When sifting through a company's period-end operating results, investors generally keep an eye on profits coming from the organization's wholly owned subsidiaries. This scrutiny tells financiers whether the business is serious about making money across the board and whether top leaders have set adequate policies to comply with generally accepted accounting principles, or GAAP.
GAAP and Wholly Owned Subsidiaries
GAAP is the product of regulatory compromise, scholarly ingenuity and business deal-making -- the kind of legislation that sees daylight after various groups provide their feedback. The GAAP formulation process receives the unwavering contribution of constituencies like academia, business lobbies, the American Institute of Certified Public Accountants and the Financial Accounting Standards Board. FASB is the entity that coordinates the standard-setting, ensuring that all relevant participants have a say in policy-making. Accounting principles consider a subsidiary "wholly owned" if a parent company holds 100 percent of the affiliate's outstanding stocks.
Financial Statement Consolidation
A parent business must consolidate its operating results with its subsidiaries' performance data as the first step in affiliate financial reporting. Accountants working for a subsidiary send all transactional data to their colleagues at the parent company's headquarters. These, in turn, perform a quick cursory review to ensure completeness, accuracy and adherence to regulatory guidelines.
The next step is the removal of inter-company transactions, which helps parent company accountants prevent double-counting and only report operating items that came from external parties with no financial or legal connection to the holding business. Under GAAP, the final step in reporting the performance information of a wholly owned affiliate lies in the publication of full-scope financial data summaries, which run the gamut from a balance sheet and an income statement to an equity statement and a statement of cash flows.
Besides financial statements, GAAP recommends that a holding company report information about its affiliates in supplemental disclosure notes. Doing so enables the business to arouse interest in the investment community and lender quarters, to tell the marketplace the company is a force to reckon with and to maintain the capacity to surprise financiers with rosy results -- especially those who initially doubted that a specific subsidiary could ever make money.
Pondering the Future
Subsidiary reporting helps a company's top brass ponder what the future holds, how to effectively instill the notion of cost management in personnel and whether to sell a moribund business unit or invest significant amounts of money to turn it around. This thinking enables senior executives to soothe the concerns of investors eager for more corporate profits, generally by mounting an aggressive charm offensive aimed at showing the financial acumen, business flair and operating prowess of the company's existing senior bench.
- Acounting Standards; Consolidated Financial Statements; 2001
- "Advanced Financial Accounting"; Richard E. Baker, et al.; 2005
- "The CPA Journal"; Consolidated Financial Statements; Michael Davis, et al.; February 2008
- "The CPA Journal"; Understanding Consolidation; Rebecca Toppe Shortridge, et al.; April 2007