Accounts for Holding Companies Notes
B.Com 2nd and 4th Sem CBCS Pattern
Corporate Accounting Notes
Accounts of Holding Companies
Q. What do you mean by Consolidated Financial Statements? What are the objectives and scope of these statements? Also point out the advantages and disadvantages of consolidation. 2015, 2018
Q. What are the advantages and
disadvantages of Holding Companies? Explain the transactions which must be
eliminated while preparing consolidated balance sheet. 2015, 2016
Q. “Balance
Sheet of Holding Company to include certain particulars as to its
subsidiaries”. Considering this statement explain the provisions of the
Companies Act, 2013. 2014,
2017
Q. What do
you mean by Holding and Subsidiary Company (2013, 2015, 2016)? How would you
ascertain the amount of minority interest and goodwill or capital reserve while
preparing a Consolidated Balance sheet? 2010, 2013
Q. Explain
the treatment of the following items in Consolidated Balance Sheet: 2012
Ø Contingent
liabilities
Ø Mutual
owing
Ø Bonus
shares
Ø Unrealised
Profit
Q. Write
short notes on:
Ø Minority interest 2014, 2015, 2017
Ø Cost of Control or
Goodwill 2017
Ø Pre-acquisition and post-acquisition
profit 2013
Ø Consolidated Balance Sheet 2016
Ø Rationale of Holding
Companies
Ø Capital
Profits 2018
Ø Capital reserve 2014
Q. Practical
Problems: Follow illustrations given in your book 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017,
2018
Meaning of Holding and Subsidiary Company
An
important development of recent times in the business world is the combining of
independent business units into a group or an economic unit. A company may
acquire either the whole or majority of shares of another company so as to have
a controlling interest in such a company or companies. The controlling company
is known as Holding or Parent Company and the company controlled is known as
Subsidiary Company.
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 ½ 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. For example, if B Ltd is a Subsidiary of C Ltd & C Ltd is a
subsidiary of A Ltd then B Ltd is also deemed to be a subsidiary of A Ltd.
Meaning of “subsidiary Company”
As per Section 2(87) of
the Companies Act, 2013, a company is a “subsidiary company” of another company, i.e. “holding
company”, if that other company:
a)
holds more than ½ of the voting rights in it, or
b)
is a member of it and has the right to appoint or
remove a majority of its board of directors, or
c)
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.
Purpose: The purpose of getting the control over another company may be to gain
advantages such as:-
1.
To
eliminate of competition.
2.
To enjoy
the economies of large scale of production.
3.
To achieve
an assured market for the product of the company.
4.
To ensure a
smooth supply of raw materials.
Advantages of Holding Company:
Following are the important advantages of holding company:
a)
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.
b)
Large Business:
A holding company can collect the capital and expand the business on
large scale.
c)
Foreign Capital: The holding company
may also attract the foreign capital for the expansion of a business.
d)
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.
e)
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.
f)
Separate Position: The subsidiary
companies can maintain their separate position under this system. They do not
lose their identity.
g)
Control on Production: A holding company
can check the production and adjusts the supply according the demand. So over
production cannot take place.
Disadvantages or Defects of Holding Company:
Following
are the main defects of the holding company:
a)
Problem of Monopoly: A holding company
tries to create monopoly over the market. Monopoly is always against the public
interest. It fixes higher prices and consumer suffers a loss.
b)
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.
c)
Costly Management: A holding company
spends a lot of money on the officers and offices. All the units are managed by
the central authority. So it is costly to maintain the proper control on large
number subsidiary companies.
d)
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.
e)
Misuse of Funds: The director of the
company enjoys unlimited powers and they take undue advantages. They misuse the
funds also.
f)
Over Capitalization: There is always a
danger of over capitalization in the holding companies. It is very harmful for
both the companies.
g)
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.
