Accounts of Holding Companies, Dibrugarh University, Corporate Accounting B.Com 2nd Semester (CBCS) B.Com 1st Year Notes, Unit 5- Myedu365

 

UNIT – 5

Accounts of Holding Companies


1. What is Holding company and Subsidiary company?

Ans: HOLDING COMPANY: As per section 2(46) “Holding Company”, in relation to one or more other companies, means a company of which such companies are subsidiary companies. According to this section, one company can become the holding company of another in any of the following three ways:

1. By holding more than half of voting power in the subsidiary company.

2. By controlling the composition of the Board of Directors of the other company so that the holding company is able to appoint or remove the directors of the subsidiary company.

3. By controlling a holding company which controls another subsidiary or subsidiaries.

SUBSIDIARY COMPANY: As per section 2(87) of the company’s Act, 2013, a company is a “subsidiary company” of another company i.e. “Holding Company”, if that other company:

1. holds more than half of the voting rights in it, or

2. is a member of it and has the right to appoint or remove a majority of its board of directors, or

3. is a member of it and controls alone, pursuant to an agreement with other members, a majority of the voting rights in it, or if it is a subsidiary of a company that is itself a subsidiary of that other company.

 

2. What are the Advantages of Holding Company?

Ans: Following are the Advantages of Holding Company:

1. Easy Formation: The holding company can be formed very easily. There is no legal formality. Any company may purchase the majority shares from stock exchange and can become holding company.

2. Large Business: A holding company can collect the capital and expand the business on large scale.

3. Foreign Capital: The holding company may also attract the foreign capital for the expansion of a business.

4. A stable combination: The holding company is a very stable form of business organization. Its life is not affected by the disagreement of subsidiary company.

5. Goodwill: When the goodwill of the holding company is established in the market, it also improves the goodwill of its subsidiary company before the public.

6. Separate position: The subsidiary companies can maintain their separate position under this system. They do not loss their identity.

7. Control on production: A holding company can check the production and adjusts the supply according the demand. So over production cannot take place.

 

3. What are the disadvantages of Holding Company?

Ans: Following are the disadvantages of Holding Company:

1. Problem of Monopoly: A holding company tries to crate monopoly over the market. Monopoly is always against the public interest. It fixes higher prices and consumer suffers a loss.

2. Unequal distribution of wealth: Due to holding companies wealth goes in few hands and society is divided into two classes, rich and poor. Rich class enjoys all the amenities of life while poor class faces poverty and hunger.

3. Costly management: A holding company spends a lot of money on its management. So it is costly to maintain the proper control on large number subsidiary companies.

4. Minority interest ignored: The interest of the minority shareholders is ignored and the members of the holding company dispose of every resolution for their own interest.

5. Misuse of funds: The director of the company enjoys unlimited powers and they take undue advantages. They misuse the funds also.

6. Over capitalization: There is always a danger of over capitalization in the holding companies. It is very harmful for both the companies.

7. False reports: Generally the directors of the company present false reports about the company’s financial position. The true condition of the company nobody knows, and due to this sometimes creditors suffer a loss.

4. What is Consolidated Financial Statements?

Ans: Consolidated financial statements refer to the financial statements which show the summative accounting figure of the holding company along with its subsidiaries. In other words, consolidated financial statements can be addressed as the combined financial statements of a holding company and its subsidiaries. Consolidated financial statements normally include consolidated balance sheet, consolidated statement of profit and loss and notes, other statements and explanatory material that form an integral part thereof, consolidated cash flow statement is presented in case a parent presents its own cash flow statement. The consolidated financial statements are presented, to the extent possible, in the same format as that adopted by the parent for its separate financial statements. 

5. What are the Objectives / purpose of consolidated financial statements / why consolidation of Balance sheet & Profit and Loss account is necessary:

Ans: In India, the law does not compel a holding company to prepare a consolidated Balance sheet & Profit and Loss account. It is only for convenience that these statements are prepared. Shareholders of a holding company are interested in knowing the affairs of the subsidiary company as part of their money given to the holding company is invested in subsidiary company. So it becomes safe for directors of the holding company to disclose to the shareholders of the holding company the extent to which they are entitled to the net assets of the subsidiary company. By way of consolidated balance sheet, the investments of the holding company in the subsidiary company are replaced by assets.

      Consolidation of Balance sheet & Profit and Loss account means the combining of the separate Balance sheet & the separate profit & loss accounts of the Holding company & its subsidiary company or companies into single Balance sheet & Profit and Loss account.

      The purpose of consolidated Balance sheet & Profit and Loss account is to show the financial position & operating results of a group consisting of a holding company & one or more subsidiaries. The consolidated statements are reports of notional accounting entity which subsist on the view that the holding & subsidiary companies are to be treated as one economic unit. The financial position & operating results reported through the consolidated statements are portrayed from the interest of the members of the holding company. 

6. What are the Advantages or benefits of consolidated financial statements of the holding companies and its subsidiary companies at the end of the financial year?

Ans: Following are the Advantages or benefits of consolidated financial statements of the holding companies and its subsidiary companies at the end of the financial year:

i. Single source document.

ii. Intrinsic value of share can calculate.

iii. Return on investment in subsidiaries is known.

iv. Acquisition of subsidiary by indicating minority interest.

v. Evaluation of holding company by evaluating past trends for future guidance. 

