Advanced Accounting-2

Chapter: Holding Company

Definition of Holding and Subsidiary Company
• There are different ways by which one company can gain control over other
companies.
• One way is to acquire all the assets and liabilities of the companies concerned which is know as
absorption or Amalgamation).

• Another way is to acquire all or the majority (50% and above) of the
Voting or Equity shares of these companies. The company acquiring the
shares is known as the holding company, the company whose shares have
been acquired is known as subsidiary company of the holding company.
• Subsidiary company is the enterprise that is controlled by another
enterprise.
• Holding or parent company is the enterprise that has one or more
subsidiaries.
Characteristics of Holding and Subsidiary Company

• The holding company has a majority shares in subsidiary company.

• The subsidiary company continues to operate as before.
• Subsidiary company maintained their separate identity.
• The relationship between a holding company and a subsidiary company is
basically one of control.
• Holding companies are able to nominate the majority of the directors of
subsidiary company and therefore control such companies.
• The public may not be aware the existence of combination among the
various company.
• Each subsidiary company prepares its own accounts and therefore
financial position and profitability of each undertaking is known.
 Advantage of Holding Company
• Holding company need not to be invest entire amount in the share capital in
subsidiary company still enjoy controlling power in such company.

• A holding company can control large properties of a subsidiary with a

minimum of investment.

• It is possible to decentralize operations with full responsibility and

accountability to the subsidiary.

• It would be possible to carry forward losses for income tax purposes.

• Holding company may additional acquired or disposed of the shares in

subsidiary company in market whenever if desired.
Disadvantages Of Holding Companies
• Inter company transaction may not be at a fair prices.

• Minority share holders interest may not be properly protected.

• The accounts of various companies may be made upon different dates to,
manipulate profit or financial position of Group companies.

• Subsidiary Companies may be forced to appoint a person of the choice of

holding company such as Auditors, Directors, other officers, etc. in dually
high remuneration.

• The Subsidiary Company may be forced for purchases or sale of goods,

certain assets, etc. as per the direction of the holding company.
Requirement of preparing Consolidated Financial Statements

• A company having one or more subsidiary shall prepare a

Consolidated Financial Statement (CFS) of the company and of all
the subsidiaries in the same forms and manners as Standalone
Financial Statement (SFS) of the parent company.
• A Consolidated Balance Sheet shows all the assets and liabilities of
the holding company and its subsidiaries.
 Consolidation Procedure
In preparing consolidated financial statements, the financial statements of the parent and
its subsidiaries should be combined on a line by line basis by adding together like
items of assets, liabilities, income and expenses. In order that the consolidated
financial statements present financial information about the group as that of a single
enterprise, the following steps should be taken:
a. The cost to the parent of its investment in each subsidiary and the parent's portion
of equity of each subsidiary, at the date on which investment in each subsidiary is
made, should be eliminated;
b. Any excess of the cost to the parent of its investment in a subsidiary over the
parent's portion of equity of the subsidiary, at the date on which investment in the
subsidiary is made, should be described as goodwill to be recognized as an asset in
the consolidated financial statements;
c. When the cost to the parent of its investment in a subsidiary is less than the
parent's portion of equity of the subsidiary, at the date on which investment in the
subsidiary is made, the difference should be treated as a capital reserve in the
consolidated financial statements;
 Consolidation Procedure (Cont’d)
d. Minority interests in the net income of consolidated subsidiaries for the
reporting period should be identified and adjusted against the income of the group
in order to arrive at the net income attributable to the owners of the parent; and
e. Minority interests in the net assets of consolidated subsidiaries should be
identified and presented in the consolidated balance sheet separately from
liabilities and the equity of the parent's shareholders. Minority interests in the
net assets consist of:
i. the amount of equity attributable to minorities at the date on which
investment in a subsidiary is made; and
ii. the minorities' share of movements in equity since the date the parent-
subsidiary relationship came into existence.
Where the carrying amount of the investment in the subsidiary is different from its
cost, the carrying amount is considered for the purpose of above computations.
 Consolidation Procedure (Cont’d)
• The parent’s portion of equity in a subsidiary, at the date on which investment is
made, is determined on the basis of information contained in the financial
statements of the subsidiary as on the date of investment.
• Intragroup balances and intragroup transactions and resulting unrealized profits
should be eliminated in full.
• Consolidated financial statements should be prepared using uniform accounting
policies for like transactions and other events in similar circumstances.
• The results of operations of a subsidiary are included in the consolidated financial
statements as from the date on which parent-subsidiary relationship came in
existence.
• The carrying amount of the investment at the date that it ceases to be a subsidiary is
regarded as cost thereafter.
• Minority interests should be presented in the consolidated balance sheet
separately from liabilities and the equity of the parent’s shareholders. Minority
interests in the income of the group should also be separately presented.
 Basic Rules for Preparing a Consolidated Balance Sheet
Rule 1: Cancellation of Investment and Share Capital
• Simply combining all the assets and liabilities of the holding company and its
subsidiary will not be a Consolidated Balance Sheet. This is because the
inter-company balances have first to be eliminated. The "Investment in
Subsidiary Company" by the holding company should cancel out the Share
Capital of the subsidiary company. Consider the following example:
Liabilities H Ltd S Ltd Assets H Ltd S Ltd
Share Capital (Tk 10 per share) 100,000 40,000 Fixed Assets 60,000 40,000
Investment- 4,000 shares in S 40,000
Ltd @Tk10

