Subsidiary: What Consolidation Requires

A subsidiary is a company under another company's control. Consolidating one means writing the group up as though it were a single business: the subsidiary's assets, liabilities, income and expenses all come in at their full amounts, the parent's investment cancels against the equity it bought, and whatever belongs to outside holders is shown apart, inside equity, as a non-controlling interest. Both sets of accounts survive, answering different questions.

Here is what sits underneath that. A subsidiaryA company that another company controls. Control, not the size of the shareholding, is what makes a company a subsidiary, and a subsidiary must be brought into the controlling company's group accounts. is not a kind of investment. A subsidiary is a company whose decisions another company can direct. Once that is true, the accounts stop treating the holding as a thing owed to the parent and start treating the operation as part of the parent. Anjani Stationers Private Limited, an invented stationery group, holds 70 per cent of Chitra Binding Works and controls it. Control is why Chitra Binding is a subsidiary, and why two complete sets of statements exist for the same business.

Both of those sets are already in hand. The parent's standaloneThe accounts of one legal company on its own, with holdings in other companies shown as investments rather than opened up. Also called separate financial statements. position is total assets of Rs 1,80,00,000, total liabilities of Rs 38,00,000 and equity of Rs 1,42,00,000, being share capital of Rs 40,00,000 on 4,00,000 shares and retained earnings of Rs 1,02,00,000. Its profit after tax is Rs 30,00,000 and its basic earnings per share is Rs 7.50. The group's consolidated position is total assets of Rs 2,09,50,000, total liabilities of Rs 50,00,000 and equity of Rs 1,59,50,000, split Rs 1,49,00,000 to the owners of Anjani Stationers and Rs 10,50,000 to the non-controlling interest, with Rs 3,50,000 of goodwill sitting inside the assets. Every one of those figures follows from one procedure: which of Chitra Binding's lines enter the group and in what proportion, why a Rs 21,00,000 asset vanishes on the way in, how Chitra Binding's entire balance sheet can be rebuilt from two statements that never showed it, how the Rs 10,50,000 non-controlling interest is checked by two routes that must agree, and which of three defensible-looking earnings per share figures is the right one.

How much of a subsidiary enters the group accounts, and why is it not 70 per cent?

Every later figure depends on the proportion, so the proportion comes first. Anjani Stationers holds 70 per cent of Chitra Binding. A reader meeting that for the first time almost always expects the group accounts to carry 70 per cent of each of Chitra Binding's lines: 70 per cent of the assets, 70 per cent of the borrowings, 70 per cent of the revenue. The group accounts do nothing of the kind, and the figure a proportional reading produces is not a figure any group reports.

Consider a shop before a balance sheet. A man runs a printing shop and has taken in a partner who put up a share of the money and takes a share of the profit, but every decision about what the shop buys, who it hires and which orders it accepts is still made by the first man. Asked what machinery the shop has, he will not describe seven tenths of a cutting machine. The whole machine is his to direct, so he will describe the whole machine. Then, separately, he will say that part of the shop's value belongs to somebody else. The machine and the ownership are two different statements about two different things, and mixing them produces nonsense.

Control is over the whole of a subsidiary and not over a fraction, so the group presents 100 per cent of a controlled subsidiary's assets, liabilities, income and expenses. The 30 per cent that belongs to other people is dealt with once, in equity, rather than by scaling every line. So Chitra Binding's Rs 47,00,000 of assets enters the group accounts as Rs 47,00,000. Its Rs 12,00,000 of liabilities enters as Rs 12,00,000. Seventy per cent of those assets would be Rs 32,90,000, a figure Rs 14,10,000 lower. Rs 32,90,000 appears nowhere in any statement Anjani Stationers publishes. The claim that outside holders have on part of the group is real and is not being denied. The claim is simply recorded in one place, as a single equity figure of Rs 10,50,000, instead of being smeared across forty line items.

Why does the parent's Rs 21,00,000 investment disappear?

Open Anjani Stationers' standalone balance sheet and one of the Rs 1,80,00,000 of assets is a line reading investment in Chitra Binding Works, Rs 21,00,000, carried at what was paid for it. Open the consolidated balance sheet and that line is gone. Nothing was sold and nothing was written off. The investment was cancelled, and the cancellation is the mechanical heart of consolidationThe procedure that combines a parent and its subsidiaries into one set of statements, adding their assets, liabilities, income and expenses together and removing anything that would otherwise be counted twice..

Ask what the Rs 21,00,000 actually represents. The Rs 21,00,000 represents a claim on 70 per cent of Chitra Binding's net assets, bought at the start of year two when those net assets stood at Rs 25,00,000. Seventy per cent of Rs 25,00,000 is Rs 17,50,000. So the investment line is one way of describing part of Chitra Binding. But consolidation has just brought Chitra Binding itself into the group accounts, asset by asset and liability by liability. If the investment line stayed as well, the group would be showing the same underlying thing twice: once as a summary priced at cost, and once as the actual machines, stock and receivables that summary stood for.