7. What are the disadvantages or demerits of consolidated financial statements?

Ans: The consolidation of financial statements is not free from following disadvantages:

i. Concealment of Information: The consolidation of financial statements may conceal important information from investors when the companies in the group differ in respect of profitability, business risk and future prospects.

ii. Misleading Information: Consolidation may mislead the investor if the activities of any subsidiary are different from other subsidiaries in the group.

8. Explain the transactions which must be eliminated while preparing consolidated balance sheet.

Ans: In preparing consolidated balance sheet, common transactions appearing as an asset and a liability or vice versa in both the balance sheets of the holding company and the subsidiary company should be eliminated. Such transactions may be:

1. Goods sold on credit by the holding company to the subsidiary company or vice versa will appear as debtors in the balance sheet of the company selling goods and as trade payable in the balance sheet of the company purchasing goods.

2. Bills drawn by one company and accepted by the other company are eliminated while preparing consolidated balance sheet but bills discounted and endorsed will continue to appear as a liability because the company, which has accepted such bills, will have to make the payment to an outsider on the due date.

3. Loans advanced by the holding company to the subsidiary company or vice versa appears as an asset in the balance sheet of the company which gives such loans and as a liability in the balance sheet of the company that takes these loans.

4. Debentures issued by one company and held by the other company.

9. Write short notes on:

a. Cost of Control/goodwill or Capital Reserve:

If the holding company purchases the shares of the subsidiary company at a price which is more than the paid-up value of the shares, the excess amount paid represents payment for goodwill or cost of acquiring control of the subsidiary company if there exist no reserves or profit or loss balance in the subsidiary company on the date of acquisition of shares of the subsidiary company. Conversely if the shares are purchased at a price which is less than the paid-up value of the shares, the less amount represents capital reserve or profit.

b. Minority Interest:

When some of the shares of the subsidiary company are held by outsiders, their interest, known as minority interest in the subsidiary company, is calculated and shown as a liability in the balance sheet of the holding company. The share of the outsiders in the subsidiary company is called minority interest because they are having less than 50% of the shares of the subsidiary company. The minority interest is calculated as follows:

 

c. Pre-Acquisition profits or Capital profit

        If there exist some reserves and profits of the subsidiary company on the date of the acquisition of shares of the subsidiary company, the outside share of such reserves and profits is added to the minority interest and the balance of such reserves and profits are capital profits of the holding company and are shown as capital reserve in the Consolidated Balance sheet. In case of cost of control or goodwill, share of such profits belonging to the holding company is adjusted to goodwill and reduces the cost of control or goodwill.

       Similarly, losses of the subsidiary company shown in the Balance sheet on the date of the purchase of shares are divided into two parts i.e., share of the minority shareholders and share of the holding company. Share of the outsiders is deducted from the amount of the minority interest and share of the holding company is added to the cost of control or goodwill or reduced from capital profit which has become available on purchase of shares of the subsidiary company at a price lower than the paid-up capital. 

d. Post-Acquisition profits or Capital profits 

    Profits of the subsidiary company made after the date of the purchase of shares by the holding company are treated as revenue profits. Holding company’s share of such profits is added to the profits of the holding company and share of such profits belonging to the minority shareholders is added to the amount of the minority interest.

     Thus to decide whether profits and reserves of the subsidiary company are capital profits or revenue profits, date of purchase by the holding company is the deciding factor. Profits or reserves shown in the balance sheet of the subsidiary company on or before the date of purchase of shares are treated as capital profits and profits earned by the subsidiary company after the purchase of shares by the holding company are called revenue profits.


e. Treatment of Unrealized Profit 

     If the goods are sold at a profit by the subsidiary company to the holding company or by the holding company to the subsidiary company remain unsold at the close of the financial year, the profit charged by the company on unsold goods remains unrealized. In such a case, it is not proper to credit the income to statement of profit & loss with such unrealized profit. So, a stock reserve is created and profit is reduced by the unrealized profit. Such unrealized profit has to be eliminated from the consolidated balance sheet in the following manner:

1. The unrealized profit should be deducted from the current revenue profit of the company which sold the goods.

2. Again, the same should be deducted from the value of stock-in-trade of the company concerned.

 

f. Treatment of Contingent Liabilities

Contingent liability is that liability which may or may not arise. Its payment depends on the occurrence of a future event which is not certain. Such a liability is shown by way of a footnote in the balance sheet. Examples of such liabilities can be:

1. Liability in respect of bills discounted not yet matured. It is possible that bills may be dishonored on the due date and liability may arise.

2. Amount uncalled on partly paid shares held.

3. Arrears of dividend on cumulative preference shares.

4. Claims against the company not acknowledged debt as yet.

5. Liability under guarantee.

     While preparing a consolidated balance sheet, the treatment of contingent liability depends on whether it is towards outsiders or it is internal between holding and subsidiary companies. The external contingent liability is shown by way of a separate note in the consolidated balance sheet and internal contingent liability is eliminated treating it as mutual owing and is not shown in the consolidated balance sheet as a separate note.

 

g. Treatment of Bonus shares

      The issue of bonus shares by the subsidiary company will increase the number of shares held by the holding company as well as the minority shareholders. Issue of bonus shares may or may not affect the cost of control depending upon whether such shares are issued out of capital profits or revenue profits. Treatment of issue of bonus shares by the subsidiary company will depend upon the source from which bonus shares are issued. Bonus shares may be issued out of pre-acquisition profits or reserves or post-acquisition profits or reserves of the subsidiary company.

 ****