Rationale of Holding Companies
a) It allows better
quality decisions to be taken at all levels. In case of public enterprises, the
Government to concentrate on macro policy, the holding company on corporate
policies and strategies and the operating levels on implementation within the
framework of established strategies.
b) It leads to a
better utilization of financial and other reserves by pooling the reserves of
group of enterprises like finance, R & D, marketing and human resources.
The holding company is well suited to the task of rationalization of public
sector through mergers, vertical integration, inter-group transfers and
allocation of social costs.
c) The management of
holding company could promote commercial and managerial culture rather than
bureaucratic systems,
d) By grouping of
enterprises into holding companies a large number could be reduced to
manageable levels from the point of co-ordination and span of control. It
provides enterprises scope to share and undertake relevant R & D work to
update technology in order to become more competitive. It could be a strategy
to turn around the sick public enterprises.
e) The holding
company is able to concentrate on corporate planning, acquisition and update
technology and building of corporate culture on sound business principles.
Meaning of Consolidated financial statements
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.
Objective/Purpose of consolidated financial statements/Why Consolidation of Balance Sheet & Profit & Loss Account is necessary?
In India,
the law does not compel a holding company to prepare a consolidated Balance
Sheet & Profit & 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 & 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
& a Single Profit & Loss Account.
The purpose
of a Consolidated Balance Sheet & Profit & 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.
General principles of consolidated financial statements
The general principles involved in
consolidated financial statements are:
1. A consolidated financial statement
should essentially provide true and fair picture of financial condition and
operating result of the business faction.
2. A consolidated financial statement
needs to be prepared on the basis of legal-entity based financial statements of
the parent company and its subsidiaries which belong to the business faction,
and prepared in accordance with the GAAP.
3. A consolidated financial statement
needs provide a clear vision about the financial info requisite for interested
parties not to mislead their judgments about the business groups’ condition.
4. The procedures and policies used
for preparing consolidated financial statements need to be applied ad infinitum
and should not be changed without any reason.
Benefits of Consolidated financial statements
a) The ultimate benefit of
consolidated financial statements should be ease of understanding and analysis
of a company's financial condition for investors, creditors and other users who
needs to know whether or not company is able to pay its liabilities and
continue as a profitable enterprise.
b) A more sinister benefit
of consolidated finances is that they can be manipulated to hide financial
problems. It is extremely difficult to ascertain from these statements whether
there are hidden problems and exactly where they are in the enterprise.
c) Since, mutual
transactions are omitted; it presents a truer view of the companies by showing
only financial activity with non-related parties.
Demerits of consolidated financial statements
a) When income statements are brought together and reported on a
consolidated basis, the revenues, expenses and net profit are presented as
combined figures. This can hide any profitability issues with one or more of
the companies. For example, if a subsidiary lost a substantial amount of money
in the year as a result of poor sales, financial statement readers may not see
that information if the loss is combined with profits of the parent company.
b) Ratio analysis done on the basis of consolidated financial
statements will give misleading results. Ratios are comparisons between
financial statement lines. For example, the current ratio is current assets
divided by current liabilities. This ratio tells investors how well the company
will be able to pay its near-term obligations. In a consolidated financial
statement, each company's assets, liabilities and income are combined.
Financial ratios based on combined numbers may not be representative of each
company's ratios. If one of the companies has a high level of debt compared to
the equity of the owners, that leverage would be hidden in a consolidated
statement.
c) All inter-company transactions are removed in a consolidation. On
one hand, this presents a truer view of the companies by showing only financial
activity with non-related parties. However, it also hides the level of
inter-company transactions.
Particulars of Balance Sheet of a Holding Company in regard of its Subsidiaries
Section 212 of the
Companies Act stipulates the conditions regarding the manner in which the
Balance Sheet of the holding Company should be prepared. The provisions of the
Section are given below:
(1) There shall be attached to the Balance Sheet
of a holding company having a subsidiary or subsidiaries at the end of the
financial year as at which the holding company’s Balance Sheet is made out, the
following documents in respect of such subsidiary or of each such subsidiary,
as the case may be:
(a) A
copy of the Balance Sheet of the subsidiary;
(b) A
copy of its Profit and Loss Account;
(c) A
copy of the Report of its Board of Directors;
(d) A
copy of the Report of its Auditors;
(e) A
statement of holding company’s interest in the subsidiary;
(f) The
statement referred to in sub-section (5) if any; and
(g) The
report referred to in sub-section (6), if any.
