Reporting for a Combined Entity
When the amount of stock owned is >50% of common stock, a parent-subsidiary relationship is formed that requires consolidated reporting.
Explain how to report for a combined entity
- A subsidiary company, or daughter company is a company that is completely or partly owned and partly or wholly controlled by another company that owns more than half of the subsidiary’s stock.
- Consolidated financial statements show the parent and subsidiary as one single entity. During the year, the parent company uses the equity method to account for its investment. At the end of the year, a consolidation working paper eliminates intercompany transactions between parent and subsidiary.
- As of 2004, the acquisition method is the only allowable method that can be used to prepare consolidated financial statements for companies that combined after 2004. Other consolidation methods previously used were the purchase and the pooling of interests methods.
- state-owned enterprise: A government-owned corporation, state-owned company, state-owned entity, state enterprise, publicly owned corporation, government business enterprise, commercial government agency,public sector undertaking or parastatal is a legal entity created by a government to undertake commercial activities on behalf of an owner government.
Reporting for a Combined Entity
The ownership of more than 50% of voting stock creates a subsidiary. The financial statements of the parent and subsidiary are consolidated for reporting purposes.
A subsidiary company, or daughter company is a company that is completely or partly owned and partly or wholly controlled by another company that owns more than half of the subsidiary’s stock. The subsidiary can be a company, corporation, or limited liability company. In some cases it is a government or state-owned enterprise. The controlling entity is called its parent company, parent, or holding company.
An operating subsidiary is a business term frequently used within the United States’s railroad industry. In the case of a railroad, it refers to a company that is a subsidiary but operates with its own identity, locomotives, and rolling stock. In contrast, a non-operating subsidiary would exist on paper only (i.e. stocks, bonds, articles of incorporation) and would use the identity and rolling stock of the parent company.
When the amount of stock purchased is more than 50% of the outstanding common stock, the purchasing company usually has control over the acquired company. Control in this context is defined as ability to direct policies and management. In this type of relationship the controlling company is the parent and the controlled company is the subsidiary. The parent company needs to issue consolidated financial statements at the end of the year to reflect this relationship.
Consolidated financial statements show the parent and the subsidiary as one single entity. During the year, the parent company can use the equity or the cost method to account for its investment in the subsidiary. Each company keeps separate books. However, at the end of the year, a consolidation working paper is prepared to combine the separate balances and to eliminate the intercompany transactions between the parent and the subsidiary, along with the subsidiary’s stockholder equity and the parent’s subsidiary investment account. The result is one set of financial statements that reflect the financial results of the consolidated entity. As of 2004, the acquisition method is the only allowable method that can be used to prepare consolidated financial statements for companies that combined after 2004. Other consolidation methods previously used were the purchase and the pooling of interests methods.
The following is an example of how to calculate consolidated net income — assume ABC Corporation owns 80% of XYZ Corporation; the remaining 20% is a non-controlling ownership interest.
Net Income for 201X for ABC is USD 20,000 and for XYZ net income is USD 8,000. First, to arrive at consolidated net income for the two companies, ABC must eliminate the effect of the equity method used to account for its investment.
ABC’s net income for the year includes 80% of XYZ’s net income, or USD 6,400. This amount must be subtracted from the net income figure to arrive at 13,600 (20,000 – 6,400).
The consolidated net income for both companies after this adjustment is USD 21,600 (20,000 – 6,400 + XYZ’s total net income of 8,000). Second, the portion of net income attributed to the non-controlling ownership interest must be deducted, or USD 1,600 (8,000 *.20).
Therefore, consolidated income for ABC and its controlling interest in XYZ is USD 20,000 (21,600 – 1,600).