Showing of Profit and Loss Summary
The consolidated balance sheet should be supported by a consolidated profit and loss summary. Just as with the balance sheet, a distinction is made between the profit and loss statement of the holding company and the consolidated profit and loss statement in which are brought together the summaries of all of the allied companies. If the holding company is primarily a financing company, its chief source of earnings will be from dividends on the stocks of the subsidiary companies held by it. The profit and loss summary of the holding company may be a true reflection of its earning condition for the current year if proper provision has been made for the losses of the subsidiary companies which have been operated unprofitably. The information which the holding company’s profit and loss summary gives, however, is not adequate or sufficient on which to base an intelligent judgment as to whether it is a correct statement of current operations. Much the same difficulties are met in connection with it as in connection with the balance sheet of the holding company referred to above. For instance, if, during a given period, some of the subsidiary companies were operated at a loss or on a narrow margin of profit but dividends were declared out of surplus earnings accumulated from other periods, there would be no indication on the profit and loss summary of the holding company as to the actual conditions under which the earnings of the holding company had been secured. In other words, there would appear on the profit and loss summary of the holding company as earnings for the current period items representing accumulated earnings from previous periods.
Thus, the profit and loss summary of the holding company would not give a true reflection of the earnings for the current period, and furthermore would give no information whereby it would be possible for an interested party to form any judgment as to the current operations of the holding company and its subsidiaries. Inasmuch as the holding company usually owns a majority interest in all the subsidiaries and therefore can dictate their policies, the management of the holding company is always in possession of the true status of affairs, but the stockholder or other interested party can form no judgment whatever as to the actual condition. On the profit and loss statement of the holding company there will be no data as to gross earnings, operating expenses, fixed charges, or miscellaneous income and expense items reflecting the operating conditions of the various subsidiaries. Furthermore, if a subsidiary company has been operating at a loss and has declared no dividend, the absence of that item of earnings from the profit and loss summary of the holding company would not be necessarily a proper reflection of the condition of the subsidiary on the holding company’s summary. It might be necessary, in order properly to show the true condition of affairs, to make provision by way of a reserve for the loss of the subsidiary.
Again, it becomes very easy, if control of the holding company is in the hands of an unscrupulous clique, to understate the profits of the holding company by refusal to declare such a dividend on the part of each subsidiary as will reflect the true earnings of the subsidiary for the current period. Such a policy may be used for the purpose of manipulating the stocks of the various companies.
The Consolidated Profit and Loss Summary
For these reasons and others of the same kind as those mentioned in connection with the balance sheet of the holding company, it is best, in order to give an intelligent showing of condition, to set up a consolidated profit and loss account. The comment made on the consolidated balance sheet is here pertinent also. It is not a profit and loss account of the holding company for it includes also items representing other interests. In some respects it is an unwieldy instrument, but it seems to be the best way in which to show the actual condition of the holding company’s operations. On the consolidated profit and loss summary the earnings from dividends which appear as the chief source of the holding company’s earnings on its profit and loss summary will be eliminated and in their stead will appear the combined earnings of the allied companies. This might seem to be an inflation of earnings inasmuch as the goods which were sold by one company and are recorded by it as earnings will be resold by another company on whose books they will appear also as earnings. The sale of the same goods may thus appear as earnings in many of the subsidiaries. However, such a showing of combined results does provide a true basis on which to judge earnings in comparison with the values invested by the various companies from the use of which values the earnings have been derived. Similarly, on the consolidated profit and loss statement will appear all the operating expenses and other items belonging to the individual profit and loss summaries of the subsidiaries. As it is necessary on the consolidated balance sheet to make some adjustments in the surplus on account of the unrealized elements of profits in the values at which the combined inventories were taken over, so this same adjustment will perhaps be best handled as an appropriation of profits in the last section of the consolidated profit and loss summary.
If the holding company owns all of the stock of the subsidiaries, a true profit and loss summary with no inflated values should be drawn up. In this there will appear only the sales to outside consumers; no intercompany sales should be shown. The cost of goods sold will be determined on the same basis, viz., the basis of cost from the standpoint of the consolidated companies as a unit organization, all intercompany profits being eliminated. All the expenses of the subsidiaries are loaded onto, and therefore absorbed in, the cost of the goods sold by the holding company. Usually only the holding company’s expenses—selling, general administrative, etc.—will appear as such on the consolidated profit and loss summary. Where, however, there are minority interests to be taken into account, the method of combining all the elements is doubtless the most satisfactory.
Illustration of Consolidated Balance Sheet
Problem. Company X, the holding company, owns all of the capital stock of Company Z and 60% of the stock of Company Y. Company X is chiefly the financing company, Company Y is the selling company, while Company Z manufactures the commodities and turns them over to Company Y at a price slightly under the market. The following balance sheets of the several companies show their condition at the close of the fiscal period. Company Z records show that the cost of the merchandise carried on the balance sheet of Company Y at $75,000 is $60,000. It is required to draw up a consolidated balance sheet of the affiliated companies.
| Company X—Balance Sheet | |||
| Cash | $ 50,000.00 | Notes Payable | $ 100,000.00 |
| Notes Receivable Y | 100,000.00 | Bonds | 500,000.00 |
| Advances to Z | 250,000.00 | Capital Stock | 1,000,000.00 |
| Stock Y | 300,000.00 | Surplus | 250,000.00 |
| Stock Z | 550,000.00 | ||
| Patents | 500,000.00 | ||
| Other Property | 100,000.00 | ||
| $1,850,000.00 | $1,850,000.00 | ||