(2) The
Balance Sheet, profit and loss accounts and the reports of the board of
directors and the auditors shall be made out in accordance with the
requirements of this Act.
(i) As
the end of the financial year of the subsidiary, where such financial year
coincides with the financial year of the holding company;
(ii) As
at the end of the financial year of the subsidiary last before that of the
holding where the financial year of the subsidiary does not coincide with that
of the holding company.
Where the
financial year of a subsidiary is shorter in duration than that of its holding
company, then financials statements of subsidiary company shall be construed
for two more financial years of the subsidiary company the duration of which,
in the aggregate, in not less than the duration of holding company’s financial
year.
(3) The
statement holding company’s interest in subsidiary company shall specify.
(a) The
extent of the holding company’s interest in the subsidiary at the end of the
financial year or of the last of the financial year of the subsidiary;
(b) the
net aggregate amount, so far as it concerns members of the holding company and
is not dealt with in the company’s accounts, of the subsidiary’s profit after
deducting its losses or vice versa.
(i) For
the financial year or years of the subsidiary aforesaid; and
(ii) For
the previous financial years of the subsidiary since it became the holding
company’s subsidiary;
(c) The
net aggregate amount of the profits of the subsidiary after deducting its
losses or vice versa.
(i) For
the financial year of years of the subsidiary aforesaid; and
(ii) For
the previous financial years of the subsidiary since it became the holding
company’s subsidiary;
(4)
Clauses (b) and (c) of sub-section (3) shall apply only to profits and Losses
of the subsidiary which may properly be treated in the holding company’s
accounts as revenue profits or losses, and the profits or losses attributable
to any shares in a subsidiary for the time being held by the holding company or
any other of its subsidiaries shall not (for that on any other propose) be
treated as aforesaid so far as they are profits or losses for the period before
the date on or as from which the shares were acquired by the company or any of
its subsidiaries.
(5) Whether the financial year or years of a
subsidiary do not coincide with the financial year of the holding company, a
statement containing information on the following matters shall also be
attached to the Balance Sheet of the holding Company:
(a)
Whether there has been any, and if so, what change in the holding company’s
interest in the subsidiary between the end of the financial year or of the last
of the financial years of the subsidiary and the end of the holding company’s
financial year;
(b)
Details on any material changes which have occurred between the end of the
financial year or of the last of the financial years of the subsidiary and the
end of the holding company’s financial year in respect of
(i) The
subsidiary’s fixed assets;
(ii) Its investments;
(iii) The
money lent by it;
(iv) The
money borrowed by it for any purpose other than that of meeting current
liabilities.
(6) If,
for any reason, the Board of Directors of the holding company is unable to
obtain information on any of the matter required to be specified by sub-section
(4), a report in writing to that effect shall be attached to the Balance Sheet
of the holding company.
(7) The
documents referred to in clauses (c), (f) and (g) of sub-section (1) shall be
signed by the persons by whom the Balance Sheet of the holding company is
required to be signed.
(8) The
Central Government may, on the application or with the consent of the Board of
Directors of the company, direct that in relation to any subsidiary, the
provisions of this section shall not apply or shall apply only to such extent
as may be specified in the direction.
(9) If the board of directors of the holding
company fails to take all reasonable steps to comply with the provisions of
this Section, he shall, in respect of each offence, be punishable with
imprisonment for a term which may extent to six months, or with a fine which
may extend to one thousand rupees, or with both, provided that no person shall
be sentenced to imprisonment for any such offence unless it was committed
willfully.
