parent company and its subsidiaries into one set of financial statements.

equity method: The equity method is an accounting technique used to record the investment in a subsidiary or associate when significant influence is exerted, typically when ownership is between 20% and 50%.