Question

What are the differences between significant influence investments and controlling investments? For the former, how to account for the investment, whereas for the latter how to account for the investment? What are the major reasons to control another company?

Answer 1

Significant influence usually translates into participation in the financial and operating policies without necessarily having full control over them. Firms holding such equity stakes are required to declare and account for them in their financial statements.

Controlling investments generally means you own over 50% of the company’s equity and significant influence means you own between 20% and 50%. While reading a vignette, you have to look for certain key words in relation to board structure, voting rights, and other key factors. For example, if a Company A owns 55% of Company B but has no board representation, can you really say Company A controls Company B? Probably not. Signs of signifcant influence include representation on the board, participation in policy making and material transactions between the investor and the investee.

That is, if Company A owns 80% or more of the stock of Company B, Company A will not pay taxes on dividends paid by Company B to its stockholders, as the payment of dividends from B to A is essentially transferring cash from one company to the other. Any other shareholders of Company B will pay the usual taxes on dividends, as they are legitimate and ordinary dividends to the shareholders.

An investor can hold a majority ownership or minority interest in a company it owns or has invested in. If it holds a minority ownership, this control can be further divided into two levels, where the investor either has minority active or minority passive control.

• power over the other company;
• exposure to variable returns from its involvement with the other company; and
• the ability to use its power over the other company to affect the amount of the company's returns. Power generally arises when the parent has rights that give it the ability to direct the relevant activities, i.e. the activities that significantly affect the other subsidiary's returns.