The parent's investment and the parent's share of the subsidiary's equity at the date it was bought are two views of one thing, so presenting both would count it twice, and consolidation therefore cancels one against the other. This is the cancellationThe step in consolidation that removes the parent's investment in a subsidiary against the parent's share of that subsidiary's equity at the date of acquisition, so the same underlying holding is not counted twice., and it is the step the phrase eliminating the investment refers to. Rs 21,00,000 of investment meets Rs 17,50,000 of acquired equity and neither survives into the group balance sheet. The difference survives. Anjani Stationers paid Rs 21,00,000 for a Rs 17,50,000 share of identifiable net assets, so Rs 3,50,000 of what it paid is not explained by anything that can be pointed at in Chitra Binding's books. The Rs 3,50,000 residue is recognised as goodwill and appears in the consolidated assets. So the group's assets carry a line the parent's own accounts never had.

Can a reader rebuild Chitra Binding's balance sheet from the two published sets?

Anjani Stationers publishes its own statements and its group statements. Anjani Stationers does not publish Chitra Binding Works' balance sheet. Yet every figure used here for Chitra Binding was obtained by subtraction from the two sets that were published, and working that subtraction through by hand is the fastest way to see what consolidation actually does to a set of numbers.

Work it in four steps and watch each one undo a step of the consolidation. Start with consolidated assets of Rs 2,09,50,000. Take out the parent's own standalone assets of Rs 1,80,00,000 and Rs 29,50,000 remains. Rs 29,50,000 is what Chitra Binding added, net of everything consolidation changed. The Rs 21,00,000 investment was inside the parent's Rs 1,80,00,000 and was cancelled on the way in, so subtracting the parent's total removed it from the group side as well. Add it back, and the running figure becomes Rs 50,50,000. Goodwill of Rs 3,50,000 is a consolidation figure and not one of Chitra Binding's own assets. Take it out and Rs 47,00,000 remains. Rs 47,00,000 is Chitra Binding's balance sheet total. The liabilities are simpler. Nothing about the liabilities is cancelled or created, so consolidated Rs 50,00,000 less standalone Rs 38,00,000 is Rs 12,00,000. Net assets are Rs 47,00,000 less Rs 12,00,000, or Rs 35,00,000.

The two published statements together reconstruct the entire balance sheet of a subsidiary that neither of them showed. The difference between the two sets is not presentational. The difference is the whole of another company. The reconstruction also settles what the standalone statements are hiding and what they are not. The standalone statements are not hiding a rearrangement of the same figures. The standalone statements are showing one company where the group statements show two.

Where does the non-controlling interest sit, and how is the Rs 10,50,000 checked?

Thirty per cent of Chitra Binding Works belongs to people who are nothing to do with Anjani Stationers. The group has just presented the whole of Chitra Binding's assets and liabilities as its own, so it now has to say, once and clearly, that part of what it has presented belongs to somebody else. The statement that part belongs to somebody else is the non-controlling interestThe portion of a subsidiary's equity that belongs to shareholders other than the parent. Older accounts and many practitioners still call it the minority interest, and both names are in use., and on this group it is Rs 10,50,000. In conversation the same figure is still called the minority interest. The older term is very much alive, so both names need recognising.

Getting the position wrong distorts every funding ratio built on the balance sheet, so the first thing to settle is where the non-controlling interest sits. The outside holders are part-owners of the group, not people the group owes anything to, so the non-controlling interest sits inside equity and not among the liabilities. The test is the one applied to any liability. Can those holders demand a payment? No. Can they set a date by which the group must hand over cash? No. Do they carry the loss if Chitra Binding has a bad year? Yes, 30 per cent of it. Every one of those answers is the answer an equity holder gives and none of them is the answer a lender gives. So the figure belongs in equity, and Schedule III presents it there, as a separate component within total equity of Rs 1,59,50,000 alongside the Rs 1,49,00,000 attributable to the owners of Anjani Stationers.

Now check the amount, and check it twice. Route one builds it up in the order events happened. When Anjani Stationers bought its holding at the start of year two, Chitra Binding's net assets were Rs 25,00,000, and 30 per cent of that is Rs 7,50,000. Rs 7,50,000 is what the outside holders' share was worth on the day. Since then Chitra Binding has earned post-acquisition profitProfit a subsidiary earns after the date the parent acquired it. Only this part is brought into the group's reserves and split with the outside holders; whatever the subsidiary earned before that date is already inside the net assets that were bought. of Rs 10,00,000, being the movement in its net assets from Rs 25,00,000 to Rs 35,00,000 with no dividend paid, and 30 per cent of that is Rs 3,00,000. Added together they give Rs 10,50,000. Route two ignores the history entirely and reads the closing position. Closing net assets are Rs 35,00,000, and 30 per cent of that is Rs 10,50,000. A figure that two independent routes reach separately is a figure that can be relied on, and if the two routes disagree the error is upstream in the net assets or in the acquisition date rather than in the arithmetic itself.