Solution:
Liabilities Taka Assets Taka
Share Capital (Tk 10 per share) 100,000 Fixed Assets ( Tk 60,000 + Tk 40,000) 100,000
 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 2: Minority Interest Calculation
• When the holding company acquires more than half but less than all the shares of the subsidiary company,
those shareholders who have a minority share are referred to as Minority Shareholders. The interest of
the minority shareholders, known as Minority Interest must be accounted for separately in the
Consolidated Balance Sheet.
• The value of the minority interest is the portion of the share capital and reserves at the date when the
holding company acquires its controlling interest and the share of income after acquisition.
Financial Position of H Ltd and S Ltd
Liabilities and Equities H Ltd S Ltd
Share Capital- Equity Share @ Tk 10 each 200,000 50,000
Long Term Borrowing-10% Debenture 40,000 --
Other Current Liabilities 60,000 20,000
Assets
Plant and Machinery 190,000 40,000
Investment – 4,000 Equity Shares in S Ltd 40,000 --
Other Current Assets 70,000 30,000

Minority Interest= Tk 50,000 – Tk 40,000= Tk 10,000

Important points regarding minority interest:

1. Minority Interest should be shown for separately in the

Consolidated Balance Sheet.

2. Minority interest is not a liability but capital of the group which

does not belong to the shareholders of the holding company.

3. Minority interest is always calculated at the date of the

Consolidated Balance Sheet— not when the holding company takes
the control.
 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 3 : Goodwill / Capital Reserve on Consolidation
• When the value of "Investment in Subsidiary" in the holding company's Balance Sheet is more than the book
value of the net assets acquired, the difference represents "Goodwill on Consolidation". In this case,
Investment in Subsidiary will not cancel out against the share capital of the subsidiary unless a goodwill equal to
the difference of the two items is shown on the assets side of the Consolidated Balance Sheet.
• Suppose, H Ltd. acquired 80% of the shares of S Ltd. for Tk 48,000. The Balance Sheets of the two companies
are as under:

Liabilities and Equities H Ltd S Ltd

Share Capital- Equity Share @ Tk 10 each 200,000 50,000
Long Term Borrowing-10% Debenture 40,000 --
Other Current Liabilities 60,000 20,000
Assets
Plant and Machinery 190,000 40,000
Investment – 4,000 Equity Shares in S Ltd @ Tk 12 48,000 --
Other Current Assets 62,000 30,000

⸫Goodwill= (Tk 48,000 - 50,000 × 80%) = (Tk 48,000 – Tk 40,000) = Tk 8,000

 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 3 : Goodwill / Capital Reserve on Consolidation
• Conversely, if the value of Investment in Subsidiary is less than the book value of the net assets acquired, the
difference represents Capital Reserve on Consolidation. In this case also, Investment in Subsidiary will not
cancel out against the share capital of the subsidiary unless a capital reserve equal to the difference of the two
items is shown on the liabilities side of the Consolidated Balance Sheet.
• Suppose, H Ltd. acquired 80% of the shares of S Ltd. for Tk 36,000. The Balance Sheets of the two companies
are as under:

Liabilities and Equities H Ltd S Ltd

Share Capital- Equity Share @ Tk 10 each 200,000 50,000
Long Term Borrowing-10% Debenture 40,000 --
Other Current Liabilities 60,000 20,000
Assets
Plant and Machinery 190,000 40,000
Investment – 4,000 Equity Shares in S Ltd @ Tk 9 36,000 --
Other Current Assets 74,000 30,000

⸫Capital Reserve= (50,000 × 80% – Tk 36,000 ) = (Tk 40,000 – Tk 36,000) = Tk 4,000

