Question

In: Accounting

Identify and briefly explain the key criteria in classifying an investment as either a subsidiary or...

Identify and briefly explain the key criteria in classifying an investment as either a subsidiary or associate, also include as part of your answer the key differences in accounting treatment of each a subsidiary and associate.

Solutions

Expert Solution

IFRS 10 defines a subsidiary as “An entity that is controlled by another entity.”

Subsidiary is an entity which is controlled by another entity. The control means that the parent company can govern the financial and operating policies of its subsidiaries to gain benefits from the operations of subsidiary. Control can be gained if more than 50% of the voting rights are acquired by the parent. This is usually done by purchasing more than 50% of the shares of subsidiary. An investor controls an investee if and only if the investor has all the following:

(a) power over the investee;

(b) exposure, or rights, to variable returns from its involvement with the investee; and

(c) the ability to use its power over the investee to affect the amount of the investor’s returns.

International Accounting Standard 28 (IAS 28) defines an associate as “An associate is an entity over which the investor has significant influence.”

Significant influence means the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies. Significant influence is usually acquired by purchasing more than 20% of voting power but less than 50%.

Summary:

An associate company may be partly owned by another company or a group of companies. As a rule, the parent company or companies do not consolidate the associate company's financial statements, as is the case with a subsidiary (where the parent company usually consolidates the financial statements). Typically, the parent company records the associate company's value as an asset on its balance sheet.

For corporate, securities and capital markets, an affiliate is a person or entity directly or indirectly controlling, being controlled by, or under common control with another person or entity. For example, executive officers, directors, large stockholders, subsidiaries, parent entities and sister companies are affiliates of other companies. Two entities may be affiliates if one owns less than a majority of voting stock in the other.

In a business setting, a subsidiary becomes part of a parent company to provide the parent with specific synergies, such as increased tax benefits, diversified risk, or assets in the form of earnings, equipment or property. For these purposes, liabilities, taxation and regulations treat subsidiaries as distinct legal entities.

The purchase of interest in a subsidiary differs from a merger in that the parent corporation can acquire the controlling interest with a smaller investment. Additionally, stockholder approval is not required in the formation of a subsidiary as it would be in the event of a merger.

Accounting:

IAS-27 specified creteria for accounting for subsidiary and IAS-28 sepcified criteria for accounting Associates


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