Subsidiary Company Definition
A subsidiary refers to a company that is subordinate, supplementary or additional to another company. A company that is under the control of a parent company or a holding company is a subsidiary. A subsidiary could be a public enterprise, a limited liability company or a corporation.
A parent company that controls a subsidiary holds more than 50% of the company’s shares. In a case where the parent company has 100% of the shares, it is a case of wholly owned subsidiary.
A Little More on How a Subsidiary Works
A company can decide to have a subsidiary for a number of reasons, in most cases, the tax benefits, diversified investments and assets that parent companies enjoy is a pushing force. A parent or holding company can have a subsidiary at a different geographical location or district, even in foreign countries. A subsidiary is not the same as the parent company, they are separate entities and are taxed separately.
Since it is possible to have a subsidiary located in a state different from the parent company, all laws and rules governing corporations in the state apply to the subsidiary. Members of the board of a subsidiary are elected with a significant influence from the parent company.
A company can purchase a smaller company which in turn becomes its subsidiary. Before a corporation, limited liability company or a public enterprise can be purchased and become a subsidiary without any approval from their shareholders. If a parent company purchases 50% of the shares of a company, the company becomes a subsidiary. A purchase of shares below 50% makes theIf 100% of a company’s shares is purchased by a wholly owned subsidiary. the company’s shares is purchased, it becomes a wholly owned subsidiary. However, if less than 50% of the shares is purchased, the relationship between the company and the firm that purchased its shares is that of an associate or affiliate.
Whether a subsidiary is a wholly owned subsidiary or not, all financial statements of a subsidiary are prepared independently and forwarded to the holding company. The holding company them consolidates the financial statements when making report to the Securities and Exchange Commission or the Internal Revenue Service.
Consolidation as a form of accounting helps to aggregate all financial statements emanating from branches of the same organization. Rather than having multiple financials for all the subsidiaries of a firm, the statements are aggregated and turned to a consolidated financial statement. However, this is not done for associates or affiliate companies.
Furthermore, there are certain exceptions where a parent company might not file a consolidated financial statement with the SEC. This mostly occurs when a subsidiary has gone bankrupt, hence, the subsidiary would become an unconsolidated subsidiary. Oftentimes, parents of unconsolidated subsidiaries have little or nothing at stake in the company, hence, these companies are treated as equity investment.
Benefits and Drawbacks to Subsidiaries
Parent or holding companies establish subsidiaries for a number of reasons, usually for the benefits they can derive from the subsidiaries. There are notable advantages of subsidiaries, so also are there disadvantages. Below is a highlight of the advantages and disadvantages of subsidiaries;
Advantages of Subsidiaries
- A subsidiary can limit the losses that a parent company can be exposed to. This is one of the main reasons parent companies establish subsidiaries.
- Subsidiaries serve as a form of protection for parent companies. It shields against financial losses and hedge lawsuits.
- Parent companies enjoy certain tax advantages and deductions through subsidiaries.
- Subsidiaries strengthen the reach of a firm and foster a good relationship with other divisions in the industry.
Disadvantages of subsidiaries
- It is more expensive to manage because subsidiaries require a greater Bureaucracy on the part of the parent company.
- More legal activities and accounting tasks are required to establish subsidiaries.
- The financial method used by the holding company becomes more complex, such as the use of consolidated financial statements.
- Total control over a subsidiary by a parent company is quite difficult.
- All debts, criminal actions and inadequacies of a subsidiary are carried by the parent company.
Real World Example of Subsidiaries
In the United States, the Security and Exchange Commission require all holding companies to file their subsidiaries under Item 601 of Regulation S-K. Many companies in the US have a long list of subsidiaries, such as Berkshire Hathaway Inc. which is owned by Warren Buffet. As at Dec. 2018, Berkshire Hathaway had 270 subsidiaries.
Alphabet Inc. is another firm in the United States with a long list of subsidiaries. All these holding companies are expected to disclose their subsidiaries under Item 601.