What Is an Unconsolidated Subsidiary?
An unconsolidated subsidiary is a company that is owned by a parent company but whose individual financial statements are not included in the consolidated or combined financial statements of the parent company to which it belongs. Instead, an unconsolidated subsidiary appears in the consolidated financial statements of the parent as an investment. This usually applies when the parent company does not have a controlling stake in the subsidiary.
- Unconsolidated subsidiaries are owned by a parent company, but their individual financial statements are not included in the consolidated financial statements of the parent company.
- Rather than their individual financial statements, unconsolidated subsidiaries appear as investments on the parent company's consolidated financial statements.
- Companies are considered to be unconsolidated subsidiaries when the parent company is not in control of the subsidiary, has only temporary control, or if the parent's business operations are different than that of the subsidiary.
- Depending on the equity stake of the parent company in the subsidiary, the investment has to be recorded either using the equity method or the historic cost method.
- Parent companies most often have less than a 50% ownership stake in the unconsolidated subsidiary. The accounting method used depends if the ownership stake is more or less than 20%.
Understanding an Unconsolidated Subsidiary
A company may be treated as an unconsolidated subsidiary when the parent company is not in control of a subsidiary, has temporary control of the subsidiary, or if the parent company's business operations are considerably different than that of the subsidiary.
Different accounting treatments apply, depending on the percentage owned by the parent company. The ownership stake, however, is always less than 50%. If the ownership stake is 20% or more (but less than 50%), the parent typically can exert some type of control over the subsidiary.
Here, the parent will use the equity method of accounting as the unconsolidated subsidiary is treated as an investment with more than 20% ownership in the voting stock of the subsidiary. This is known as an influential investment. Under this method, the parent must record any profit or losses realized from the subsidiary on its income statement.
Parent companies with less than a 20% stake and no control of the subsidiary merely record the investment at historical cost or the purchase price on its balance sheet. This is known as a passive investment. However, if dividends are paid, which are cash payments to shareholders, the parent records the dividend income but does not record any investment income earned from the subsidiary.
Reasons to Have an Unconsolidated Subsidiary
Most often, a parent company will create the unconsolidated subsidiary itself. There are a variety of reasons it may do so, including creating joint ventures (JVs) to split costs with another company or special purpose vehicles (SPVs) to segregate revenues, costs, and profits for special projects from that of the parent company.
When a subsidiary or affiliated entity is a sizable operation, a parent company’s financial statements may not fully reflect its true exposure to all attached elements of its business.
While a parent company may not have managerial control of a subsidiary, it could have significant exposure to the financial and operational dealings of the subsidiary. For instance, a multinational enterprise may experience political risk in another region. From an accounting sense, it might not make sense to account for the subsidiary beyond an investment on a parent’s financial statements, but the exposure does extend to the parent’s core business.
Example of an Unconsolidated Subsidiary
As an example, let's say that Company ABC has a 40% controlling interest in its unconsolidated subsidiary, Business XYZ, which it created as an SPV for a new construction project in a foreign country that will only last for a year.
XYZ records $1 billion in profits for the year. Because ABC owns more than 20% of XYZ (but less than 50%), it will use the equity method of accounting for its unconsolidated subsidiary. ABC must record $400 million in earnings on its income statement since ABC has a 40% stake and exerts some control over XYZ. Also, ABC needs to record the increase in the value of the initial investment, listed on the balance sheet, by $400 million.