Key Difference – Subsidiary vs Associate
Companies can hold varying degree of interests in other companies by acquiring a shareholding. The portion of shareholding decides the power and other rights the company will have over the holding company. These types of holding companies can take two major forms, namely Subsidiary or Associate. The company that holds an interest in another company is referred to as the ‘parent company’. The key difference between Subsidiary and Associate is that while subsidiary is a company where the parent is a majority shareholder, parent holds a minority position in an associate.
CONTENTS
1. Overview and Key Difference
2. What is a Subsidiary
3. What is an Associate
4. Side by Side Comparison – Subsidiary vs Associate
5. Summary
What is a Subsidiary
Recognition and accounting criteria for Subsidiary are governed by IAS 27- ‘Consolidated and Separate Financial Statements’. According to IAS 27, Subsidiary is defined as an entity over which the parent exerts control, i.e. the power to govern the financial and operating matters and to obtain benefits from its activities. In order to do this, the parent has to acquire a percentage of ownership exceeding 50% in the holding company. Furthermore, the parent must be structured as an independent business entity in order to obtain a Subsidiary.
Even with the sufficient percentage of ownership; meeting following criteria is vital in order to exert control.
- To have over more than one-half of the voting rights by virtue of an agreement with other investors, or
- To govern the financial and operating policies of the entity under a statute or an agreement; or
- To appoint or remove the majority of the members of the board of directors; or
- To cast the majority of votes at a meeting of the board of directors
World’s most prestigious companies such as Boeing, Nestle and Microsoft hold many subsidiaries.
Figure 1: Major subsidiaries owned by Nestlé, world’s largest food manufacturer
Reasons for Purchasing Subsidiary
Obtaining Access to New Markets
Making a substantial investment in an unknown market can be a significant risk that many companies are not willing to take. This risk can be mitigated by acquiring an already established corporation.
Eliminating Competition
Some companies acquire a controlling stake in competitors, the decisions of the competitors can be controlled to combat competition
Consumer Purchasing Behaviour is not Disrupted
Even after acquiring a stake by the parent, the subsidiary will continue business. As a result, the customers of the Subsidiary indirectly becomes customers of the parent.
Better Utilisation of Excess Finance
Purchasing Subsidiaries is not for everyone since it requires substantial amounts of capital. Only a company having excess funds can pursue an interest in purchasing a holding in another company. This type of an investment is a long term one with increased ability to result in higher value to the parent.
Financial results of a subsidiary should be incorporated into the financial statements of the parent company. This is done by accounting for the share assets, liabilities, incomes and expenses of the Subsidiary owned by the parent.
E.g. ABC Ltd is a parent company that holds 60% of DEF Ltd. Thus, 60% of the assets, liabilities, incomes and expenses of DEF Ltd will be recorded in the books of ABC Ltd.
What is an Associate
According to IAS 28- ‘Investments in Associates’, an Associate is referred to as an entity where the parent can exert significant influence, but not control. If the parent acquires a percentage of ownership between 20%-50% in the holding company, the parent has the right to influence financial, operational and other decisions of the Associate. IAS 28 specifies the criteria to have significant influence as follows.
- Representation on the board of directors or equivalent governing body of the Associate
- Participation in the policy-making process
- Material transactions between the parent and the Associate
- Interchange of managerial personnel
- Provision of essential technical information
The Associate is initially recorded at cost and subsequently adjusted to reflect the investor’s share of the net assets of the associate. Sometimes, purchasing a controlling stake in another company, especially in a competitor, can be difficult; thus, an Associate makes an attractive investment option. Once a stake in the Associate is purchased, the parent has the opportunity to increase the shareholding up to a controlling interest in the future.
What is the difference between Subsidiary and Associate?
Subsidiary vs Associate |
|
| Parent is a majority shareholder in Subsidiary (control). | Parent is a minority shareholder in Associate (significant influence). |
| Percentage of Ownership | |
| Parent need to purchase a share that exceeds 50% in the Subsidiary. | If the parent owns a share between 20%-50%, an Associate can be accounted for. |
| Accounting Standards | |
| IAS 27 specifies criteria regarding accounting for Subsidiary. | Associates are regulated by IAS 28. |
Summary – Subsidiary vs Associate
Subsidiary and Associate give an opportunity for businesses to pursue swift growth strategies and enter into otherwise restricted markets. The main difference between Subsidiary and Associate is subjected to the percentage of ownership and the degree of control or influence exerted by the parent company. Investments in Subsidiary and Associate are practiced by many established companies for their proven positive results and the value created.
Reference:
1. Phung, Albert. “What are the differences between affiliate, associate and subsidiary companies?” Investopedia. N.p., 13 May 2016. Web. 28 Feb. 2017.
2. Buehler, Nathan. “Top 4 Companies Owned By Nestle.” Investopedia. N.p., 22 Dec. 2015. Web. 28 Feb. 2017.
3. “IAS Plus.” IAS 27 – Consolidated and Separate Financial Statements (2008). N.p., 20 July 2012. Web. 28 Feb. 2017.
4. “IAS Plus.” IAS 28 – Investments in Associates and Joint Ventures (2011). N.p., 23 July 2012. Web. 28 Feb. 2017.
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