Write Short notes on the following
1. Pre & Post Acquisition of Profits
General Reserve & Profit & Loss Account (credit balance)
appearing in the books of the subsidiary company on the date of acquisition are
treated as pre – acquisition profits. Since, they were not earned by the
holding company in the ordinary course of business they are capitalized &
set off against the purchase price of the shares.
A pre – acquisition loss appearing in the books of the subsidiary
company is treated as a capital loss & debited to goodwill account. Post-acquisition
profits or losses are those that are made or suffered by a subsidiary company
after its shares have been purchased by the holding company. Revenue profits
are added to the profits of the holding company if it acquires all the shares
of the subsidiary company or to extent of its shareholding in the subsidiary
company. A post acquisition loss is treated as a revenue loss & deducted
from the profits of the holding company.
If the date of acquisition is during the course of the year it becomes
necessary to make an estimate of pre-acquisition & post acquisition periods
on time basis so as to apportion profits.
2. Pre- acquisition and Post –
acquisition period
Pre-Acquisition Period: Pre acquisition period is the period which
falls on or before the date on which the shares of the subsidiary company are
acquired by the holding company.
Post-Acquisition Period: Post acquisition period is the period which
falls on after the date on which the shares of the subsidiary company are
acquired by the holding company.
3. Cost of Control (Goodwill)
In practice the holding company may pay more or less than the net
worth of the subsidiary company. If the holding company feels that a company,
the shares of which it wants to acquire enjoys considerable reputation or
exceptionary favourable factor it may pay more than the paid up value of shares
or net assets.
The excess of acquisition price over net assets represents goodwill or
cost of control. If on the other hand the acquisition price is less than the
paid up value of shares the difference is again to the holding company & is
known as capital reserve.
4. Minority Interest
When some of the shares in the subsidiary are held by outside
shareholders they will be entitled to a proportionate share in the assets and
liabilities of that company. The share of the outsider in the subsidiary is
called minority interest.
Amount of minority interest is calculated by adding subsidiary
company’s share in pre-acquisition profit, post-acquisition profit and in share
capital of the company. Preference share capital to the extent of not purchased
by holding company is also added with minority interest. In the consolidated
balance sheet all the assets and liabilities of the subsidiary are consolidated with assets and liabilities
of the holding company and the minority interest representing the interest of
the outsider in the subsidiary is shown as a liability.
5. Wholly owned and partly owned
subsidiary company
Wholly owned subsidiary company: When all the shares of a subsidiary
company are held or owned by the holding company, the subsidiary company is
known as a wholly owned subsidiary company.
Partly owned subsidiary company: When a majority of shares, but not
all the shares of a subsidiary company are owned by the holding company, the
subsidiary company is known as a partly owned subsidiary company.
Explain the treatment of following items in consolidated balance sheet
1. Treatment of Unrealized Profits
An unrealized inter-company profits exist where the company still
holds (at the date of consolidation)
stocks sold to it by the other company at a profit. It is considered that only the holding company share of unrealized
profit should be eliminated since for the minority shareholders the profit is
nothing but a realized profit. Stock reserve is created whether the goods are
sold by the holding company to the subsidiary and vice versa. The amount of
unrealized profit (stock reserve) is deducted from the stock on the asset side
and also the profit and loss account on the liability side of the consolidated
balance sheet.
Example: A subsidiary sells goods to the holding company goods worth
Rs 30,000 on which the subsidiary company made 20% profit on selling price
(holding company share holds 3000 out of 4000 shares)
Unrealized profit = 20% of 30,000 = 6,000
Holding company’s share = ¾ *6,000 = 4,500.
2. Contingent Liability
Contingent
liabilities which may or may not materialize into liabilities are shown in the
usual way by appending a footnote in the individual balance sheet. For the
purpose of consolidation, the treatment depends upon whether they are internal or external. External contingent liability between the
company in the group and a third party
continue to appear by way footnote. Internal contingent liability
between holding and subsidiary are eliminated
without being shown in the consolidated balance sheet.
