What is an unconsolidated subsidiary?

A firm that a parent company owns but whose separate financial statements are not included in the parent company’s consolidated or combined financial statements is known as an unconsolidated subsidiary. Instead, an unconsolidated subsidiary is shown as an investment in the parent company’s consolidated financial statements. This often occurs when the parent business does not own most of the subsidiary.

An Unconsolidated Subsidiary’s Meaning

When a parent company does not control a subsidiary, temporarily takes control of the subsidiary, or when the parent company’s business activities diverge significantly from the subsidiary’s, the firm may be classified as an unconsolidated subsidiary.

Depending on the parent company’s ownership share, different accounting procedures apply. Nonetheless, the ownership share is seldom more than 50%. The parent usually has some influence over the subsidiary if it owns 20% or more of the company but less than 50%.

Since the unconsolidated subsidiary is regarded as an investment with more than 20% ownership in the subsidiary’s voting shares, the parent will apply the equity method of accounting in this case. This investment is regarded as influential. Using this procedure, any profit or loss earned by the parent company must be shown on the income statement.

Less than 20% ownership and no control over the subsidiary mean that parent businesses only report the investment on their balance sheet at historical cost or acquisition price. We refer to this as a passive investment. If dividends—cash payments sent to shareholders—are made, the parent records the income from the dividends but not the revenue from the subsidiary’s investments.

Motives for Having a Disaggregated Affiliate

A parent business will often establish the unconsolidated subsidiary on its own. It may do this for several reasons, such as establishing special purpose vehicles (SPVs) to separate revenues, expenses, and profits for specific projects from those of the parent company or joint ventures (JVs) to share costs with another business.

The financial statements of a parent firm may not accurately represent its real exposure to all linked parts of its business when the subsidiary or affiliated organization is a substantial operation.

A parent firm may be heavily exposed to a subsidiary’s financial and operational activities, even if it does not have management control over the latter. For example, political risk in another location might affect a global corporation. Although the exposure to the subsidiary does extend beyond the parent’s primary company, it may not make sense to account for the subsidiary beyond an investment on a parent’s financial statements.

An Unconsolidated Subsidiary Example

For illustration purposes, we assume that Business ABC controls 40% of an unconsolidated subsidiary, Business XYZ, which was established as a particular purpose vehicle (SPV) for a one-year construction project in a foreign nation.

For the year, XYZ reports $1 billion in earnings. ABC will use the equity method to account for its unconsolidated subsidiary since it owns more than 20% (but less than 50%) of XYZ. Given that it owns 40% of XYZ and has some influence over the company, ABC must report $400 million in profits on its income statement. ABC must report the $400 million rise in the original investment’s value shown on the balance sheet.

Conclusion

• A parent business has unconsolidated subsidiaries, but the parent company’s consolidated financial statements do not contain the individual financial statements of these subsidiaries.
• Unconsolidated subsidiaries appear as investments on the parent company’s consolidated financial accounts rather than their financial statements.
• When a parent company does not control its subsidiary, only temporarily does so, or if the parent’s business activities vary from the subsidiary’s, then the two companies are classified as unconsolidated subsidiaries.
• The equity or historical cost method must be used to report the investment, depending on the parent company’s ownership holding in the subsidiary.
• Most of the time, parent firms possess less than 50% of the unconsolidated subsidiary. The accounting technique used determines whether the ownership share is higher or less than 20%.