Accounting theory and practice, Volume 2 (of 3)

by Roy B. Kester

To maintain a fairly constant supply of labor, a corporation frequently finds it necessary to provide housing accommodations for its employees. This may be because the concern is located far from a settled community and outside capital cannot be induced to provide the needed accommodations. Accordingly, corporations oftentimes spend large sums in so-called social betterment work, and it is customary for the corporation to charge a fair rental on workmen’s dwellings. The expense in connection with such work is to be treated rather as an item of extraordinary expense just as the income from the corporation’s investment in workmen’s dwellings must be treated as income outside the regular operations of the business. The problem here is simply the determination of the proper place to show the items of expense and income in the profit and loss summary for the period.

CHAPTER XXXIV
THE CONSOLIDATED BALANCE SHEET
AND PROFIT AND LOSS SUMMARY

Purpose and Function

The consolidated balance sheet is a form of statement distinctively American. As indicated in previous chapters, its use has arisen as a result of the corporation laws of some of the states which allow the formation of the holding company. This, if strictly a financing company, has a very simple operating organization. Its chief assets are usually the securities, capital stock and bonds, of the subsidiary companies which it owns in part or in full. Accordingly, its balance sheet is comparatively simple; in fact this very simplicity results in giving little information as to its real financial condition or that of the subsidiaries which it owns. If, however, the holding company is at the same time both an operating and a financing corporation, all the complexities encountered in the balance sheet of a manufacturing company will be found on that of the holding company. However, the financial statement of an operating holding company is not any more intelligible because of its complexity than that of a purely financing corporation.

The items on the balance sheet of either type of corporation which are evidence of the activities peculiar to a holding company are, as stated above, the securities of the subsidiary concerns held by the holding company and whatever advances have been made on open account to the various subsidiaries in order to provide funds for making extensions or for recouping losses incurred by the subsidiaries. The principles governing the valuation of the securities of the holding company have already been stated and explained in Chapter XV. In that chapter were stated the different applications of the principles of valuation to the three conditions met; namely, (1) the condition in which the holding company owns the entire capital stock of the subsidiary; (2) the condition in which a controlling but partial interest only is held; and (3) the condition in which the holding company is a minority stockholder of the subsidiary. In making up the balance sheet of the holding company the application of these principles to the valuation of the holdings of the corporation must be carefully handled. Aside from this problem of valuation, the balance sheet of the holding company presents no new problems. Such a balance sheet, however, gives very little information as to the actual financial condition of the corporation because its finances are tied up so completely with the financial condition of the various subsidiaries. In order, therefore, to present a statement which will intelligently show the real condition of the holding company, it becomes necessary to combine or consolidate the statements of financial condition of all its subsidiaries.

Problem of Partial Ownership

Where the ownership of the subsidiaries is complete, the consolidated balance sheet in which are brought together all the various assets and liabilities of the subsidiaries, presents a true, full, and intelligent statement of the financial condition of the holding company. Where, however, ownership is not complete, in which case there may be majority or minority holdings, the problem of drawing up a statement which will present the actual condition of the holding company is more difficult and much more complex. Manifestly, a consolidated balance sheet under either of these latter conditions as to partial ownership cannot be applicable alone to the holding company, inasmuch as in such a statement there must be included interests over which the holding company has no direct control or authority.

Because of this difficulty, three different ways of attempting to show the holding company’s condition are met with. One method makes no attempt to overcome the difficulty but limits itself to showing simply the balance sheet of the holding company as explained in the early part of this chapter. A second method consists in showing the balance sheet of the holding company supported by the separate balance sheets of all of the subsidiary companies. The third method is the method of the consolidated balance sheet which has just been briefly explained. This last is, perhaps, the most satisfactory method of the three. The insufficiency of the first method and the objection to it have been referred to already. The second method gives all essential information but presents it in such form that it is practically impossible for anyone but a trained student of finance and accounting to correlate the various parts and arrive at an intelligent understanding of actual conditions. The stockholder or the outsider is usually completely at a loss to know the meaning of all the figures and statements presented. Under the third method the data as to the condition of the various companies are brought together and presented in logical form on the consolidated balance sheet so that the combined statement shows as clearly as is possible the condition of the holding company.

Conditions under which Used

It should be clearly understood that the consolidated balance sheet is not a balance sheet of the holding company except and only when the holding company owns the entire capital stock of all the subsidiaries. A consolidated balance sheet, therefore, is a statement which presents the condition of all of the subsidiary companies. If it reflects the condition of the holding company better than the latter’s balance sheet, then, and then only, should a consolidated balance sheet be used. A fine distinction must sometimes be drawn to determine when it is more desirable, in the interests of an accurate showing of condition, to present a consolidated balance sheet rather than the balance sheet of the holding company, and a delicate appreciation is needed of the various financial problems involved. When the holding company is not the complete owner but nevertheless has a controlling interest in all the subsidiaries, the method of the consolidated balance sheet is usually the better way of showing its financial condition. Where the holding company, however, holds only minority interests, it is oftentimes open to question as to whether the consolidated balance sheet gives a true presentation of the facts of financial condition, especially in view of the fact that the holding company cannot always control the policies of its subsidiaries.