What does the whole consolidation look like line by line?

Every figure is now on the table, so the group balance sheet goes together in one pass, with the check closed at the end. The assets column reads downward first, then the claims column. Only two figures in the whole of it were not simply added: the investment, removed, and the goodwill, created by the removal.

The check closes: Rs 2,09,50,000 of assets equals Rs 50,00,000 of liabilities plus Rs 1,59,50,000 of equity, and if it did not, the error would be in the cancellation or in the split of post-acquisition profit rather than anywhere else. Notice the one line in the equity column that a reader might not have predicted. The investment is carried at cost and Chitra Binding paid no dividend, so Anjani Stationers' own equity of Rs 1,42,00,000 contains nothing at all from Chitra Binding. The group's owners' equity is therefore the parent's Rs 1,42,00,000 plus its Rs 7,00,000 share of what Chitra Binding earned after being bought, and that Rs 7,00,000 exists only in the consolidated statements.

Why does consolidated profit exceed the parent's own, and which earnings per share is right?

The balance sheet is settled. In the profit statement the same logic runs again, and it produces the figure most often misread in a set of group accounts. Anjani Stationers earned profit after tax of Rs 30,00,000 in year two. Chitra Binding earned Rs 10,00,000, all of it after the acquisition date since it was bought at the start of year two. Consolidation adds income and expenses in full exactly as it added assets, so consolidated profit after tax is Rs 40,00,000.

Then the same Rs 40,00,000 is cut a second time, on a different line. The first cut asked where the profit was earned: Rs 30,00,000 in the parent, Rs 10,00,000 in the subsidiary. The second cut asks who it belongs to: Rs 37,00,000 attributable to the ownersThe part of a group's profit or equity that belongs to the shareholders of the parent company, as distinct from the part belonging to outside shareholders of subsidiaries. Group statements present both, separately. of Anjani Stationers, being their own Rs 30,00,000 plus their 70 per cent share of Chitra Binding's Rs 10,00,000, and Rs 3,00,000 to the non-controlling interest. Both cuts total Rs 40,00,000 and both are printed in a real set of group accounts.

The whole of the subsidiary's earnings has been added, so consolidated profit exceeds the parent's own profit. The investment is held at cost and Chitra Binding paid no dividend, so the parent's own statements carry none of those earnings at all. The dividend condition matters more than it looks. If Chitra Binding had paid a dividend, some of its profit would have reached Anjani Stationers' standalone statements as dividend income. Chitra Binding paid none, so the standalone Rs 30,00,000 is untouched by a subsidiary that earned Rs 10,00,000. The entire Rs 10,00,000 sits in Chitra Binding's own net assets, and that is exactly why those net assets rose from Rs 25,00,000 to Rs 35,00,000.

Now the trap. Three earnings per share figures can be computed from this one group, all on the same 4,00,000 shares, and all three look defensible until the question being answered is asked. Rs 30,00,000 over 4,00,000 shares is Rs 7.50, and that is the parent company's own basic earnings per share, correct and published as such. Earnings per share uses the profit attributable to the owners of the parent, so Rs 37,00,000 over 4,00,000 shares is Rs 9.25, the group's consolidated basic earnings per share. Rs 40,00,000 over 4,00,000 shares is Rs 10.00, and that answers nothing at all. Rs 3,00,000 of that numerator belongs to people who hold no Anjani Stationers shares.

Consolidated earnings per share is Rs 9.25, computed on the owners' Rs 37,00,000 and never on the whole Rs 40,00,000. The Rs 0.75 a share between Rs 9.25 and Rs 10.00 is precisely the Rs 3,00,000 belonging to Chitra Binding's outside holders spread over 4,00,000 shares. Check that yourself, because it is the cleanest proof available that the right numerator has been used: Rs 0.75 multiplied by 4,00,000 shares is Rs 3,00,000, which is exactly the non-controlling interest's share of profit. Any time a consolidated earnings figure and a naive one differ, the gap should reconcile to the non-controlling interest and nothing else.

