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Holding Company Accounting Anonymous University of Mississippi eGrove Haskins and Sells Publications Deloitte Collection 1927 Holding company accounting Anonymous Follow this and additional works at: https://egrove.olemiss.edu/dl_hs Part of the Accounting Commons, and the Taxation Commons Recommended Citation Haskins & Sells Bulletin, Vol. 10, no. 02 (1927 February), p. 10-12 This Article is brought to you for free and open access by the Deloitte Collection at eGrove. It has been accepted for inclusion in Haskins and Sells Publications by an authorized administrator of eGrove. For more information, please contact [email protected]. 10 HASKINS & SELLS February Holding Company Accounting N a country where industrial expansion However, looking beyond the legal fiction I has occurred in unparalleled fashion, of the separate corporate entities and view• especially in corporate form, and in a ing the related companies as a single generation which has seen the develop• organization, it becomes desirable from a ment of the automobile, aeroplane, radio, business point of view to have information etc., until new inventions merely form a in addition to that contained in the bal• part of the day's news, it is no small won• ance sheet of the holding company. der that the rapid growth of the holding There are three principal methods which company should be accepted as naturally are used to present such information con• as the growth of a single child in a large cerning the subsidiaries: (1) to submit family. The many advantages attending statements of each subsidiary individually; the use of the holding company device, (2) to submit combined statements of the principally in the functions of manage• holding company and all subsidiaries; ment and finance, have given this form of (3) to submit consolidated statements of organization a secure place in the indus• the holding company and all subsidiaries. trial world. The chances are it will be The first method is feasible only where displaced only by a more advantageous the number of subsidiaries is very small. type of business organization; not by legal Advantage lies in the fact that individual restraint. In the public utility field alone analysis permits of discerning the weak approximately seventy per cent of the members of the group. Where there are billions of dollars invested in electric, gas, many related companies, however, it would street and interurban railway companies be difficult to visualize the situation as a is controlled by holding companies and whole by viewing a large number of in• their subsidiaries. dividual financial statements. In contrast to the rather well established Combined statements of the holding procedure in most phases of corporate company and all subsidiaries sometimes accounting, there is as yet no standard are prepared to show total investments, form of accounting for holding companies. but such statements are inclined to be mis• Operating companies in the public utility leading. A combined statement merely field ordinarily follow lines prescribed by shows the aggregate, without elimination, regulatory bodies; however, pure holding of the intercompany balances according to companies in the utility field may employ the individual statements of the related different methods of accounting in pre• companies. A consolidated statement in• paring their annual reports. cludes the total of the holding company A holding company is a legal entity in figures and all subsidiaries with proper that, in the absence of fraud, a right of elimination of intercompany items. It is action against a subsidiary company cannot doubtful as to what proportion of pros• be enforced against the parent company, pective investors are aware of this dis• and vice versa. From the legal point of tinction between a combined and a con• view, therefore, the balance sheet of the solidated statement. In one instance the holding company by itself would suffice. combined net income, as exhibited in the Bulletin HASKINS & SELLS 11 prospectus of a company, exceeded the In case a consolidated balance sheet is consolidated net income by more than not prepared it is desirable that invest• thirty per cent. The combined net income ments in subsidiaries be shown separately in this case included the net income of in the parent company's balance sheet company A and dividends of company A rather than under the general heading of taken up as income of company B. Investments. This adds clearness to the Consolidated statements are by far the situation, since the investments in subsidi• kind most commonly used in the United aries are fixed assets while other invest• States. Business men at first were re• ments may be current. Similarly any lia• luctant to adopt them, but the example bilities of the parent company to subsidi• set by some of the larger and more im• aries should be set out separately. portant holding companies led others to Cost of acquisition is a basis generally follow in their footsteps. The value of used in the valuation for balance sheet consolidated statements as a means of purposes of a holding company's interests portraying the financial condition and in subsidiaries. But occasionally the losses operations of a corporation having large of some of the subsidiaries since the date interests in subsidiaries readily became ap• of acquisition exceed the undistributed parent, and it was not long before the New profits of the more successful subsidiaries. York Stock Exchange required the filing of If the parent company makes no provision consolidated balance sheets. Later the for this loss, the investment in subsidiaries Federal Reserve Board indorsed the use of as shown on the balance sheet does not consolidated statements by parent com• represent the true state of affairs. In panies applying to members of its system practice, some companies take up 100% for credit. Eventually the Federal income of such losses rather than the propor• tax laws recognized the necessity of adopt• tionate share applicable to its stock hold• ing the principle of consolidation as applied ings. This procedure is supported on the to financial statements and provided for grounds of conservatism, but nowadays, consolidated returns. when undervaluations are more common The consolidated balance sheet is very than formerly, the secret reserve which seldom used in England, or, in fact, in any thus may be created also is to be avoided. part of Europe. The holding company, The true situation should be presented and each of its subsidiaries which is a pub• and in view of the fact that subsidiary lic company, publishes a "legal" balance losses decrease the value of stock held by sheet as required by law. Not only are the minority as well as the parent company, directors in British corporations reluctant it should not be considered obligatory for about making known any additional in• the holding company to assume all such formation, but many company officials losses. consider it improper for a holding com• The cost of acquisition, whether more pany to incorporate the assets and lia• or less than the book value according bilities of subsidiaries in its balance sheet to the subsidiary's accounts, should in• when they are not legally the assets or clude all undistributed profits earned prior liabilities of the holding company. Share• to the date of acquisition. Dividends paid holders are fortunate if they know the out of subsequent earnings should be names of subsidiary companies, so that credited to income by the parent company. they may obtain further information from Although a dividend may be declared the separate balance sheets. Even this is legally out of "purchased" profits of the not possible if the subsidiaries are private subsidiary, to the parent company it is a companies. return of assets previously paid for; hence, 12 HASKINS & SELLS February the investment account of the parent com• but some nice questions arise in the ap• pany should be reduced accordingly. plication of that principle in practice. It has been stated that profits of a What determines whether a related com• subsidiary should not be used as a basis pany should be consolidated? At one for the declaration of dividends by the time ownership of 75% or more of the capi• holding company beyond the extent to tal stock was. considered necessary. If which such profits have been actually dis• effective control of policy is to be the basis, tributed as dividends by the subsidiary. not even 51% is necessary, for many cor• But this does not go far enough. In one porations with diversified stock ownership instance the parent company A owned are controlled by interests holding 35% the entire capital stock of subsidiaries of the common stock. Nor does the prob• B and C. B made a substantial profit lem end here. Suppose a subsidiary con• and declared a dividend thereon. C suf• trolled by 40% stock ownership was in fered a loss so that the condition of the turn a holding company and directed the organization in its entirety as represented policy of other subsidiaries and minor by consolidated statements did not war• holding companies with a partial owner• rant the payment of a dividend. Never• ship of stock. Within what bounds should theless A ignored the loss of C, took up the major holding company be restricted the dividend from B as income and de• in the inclusion of subsidiaries in con• clared a dividend out of the resulting solidated statements? Apparently this profit. The principle that a holding com• is one direction in which the use of pany may distribute dividends to its stock• consolidated statements needs to be holders to the extent that dividends are limited. received from subsidiaries is. appropriate, The development of consolidated state• therefore, only when the amount dis• ments was brought about by the demand tributed does not exceed the net aggregate for further information regarding the true profits of the subsidiaries.
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