Interests in subsidiaries not consolidated

3 key takeaways

• Interests in subsidiaries not consolidated occur when a parent company does not have full control over a subsidiary or chooses not to include it in consolidated financial statements.
• These interests are typically accounted for using the equity method or as financial investments, depending on the level of influence the parent company has over the subsidiary.
• Proper accounting for these interests is essential for accurate financial reporting and compliance with accounting standards.

What are interests in subsidiaries not consolidated?

Interests in subsidiaries not consolidated represent investments in subsidiary companies where the parent company either lacks sufficient control to consolidate them or opts not to consolidate them due to specific circumstances. These subsidiaries are not included in the consolidated financial statements of the parent company, which means their financial results are not combined with those of the parent and other subsidiaries.

Reasons for not consolidating subsidiaries

Several reasons might lead a parent company to not consolidate a subsidiary:

• Lack of Control: The parent company might own a significant but non-controlling interest, typically less than 50% of the voting shares, limiting its ability to control the subsidiary’s operations.
• Different Business Activities: The subsidiary might operate in a different industry or sector, making consolidation less relevant or practical.
• Regulatory Restrictions: Legal or regulatory requirements might prevent consolidation.
• Joint Ventures: The subsidiary might be a joint venture where control is shared with other entities.

Accounting for interests in subsidiaries not consolidated

When a subsidiary is not consolidated, the parent company typically accounts for its interest in one of the following ways:

• Equity Method: Used when the parent company has significant influence over the subsidiary, generally indicated by an ownership interest of 20% to 50%. Under this method, the investment is initially recorded at cost, and the carrying amount is adjusted for the parent’s share of the subsidiary’s profits or losses.
• Cost or Fair Value Method: Used when the parent company has little to no influence over the subsidiary. The investment is recorded at cost or fair value, with adjustments made for any impairments or changes in market value.

Example of equity method

Suppose a parent company owns 30% of a subsidiary and has significant influence over its operations. The parent company initially records the investment at $1 million. If the subsidiary reports a net income of $200,000, the parent company recognizes its share of the income:

Parent’s Share = 30% × $200,000 = $60,000

The parent company increases the carrying amount of the investment by $60,000, reflecting its share of the subsidiary’s profit.

Financial statement presentation

Interests in subsidiaries not consolidated are presented differently in financial statements compared to consolidated subsidiaries:

• Balance Sheet: The investment in the subsidiary is shown as a single line item, such as “Investment in Associates” or “Investment in Joint Ventures,” rather than combining individual assets and liabilities.
• Income Statement: The parent’s share of the subsidiary’s profit or loss is reported as a single line item, often under “Equity in Earnings of Affiliates” or a similar heading.

Implications for financial analysis

Understanding interests in subsidiaries not consolidated is important for financial analysts and investors:

• Transparency: Separate disclosure provides clarity on the nature and performance of these investments.
• Performance Assessment: Analysts can assess the impact of non-consolidated subsidiaries on the parent company’s overall financial health and profitability.
• Risk Evaluation: It helps in evaluating the risks associated with investments in subsidiaries that are not fully controlled by the parent company.

Proper accounting and disclosure of interests in subsidiaries not consolidated ensure accurate financial reporting and compliance with accounting standards. This approach provides transparency and allows stakeholders to understand the nature and impact of these investments on the parent company’s financial performance.