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Meaning of Holding Companies When a company acquires majority of shares (more than 50%) in the ownership or is in a position to control the management of the company is called a holding company and the other is called a subsidiary company. A holding company is able to exercise control over the management of other companies by virtue of its shares ownership. The main objective behind the holding companies is to promote combination movement so that competition may be eliminated, also advantages of monopoly or near monopoly may be enjoyed and economies in management and production may be secured.
Under the following circumstances a company can become a subsidiary to other company: • If a company acquires all or majority of equity shares in other company. • If the other company controls the management or the composition of its Board of Directors. • If the company becomes a subsidiary of another company which itself is a subsidiary of a third company.
Both companies can retain their identities as there is no need to liquidate themselves and lose their identity. Various income tax benefits can be enjoyed by forwarding their existing losses. Subsidiary company can enjoy the advantage of existing goodwill. Advantage of monopoly and near monopoly may be enjoyed. Holding company device is best suited for promoting combination movement in business. Advantages of Holding Companies
Profitability and the financial position of each company can be easily known as each company has to prepare its own books of accounts. • Less investment is required to acquire the controlling interest in another company as compared to another technique i.e. absorption and amalgamation. • Economies in production and management may be secured.
Disadvantage of Holding companies • These companies can manipulate the accounts for their fraudulent purposes. • Danger of oppression of minority shareholders. • Figures of inter company transactions may also be manipulated. • Holding companies enjoys all the benefits of monopoly but this is clearly a disadvantage from social point. • Subsidiary company may be forced to appoint persons of the choice of holding company. • Holding company can unreasonably exploit the subsidiary company.
Capital profits (Pre acquisition reserve and profits) If there exists some reserves and profits of the subsidiary company on the date of the acquisition of shares of the subsidiary company, the outsider share of such reserves and profits is added to the minority interest and the balance of such reserves and profits are capital profits of the holding company and are shown as capital reserve in the Consolidated Balance Sheet. Similarly, losses of the subsidiary company shown in the B/S on the date of purchase of shares are divided into two parts i.e share of minority shareholders and share of the holding company. Share of outsiders is deducted from the amount of minority interest and share of holding company is added to the cost of control or g/w or reduced from capital profit.
Revenue (post acquisition profit) Profit of the subsidiary company made after the date of the purchase of shares by the holding company are treated as revenue profits. Holding company’s share of such profits is added to the profits of the holding company and share of such profits belonging to the minority shareholders is added to the amount of the minority interest.
Common transactions between the holding and the subsidiary company In preparing consolidated Balance Sheet, common transaction appearing in both the balance sheet of the holding company and the subsidiary company should be eliminated. Such transactions may be: Debtors and Creditors Bills Receivable and Bills Payable Loans Debentures
Treatment of Bonus issue by Subsidiary Company Treatment of issue of bonus shares by the subsidiary company will depend upon the source from which the bonus shares are issued. Bonus shares may be issued out of • Pre acquisition profits or reserves or • Post acquisition profits or reserves of the subsidiary company.
I-Issue of bonus shares out of Pre acquisition profits Such Issue will have no effect on the consolidated balance sheet because holding companies share in pre acquisition profits is reduced on account of issue of bonus shares and on the other hand paid up value of shares held be holding company increases. So , cost of Goodwill and Minorities interest will remain the same as these were before the issue of bonus share.
II-Issue of bonus shares out of Post acquisition profits Such issue will have effect on the consolidated balance sheet. The shares of holding company shall reduce in revenue profits( post acquisition) and the paid up value of shares held by the holding company will increase. Increased paid up value of shares held will reduce the cost of control or Goodwill or increase the value of capital reserve.
Treatment of unrealised profits Some time subsidiary company sold goods to holding company (or vice versa) at selling price (i.e. after adding profit to its cost). If some part of these goods still lying with the purchasing company in its stock, then profit included in such value of unsold stock is called as unrealised profit. In such a case, reserve has to be created for such unrealised profit. • Such reserve shall be deducted out of the value of stock in consolidated profit. • Reserve is deducted out of the balance of profit and loss account of holding company.
Treatment of goodwill Goodwill appearing in the Balance Sheet of subsidiary of company will be shown along with goodwill (if any) of the holding company. In case there is capital reserve it will be adjusted in capital reserve on consolidation.