3. Bonus Shares
When a
company issues bonus shares out of its accumulated profits it is necessary to
distinguish between pre & post acquisition profits utilized for this
purpose. In case bonus shares are issued out of pre – acquisition profits no
adjustments are necessary for preparing the consolidated balance sheet because
in such a case the holding company’s share of such profits gets reduced &
the paid up value of the shares held by it will increase. As such the amount of
goodwill remains the same.
Bonus
shares issued out of post-acquisition profits will reduce the holding company’s
share in revenue profits & increase the paid up value of the shares held.
Consequently, the amount of goodwill gets reduced.
4. Preference shares of subsidiary companies
If
preference shares of subsidiary companies are acquired by the holding company
along with equity shares, then holding company’s share is deducted with cost of
investment and subsidiary company’s share is added with minority interest.
Again, if preference shares of subsidiary companies are not acquired by the
holding companies, then the full amount is added with minority interest.
Inter-Company Balances must be eliminated from consolidated balance sheet
1.
Inter-company sales: When goods are sold by holding company to its subsidiary
or vice-versa then such amount is appeared in the balance sheet of one company
as debtors and as creditors in the balance sheet of other company. These
transactions should be eliminated from the consolidated balance sheet by
deducting both from debtors and creditors.
2. Bills of
Exchange: Bills drawn by the holding company on its subsidiary and vice versa
appearing as bills payable in one balance sheet and bills receivables on the
other. Such transactions should be eliminated from the consolidated balance
sheet. However, bills discounted cannot get cancelled because of the liability
in respect of bills payable by the accepting company and a contingent liability
in the company getting the bills discounted.
a. The
company discounting the bill will include the proceeds of the bills in its bank
balance and will appear as a note to show the contingent liability.
b. In the
consolidated balance sheet the total of bills discounted appear as bills payable representing actual liabilities.
3.
Inter-company Debts: When loans are advanced to the subsidiary company by the
holding and vice versa the same will appear on the asset side of the lending
company’s balance sheet and on the liability side of the borrowing company’s
balance sheet. These being inter-company items they should be eliminated from
the consolidated balance sheet.
4.
Debentures: Debentures issued by one of the companies in the group and held as
investment by another in the same group gets cancelled in the consolidated
balance sheet and should be eliminated.
5.
Elimination of Investments in shares: Where a holding company holds all the
shares of a subsidiary or its assets belong to the holding company, which is
also liable for all its debts. In other words, the investment by the holding
company in the shares of subsidiary company represents excess of assets over
liabilities or capital.
While preparing the consolidated balance sheet it is necessary to eliminate investment & its complement of the paid up capital of subsidiary company. Holding company’s investment which its subsidiary’s capital, which in turn is equal to the excess of assets over liabilities of the subsidiary, become internal items in the consolidated balance sheet. Hence, the two are cancelled against each other & substituted by the assets & liabilities of the subsidiary.
CORPORATE ACCOUNTING CHAPTER WISE NOTES
Unit-I: Shares & Debentures
1. ISSUE OF SHARES AND SHARE CAPITAL
2. RIGHTS SHARES AND BONUS SHARES
4. REDEMPTION OF PREFERENCE SHARES
5. ISSUE AND REDEMPTION OF DEBENTURES
Unit II: Preparation of financial statements of companies
1. FINAL ACCOUNTS OF COMPANIES
2. ACCOUNTS OF BANKING COMPANIES
Unit-III: Valuations of Goodwill and Shares & Cash Flow Statement
1. VALUATIONS OF GOODWILL AND SHARES
Unit-IV: Amalgamation, External Reconstruction and Internal Reconstruction
1. AMALGAMATION AND EXTERNAL RECONSTRUCTION
2. INTERNAL RECONSTRUCTION AND CAPITAL REDUCTIONS
Unit-V: Accounts of Holding Companies