Definition: A subsidiary is company controlled by another company, often called the parent, which owns at least 50 percent of its voting stock. In other words, it’s an entity that is predominately owned and controlled by another company.
What Does Subsidiary Mean?
A parent company has controlling interest in the subsidiary because it owns a majority of its equity securities. You can think of this as a company that purchases another company. There have been a number of larger publicized buyouts in the last few years Instagram being one of the most well known. Facebook purchased all of the voting stock in Instagram for $1 billion in early 2012 making it one of Facebook’s subsidiaries.
As a parent corporation, Facebook could dissolve Instagram entirely, claim its assets, and merge the two companies, but there is numerous legal, tax, and marketing reasons to keep the entities separate. Instead, Facebook has decided to keep the two companies separate. This allows the two entities to keep separate accounting records, duties, and responsibilities. There are a few reporting requirements to follow, however.
Reporting the parent and subsidiary relationship must be detailed in the financial statements issued at the end of each accounting period. Wholly owned subsidiaries must be reported on a consolidated set of financial statements even though they are technically considered separate companies. Why? Since the parent company owns and controls the subsidiary, the sub basically just becomes an extension of the parent. In effect, it is the same company.
External users need to see this relationship in order to get a clear picture of the entire organization. For example, if Facebook had huge profits and Instagram had equal losses, investors would want to know that the overall entity actually broke even. Thus, the equity method is used to consolidate accounting activities of the two separate companies and report both companies on a single set of financial statements.