An affiliate business is another word for subsidiary, so the accounting standards are the same regardless how the entity is labeled. A subsidiary’s financial activity is consolidated into the financial statements of the controlling, or parent’s, company for reporting purposes. As a result, all of the financial assets and income is reported as the parent’s, although the subsidiary’s individual assets and income may be identified separately in the parent’s financial footnotes. When preparing financial statements, consult with a certified public accountant.
Affiliate and Subsidiary Definitions
Affiliate and subsidiary both describe the same type of relationship between two businesses. A subsidiary business is one that is controlled by another corporation, or parent. Control is defined by whether the parent owns at least 50 percent plus one share of the voting stock of the affiliate. Ownership of those shares can be established several ways outside of the parent merely possessing the shares outright. If a parent and one of its subsidiaries combine to own more than 50 percent of a company’s voting stock, then the third company also is a subsidiary. Also, if a parent owns a subsidiary that controls another company, the third company is a subsidiary of the parent.
GAAP in General
Accounting procedures and reporting standards in the United States are defined by the generally accepted accounting principles. GAAP is a collection of pronouncements from a series of professional accounting agencies, which define how financial data is to be reported. Certified public accountants are required to use GAAP when preparing financial reports, and failure to do so could cause them to lose their licenses. One of the highest authorities in GAAP are Financial Accounting Standards Board Standards and Interpretations.
FASB Standard No. 94 defines how the financial activities of a subsidiary are to be reported. FASB 94 amends the prior standard for subsidiary reporting, Accounting Research Bulleting No. 51. FASB 94 requires that all subsidiaries' financial activities be consolidated. The exception is if the majority ownership is temporary and the control rights are vested with another entity. An example of where this would occur is if a business went bankrupt and the debtor gained a majority of the stock to settle the debt. While the debtor would have the majority of the stock, the bankruptcy trustee would retain control of the bankrupt business’s assets.
The consolidation process is complicated and requires significant adjustments to the parent’s financial statements. First, the balance sheet accounts must be combined by adding the assets and liabilities together. For example, the consolidated balance sheet’s cash accounts would equal the parent’s cash account plus the subsidiary’s cash account. The value of the subsidiary’s assets is valued based on the price the parent paid to acquire the subsidiary for purposes of the consolidation. The shareholder’s equity accounts on the consolidated statements equals the value of equity on the parent company’s books; you do not add the subsidiary’s equity values as you do with assets and liabilities. Generally, consolidating income and expenses of the two businesses will be straightforward, as you merely add the two together.
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.