Unconsolidated Subsidiary: Individual Financial Statements

An unconsolidated subsidiary refers to a subsidiary whose financial statements are not included in the parent company's consolidated financial statements. Instead, the equity method of accounting is used.

An unconsolidated subsidiary is a company that is controlled by a parent company but whose financial results are not included in the consolidated financial statements of the parent company. Instead, the equity method of accounting is used to reflect the investment in the subsidiary.

The Equity Method of Accounting

The equity method is an accounting technique used to record investments in which the investor has significant influence but does not control, typically representing ownership of 20% to 50% of the voting stock. When the equity method is used, the investment is initially recorded at cost, and subsequently adjusted to reflect the investor’s share of the net income or loss of the investee.

Formula

Using the equity method, the investment is reflected by the following:

$$ \text{Investment Value} = \text{Initial Cost} + \text{Investor’s Share of Net Income} - \text{Dividends Received} $$

Example

If Company A owns 30% of Company B and Company B earns $100,000 in net income, Company A’s share would be $30,000. This amount is added to the investment value in Company B on Company A’s balance sheet. Conversely, if Company B declares and pays dividends, Company A’s investment value in Company B would decrease accordingly.

Types of Unconsolidated Subsidiaries

• Significant Influence: Situations where the parent has between 20% and 50% ownership.
• Joint Ventures: Entities where control is shared among two or more parties.
• Non-operational Subsidiaries: Subsidiaries that do not actively participate in the parent company’s core business activities.

Special Considerations

While using the equity method, it’s essential to adjust for:

1. Changes in the ownership percentage.
2. Transactions between the investor and the investee.
3. Observance of any dividend distributions.
4. Adjustments for impairment if the investment’s market value significantly declines.

Historical Context

Historically, the equity method was introduced to provide a clearer representation of the financial interrelations between the parent company and the investee, allowing stakeholders to get a better picture of the earnings and value contribution from the investee.

Applicability and Comparisons

An unconsolidated subsidiary is typically used where the parent company’s control is not absolute, making consolidation inappropriate. This contrasts with:

• Consolidated Subsidiaries: When the parent has complete control and consolidates all financials.
• Minority Investments: Usually, when ownership is below 20%, often recorded using the cost method.

Related Terms

• Consolidated Financial Statements: Financial statements that factor in the assets, liabilities, income, and expenses of all subsidiaries.
• Cost Method: Accounting method generally used for investments where the investor has little or no influence.
• Control: The power to govern financial and operating policies.

FAQs

Why are some subsidiaries unconsolidated?

If the parent does not have full control, or the subsidiary is not material, the unconsolidated approach might be more appropriate.

How does the equity method affect financial ratios?

The equity method impacts the investor’s financial ratios differently from full consolidation, as only net income and equity change but not balance sheet items like assets and liabilities.

Can a company choose between consolidation and equity method?

The choice depends on the level of control. Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) typically dictate the appropriate method.

References

• International Financial Reporting Standard (IFRS).
• Financial Accounting Standards Board (FASB) guidelines.
• “Accounting Principles” by Kieso, Weygandt, and Warfield.

Summary

An unconsolidated subsidiary is one where the parent company uses the equity method rather than consolidating the subsidiary’s financial results. This approach is used primarily when the parent does not have sufficient control over the subsidiary but still has significant influence. The equity method provides a mechanism to reflect the investor’s share of the subsidiary’s net income or loss without including detailed financial statements of the subsidiary in the parent company’s consolidated financials.