Four positions on the slider are worth knowing. At 51 per cent, consolidated assets read Rs 2,14,25,000, the non-controlling interest is Rs 17,15,000, the owners hold Rs 1,47,10,000 and earnings per share is Rs 8.78. At the published 70 per cent, the readings are Rs 2,09,50,000, Rs 10,50,000, Rs 1,49,00,000 and Rs 9.25. At 85 per cent they are Rs 2,05,75,000, Rs 5,25,000, Rs 1,50,50,000 and Rs 9.63. At 100 per cent they are Rs 2,02,00,000, nil, Rs 1,52,00,000 and Rs 10.00. Chitra Binding's Rs 47,00,000 of assets and Rs 12,00,000 of liabilities enter the group in full at every one of those positions, and consolidated liabilities read Rs 50,00,000 at every one of them, so what the holding actually changes is the split of the group rather than the size of it. Two further readings are worth having. The Rs 10.00 error is right only at 100 per cent, where there is no non-controlling interest left for it to swallow. The coincidence at 100 per cent is exactly why the error feels safe and is not. And the presentation mistake costs 9.25 percentage points on the liabilities to equity reading at 70 per cent, 31.35 per cent correctly against 40.60 per cent with the non-controlling interest pushed into liabilities, on a balance sheet where not one underlying figure has changed.

Which set of statements should a reader use, and for what?

Both sets are audited, both are published, and neither is a summary of the other. A reader who treats the consolidated statements as the real ones and the standalone as a formality will misjudge what the parent can actually do, and a reader who does the reverse will misjudge the size of the operation entirely.

Take a household as the shape of it. A woman has her own bank account and also runs a shop with her brother, in which she holds the larger share and makes the decisions. Ask what she is responsible for and the honest answer includes the whole shop. Taking money out of the shop needs a decision made with her brother and a share paid to him alongside. So ask what she can pay her daughter's fees from this month, and the honest answer is only what is in her own account. Two true statements, two different questions, and answering the second with the first gets somebody's fees paid late.

The consolidated statements answer what the group as a whole holds, owes and earns; the standalone statements answer what the parent company itself can pay a dividend from and what a lender to the parent alone can reach; and neither is more correct than the other. Run the two questions through the figures. What does this operation earn? Rs 40,00,000, and the group statements are the only place that appears. What can Anjani Stationers pay out to its own shareholders? The answer lives in the standalone statements, in the parent's own distributable profits and its own cash, and it takes no account of Chitra Binding's Rs 10,00,000 until Chitra Binding declares a dividend of its own. What can a lender to Anjani Stationers alone enforce against? The parent's own Rs 1,80,00,000 of assets. Inside those, a shareholder ranks behind Chitra Binding's own Rs 12,00,000 of creditors, so the interest in Chitra Binding is a Rs 21,00,000 shareholding and not Rs 47,00,000 of machines.

Who opens which set, and what do they do with what they find?

Step back from the mechanism. The choice between the two sets is made by real people with real questions, and three of them would reach for different volumes off the same shelf.

A lender to the parent company alone reads the standalone statements first and the group note second, an analyst reads the consolidated statements and then checks how much of the profit is not the owners', and Vaidehi Rao reads the standalone retained earnings before she puts a dividend to the board. Watch each of them work. The lender's security and its enforcement rights run against Anjani Stationers Private Limited, the legal company that signed the loan, so its assets are the standalone Rs 1,80,00,000 and its liabilities are the standalone Rs 38,00,000. Inside those assets, the interest in Chitra Binding is a Rs 21,00,000 shareholding. Chitra Binding's own Rs 12,00,000 of creditors are paid before any shareholder sees anything, and Anjani Stationers is a shareholder there, so the interest is not Rs 47,00,000 of binding machinery. A lender who looked only at the consolidated Rs 2,09,50,000 would think it had far more standing behind it than it does. The group note is still worth reading. It tells the lender where the operation actually is.

The analyst's habit is the opposite one and just as necessary. Consolidated statements are the right place to see the size of an operation, so the analyst starts there, and then immediately asks how much of the Rs 40,00,000 is the owners'. On this group the answer is Rs 37,00,000, and the Rs 3,00,000 that is not is small. On a group with several large partly held subsidiaries it can be a fifth of reported profit or more, and any per share figure, any return on equity and any earnings multiple built on the wrong numerator is wrong by that proportion. And Vaidehi Rao, as finance controller, has the most immediate use of all. A dividend from Anjani Stationers is paid out of Anjani Stationers' own distributable profits and its own cash, so she reads the standalone retained earnings of Rs 1,02,00,000, not the group's. If the board wanted to draw on Chitra Binding's Rs 10,00,000 of earnings, that needs Chitra Binding to declare a dividend of its own, on which 30 per cent leaves the group entirely to the outside holders. Neither of those is a reason to prefer one set of statements; it is the reason both exist.

Anjani Stationers Private Limited, Chitra Binding Works Private Limited and Vaidehi Rao are invented.
Educational material. Not advice on any investment, tax, budget or market position.