 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 4 : Reserves of the Holding and Subsidiary Company
• While calculating goodwill or capital reserve on consolidation and the minority interest, Reserves of Subsidiary
are to be apportioned between the holding company and the minority shareholders. The reserves of the
subsidiary company at the date of the acquisition form a part of goodwill / capital reserve and minority interest
calculation. The reserves of the holding company are shown along with the holding company's share capital in
the Consolidated Balance Sheet.
• Suppose, H Ltd. acquired 80% of the shares of S Ltd. on 31.3.2018 for Tk 48,000. The Balance Sheets of the two
companies on that date are as under:
Liabilities and Equities H Ltd S Ltd
Share Capital- Equity Share @ Tk 10 each 200,000 50,000
General Reserve 50,000 10,000
Long Term Borrowing-10% Debenture 40,000 --
Other Current Liabilities 60,000 20,000
Assets
Plant and Machinery 190,000 40,000
Investment – 4,000 Equity Shares in S Ltd @ Tk 12 48,000 --
Other Current Assets 112,000 40,000

• Minority Interest = {(Tk 50,000 + Tk 10,000) – Tk 48,000} = Tk 12,000

 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 4 : Reserves of the Holding and Subsidiary Company
Minority Interest = {(Tk 50,000 + Tk 10,000) – Tk 48,000} = Tk 12,000
Liabilities and Equities Notes H Ltd S Ltd
Share Capital- Equity Share @ Tk 10 each 200,000 50,000
General Reserve 50,000 10,000
Long Term Borrowing-10% Debenture 40,000 --
Other Current Liabilities 60,000 20,000
Assets
Plant and Machinery 190,000 40,000
Investment – 4,000 Equity Shares in S Ltd @ Tk 12 48,000 --
Other Current Assets 112,000 40,000

Consolidated Financial Position/Balance Sheet

Liabilities and Equities Notes Taka
Share Capital- Equity Share @ Tk 10 each 200,000
General Reserve 50,000
Minority Interest 12,000
Long Term Borrowing-10% Debenture 40,000
Other Current Liabilities 80,000
Assets
Plant and Machinery 230,000
Other Current Assets 152,000
 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 5 : Pre- and Post-acquisition Profit of Subsidiary
The profits earned by the subsidiary company before the holding company acquires its
control, is known as pre-acquisition profit or capital profit. Undrawn pre-acquisition profit is
taken into consolidation for calculation of goodwill or capital reserve. It is split between cost
of control (goodwill / capital reserve calculation) and minority interest.

The profits earned by the subsidiary company after the holding company acquires its control,
is known as post-acquisition profit or revenue profit, which can be distributed as dividend. It
should be noted that post-acquisition profit of a subsidiary company do not form part of the
goodwill or capital reserve calculation.

Minority shareholders are not concerned whether the profits are pre-acquisition or post-
acquisition. Post-acquisition profit is apportioned between holding company and minority
shareholders. The share of holding company is added with its profit, while the share of the
minority shareholders form a part of the calculation of minority interest.
 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 6 : Cancellation of Inter-company Debts and Acceptances
It is very common that member companies have business dealing not only with
outsiders but also with each other. Inter-company transactions may lead to inter-
company debts and acceptances.
At the time of consolidation, inter-company debts and acceptances which are part of the
same group, are to be cancelled out.
Inter-company Debts: Inter-company debts for the sale of goods on credit owing by
one company to the other company in the same group should be eliminated from
sundry debtors and sundry creditors.
Inter-company Bills of Exchange: Bills drawn or accepted either by the holding
company or its subsidiary is not an outside obligation. The item "Bills Receivable" in
one company's Balance Sheet and corresponding item "Bills Payable" in another
company's Balance Sheet are to be cancelled out against each other like ordinary debts.
 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 7: Cancellation of Inter-company Loans and Advances
Usually a Current Account is used to record inter-company loans and
advances. When a loan is provided by either of the companies to the other, a
current account will exist between the holding company and its subsidiary.

Example, if the holding company makes a loan of 10,000 to its subsidiary, it will
appear as an asset in the Balance Sheet of the holding company and as a liability
in the Balance Sheet of the subsidiary company.

At the time of preparing the Consolidated Balance Sheet, these two amounts are to
be cancelled out.
 Basic Rules for Preparing a Consolidated Balance Sheet (Cont’d)
Rule 8 : Adjustment of Bank Balances
Bank accounts may be held by the holding company and its subsidiary at different
banks. While some balances are favorable, others are overdrawn balances, they
should appear in the Consolidated Balance Sheet as assets and liabilities
respectively.

It would be incorrect to adjust the overdraft balances against credit balances for the
purpose of the Consolidated Balance Sheet. But when both the companies maintain
their bank accounts at the same branch and the bank has a 'set off' agreement
between the holding company and its subsidiary, the usual method is to combine
all bank balances and to set off overdraft against credit balances.