When one company controls another company the controlling company is called the parent and the controlled company is called the subsidiary. Since the parent controls the operating and financing decisions of the subsidiary, it is worthwhile to look at both the companies' financial performance and financial position together. Consolidated financial statements are prepared to achieve this objective. US GAAP and IFRS require the consolidated financial statements to be prepared under the acquisition method.
In the acquisition method, the parent includes all the assets of the subsidiary on its consolidated balance sheet and includes all the subsidiary's revenues and expenses in its consolidated revenues and expenses. It creates a component called 'non-controlling interest' or 'minority interest' in its equity section which represents the claim of others on the subsidiary's net assets. A line item also appears on the consolidated income statement below net income which represents net income attributable to the non-controlling interest.
Company P currently holds 75% of the outstanding share capitals of Company S. Company P's assets are $30 million, its liabilities are $20 million and its shareholders' equity is $10 million. Company S's assets are $10 million, its liabilities are $7 million and its equity is $3 million.
Company P will include the assets of Company S on its balance sheet so its total assets will be $40 million ($30 million + $10 million), its total liabilities will be $27 million ($20 million + $7 million). Its equity will be $13 million ($40 million minus $27 million) but it will have two components: first component would result to the interest of the Company P in Company S's net assets while the other component is called the non-controlling interest and it represents the interest of other Company S shareholders who hold the remaining 25% of the outstanding shares. Non-controlling interest on Company P's balance sheet would equal 25% of Company S's net assets ($10 million minus $7 million) which equals $0.75 million. The equity component that represents Company P's interest is hence $12.25 million (total equity of $13 million minus non-controlling interest of $0.75 million).
Written by Obaidullah Jan