Treatment of Contingent liability Contingent liabilities are those liabilities which may or may not occur in future. Examples: • Liability in respect of bills discounted not yet matured • Amount uncalled on partly paid up shares held as investment. • Areas of dividend on cummulative Preference shares. • Claims against the company not acknowledged as debt. While preparing consolidated balance sheet the treatment of contingent liability depends on whether it is towards outsiders or it is internal between holding and subsidiary company. The external liability is shown by way of footnote in the consolidated balance sheet. The internal contingent liability is not to be shown anywhere because it is treated as mutual owing.
Treatment of fictitious assets If fictitious assets (i.e. preliminary expenses, discount on issue of shares and debentures, underwriting commission etc.) are given on the assets side of the B/S of subsidiary company then these items must be deducted from the capital profits (or added to capital loss) before distributing the same among the holding company and minority shareholders.
Treatment of Preference shares of subsidiary company held by the holding company Three step treatment for, preference shares of subsidiary company held by the holding company whether the same are held either wholly or partly. The accounting treatment in the consolidated Balance Sheet is as follows: • The preference dividend accrued shall be deducted from the profits and the accrued preference dividend is apportioned between minority shareholders and holding company in proportion to holding. The remaining profits are divided among equity shareholders (i.e. minority shareholders and holding company) in accordance with the shares held by them. If there are losses for the current year of subsidiary company then no preference dividend is provided for.
2. Secondly while calculating the minority interest, the paid up value of preference shares held by them shall be added to their shares. 3. Thirdly the excess amount paid by the holding company for acquiring preference shares over the paid up value is treated as cost of control.
Consolidated balance sheet While preparing consolidated balance sheet of Holding company and its subsidiary company, three items are never shown. • Share capital (paid up) of subsidiary company (say S Ltd.) • Reserves and surplus of S Ltd. • Investment of Holding company (say H Ltd.) in S Ltd in the form of Equity shares or Preference shares or Debentures.
Steps for preparing consolidated balance sheet Step 1- Calculate ratio of equity shares held by H Ltd and outsiders (minority) in S Ltd as their investment. Step 2- Calculation of period prior to the date of acquisition of shares by H Ltd in S Ltd and period post to the date of such acquisition.
Step 3- Calculation of pre acquisition or capital profit of S Ltd Balance of P&L a/c as in the beginning of the year xxx G/R or other reserve as in the beginning of the year xxx Current years profits for the pre acquisition period xxx xxx Add: Increase in the value of fixed assets of S Ltd. xxx Less: Decrease in the value of fixed assets of S Ltd. xxx Less: Amount of bonus shares issued by S Ltd (if out of pre acquisition period profits) xxx Less: Fictitious assets of S Ltd (now to be written off) xxx Pre acquisition or capital profit or loss xxx
Step 4- Calculation of post acquisition or revenue profit of S Ltd. Current years profits for post acquisition period xxx Less: Amount of bonus issue by S Ltd. (if out of post acquisition profits) xxx Add :Depreciation on decrease in value of fixed assets for post acquisition period xxx Less: Depreciation on increase in value of fixed assets for post acquisition period xxx Revenue Profits or Loss xxx
Step 5-Calculation of cost of control (or goodwill) or capital reserve Amount invested by H Ltd in S Ltd (as per balance sheet of H Ltd) -In Equity shares xxx -In Preference shares xxx xxx Less-(i) Face value of equity shares held by H Ltd. In S Ltd. Xxx (ii) Face Value of preference shares held by H Ltd in S Ltd xxx (iii) Proportionate share of H Ltd in Capital profits of S ltd. Xxx (iv) Proportionate shares of H Ltd in bonus issue (whether out of capital or revenue profit) xxxxxx Goodwill (if +ve) Capital Reserve (if –ve) xxx Add: Goodwill already shown in the balance sheet of H Ltd & S Ltd. ___ Net goodwill or capital reserve xxx
Step 6- Calculation of minority (or outsiders) interest Face value of equity shares in S Ltd held by outsiders xxx Face value of preference shares in S Ltd held by outsiders xxx Dividend on preference shares held by outsiders xxx Proportionate share of outsiders in capital profits xxx Proportionate share of outsiders in revenue profits xxx Proportionate share of outsiders in bonus issue xxx Value of minority interest xxx
Step 7-Calculation of balance of profit and loss account of H Ltd Balance of P&L a/c of H Ltd as per its balance sheet xxx Add: Proportionate share of H Ltd in revenue profits xxx Less: Unrealised profits on unsold stock xxx Balance of profit and loss a/c of H Ltd xxx
