An unconsolidated subsidiary is a company that is owned by a parent company but whose financial results are not included in the consolidated financial statements of the parent company. Instead, the investment in the unconsolidated subsidiary is typically accounted for using either the cost method or the equity method of accounting, depending on the level of influence the parent company has over the subsidiary.
- Less Than Majority Ownership: Often, unconsolidated subsidiaries are companies in which the parent holds a significant but non-controlling stake, generally less than 50% of the voting stock.
- Influence but No Control: In such situations, the parent company might have significant influence but does not have the control that would warrant consolidation with its financial statements.
- Equity or Cost Method: The parent usually accounts for its investment in the subsidiary using the equity method if it has significant influence, or the cost method if it has little to no influence.
- Separate Financial Statements: Because they are not consolidated, unconsolidated subsidiaries will release their own, separate financial statements, which are distinct from the consolidated statements of the parent.
- Strategic Reasons: Sometimes, companies prefer to keep subsidiaries unconsolidated for strategic or regulatory reasons, even when they have a greater than 50% stake.
Example of an Unconsolidated Subsidiary
Let’s consider a fictional example involving two companies: AlphaTech Inc. and BetaSoft LLC.
- AlphaTech Inc. is a leading technology company that specializes in cloud computing services.
- AlphaTech acquires a 40% stake in BetaSoft LLC, a smaller software development firm, for $4 million. This gives AlphaTech significant influence over BetaSoft, but not outright control.
Because AlphaTech owns less than 50% of BetaSoft and does not control its operations, BetaSoft is considered an unconsolidated subsidiary of AlphaTech.
- AlphaTech would typically use the equity method to account for its investment in BetaSoft.
- Initially, AlphaTech records the investment at cost, which is $4 million in this case.
Journal Entry at Time of Purchase:
- Debit Investment in BetaSoft: $4,000,000
- Credit Cash: $4,000,000
Let’s assume BetaSoft reports net income of $500,000 at the end of the year.
- AlphaTech would recognize 40% of this net income as its share, which amounts to $200,000 (40% of $500,000).
Journal Entry for Share of Net Income:
- Debit Investment in BetaSoft: $200,000
- Credit Equity Income from BetaSoft: $200,000
This equity income would appear on AlphaTech’s income statement, and the carrying amount of the investment in BetaSoft on AlphaTech’s balance sheet would now be $4,200,000 ($4,000,000 initial investment + $200,000 share of net income).
If BetaSoft Issues Dividends:
If BetaSoft issues dividends totaling $100,000 during the year, AlphaTech would receive 40% of that amount, which is $40,000.
Journal Entry for Dividends Received:
- Debit Cash: $40,000
- Credit Investment in BetaSoft: $40,000
This would reduce the carrying amount of the investment in BetaSoft back down to $4,160,000 ($4,200,000 – $40,000).
By understanding this example, one can better grasp how an unconsolidated subsidiary is accounted for and how it impacts the financial statements of the parent company.