Corporate Accounting

UNIT II

Holding Companies: Definition, Advantages and Disadvantages

Definition of Holding Companies:

A holding company is a company which controls another company known as subsidiary

company by owning its majority of the shares carrying voting rights or controlling the

composition of its board of directors Accounting Standard 21 on Consolidated Financial

Statements gives the following definitions:

A subsidiary is an enterprise that is controlled by another enterprise (known as the parent).

A parent is an enterprise that has one or more subsidiaries.

A group is a parent and all its subsidiaries.

Thus, the Accounting Standard calls the holding company, a parent.

Advantages of Holding Companies:

Holding companies have been used extensively to further the combination movement.

Particularly in the United States of America, the holding company device was found to be useful

in bringing a number of companies under one control, and it is only when the combination

movement gathered momentum that holding companies became popular.

The advantages of holding companies are as under:

1. Subsidiary companies maintain their separate identities and as such they maintain their

goodwill.

2. The public may not be aware of the existence of combination among the various companies

and, therefore, the fruits of monopoly or near monopoly may be enjoyed without resentment in

the minds of the people.

This, however, is clearly a disadvantage from the social point of view, because, if there is a

monopoly, the public ought to know.

3. The persons controlling the holding company need invest a comparatively small amount in

order to control the subsidiary companies. If, for example. A, a holding company, has two

subsidiaries, B and C and if B and C in turn have three subsidiaries each, the persons who have

the majority of shares in A will be able to control eight other companies.

Had these companies been amalgamated, a much larger amount would have been required in

order to control the concerns.

This, again, is a disadvantage from the social point of view, because it may lead to ir-

responsibility.

4. By maintaining the separate identities of various companies, it would be possible to carry

forward losses for income tax purposes.

5. Each subsidiary company has to prepare its own accounts and, therefore, the financial position

and profitability of each undertaking is known.

6. Should it be found desirable that the control of the holding company be given up, it can be

easily arranged; all that is required is that the shares in the subsidiary companies should be

disposed of in the market.

Disadvantages of Holding Companies:

The disadvantages of holding companies are the following:

1. There is a possibility of fraudulent manipulation of accounts, especially if the accounts of

various companies are made up to different dates.

2. Inter-company transactions are often entered at fanciful or unduly low prices in order to suit

those who control the holding companies.

3. There is the danger of the oppression of minority shareholders

4. There may be accounting difficulties in appraising the financial position of companies due to

inter-company transactions carried on at too high or too low prices.

5. The shareholders in the holding company may not be aware of the true financial position of

the subsidiary companies.

6. Similarly, the creditors and outside shareholders in the subsidiary companies may not also be

aware of the true financial position.

7. The subsidiary companies may be forced to appoint persons of the choosing of holding

companies as directors or other officers at unduly high remuneration.

Whatever the advantages and disadvantages, the holding company has come to stay and the law

now wisely tries to regulate its working. The law has defined a holding company and a

subsidiary company. Private companies, subsidiary to a public company, do not enjoy the

privileges given to private companies. Also, the law compels the holding company to give

information about the subsidiary companies.

Meaning of Holding Company

Section 4 of the Companies Act, 1956 defines a holding company. According to this section, one

company can become the holding company of another in any of the following three ways:

1. By holding more than 50% of nominal value of the equity shares of the other company i.e. the

holding company holds the majority of voting power in the subsidiary company.

2. By controlling the composition of the Board of Directors of the other company so that the

holding company is able to appoint or remove the directors of the subsidiary company.

3. By controlling a holding company which controls another subsidiary or subsidiaries. For

example, if B Ltd is a Subsidiary of C Ltd & C Ltd is a subsidiary of A Ltd then B Ltd is also

deemed to be a subsidiary of A Ltd.

Purpose

The purpose of getting the control over another company may be to gain advantages such as:

1. To eliminate of competition.

2. To enjoy the economies of large scale of production.

3. To achieve an assured market for the product of the company.

4. To ensure a smooth supply of raw materials.

Disadvantages or Defects of Holding Company: Following are the main defects of the holding

company:

a) Problem of Monopoly: A holding company tries to create monopoly over the market.

Monopoly is always against the public interest. It fixes higher prices and consumer suffers a loss.

b) Unequal Distribution of Wealth: Due to holding companies wealth goes in few hands and

society is divided into two classes, rich and poor. Rich class enjoys all the amenities of life while

poor class faces poverty and hunger.

c) Costly Management: A holding company spends a lot of money on the officers and offices.

All the units are managed by the central authority. So it is costly to maintain the proper control

on large number subsidiary companies.

d) Minority Interest Ignored: The interest of the minority shareholders is ignored and the

members of the holding company dispose of every resolution for their own interest.

e) Misuse of Funds: The directors of the company enjoys unlimited powers and they take undue

advantages. They misuse the funds also.

f) Over Capitalization: There is always a danger of over capitalization in the holding

companies. It is very harmful for both the companies.

g) False Reports: Generally the directors of the company present false reports about the

company's financial position. The true condition of the company no body knows, and due to this

sometimes creditors suffer a loss.

h) Chances of Fraud: In the preparation of accounts the chances of fraud are bright in company

transaction.

Short notes on holding and subsidiary companies

Where one company controls the management of another company the former is called the

‘Holding Company’ and the latter over which the control is exercised is termed as a ‘Subsidiary

Company’. The Act defines these terms as follows:

Holding company :

“A company shall be deemed to be the holding company of another, if that other is its

subsidiary” [Sec. 4 (4)].

Subsidiary company :

A company shall be deemed to be a subsidiary of another.

(a) if that other company controls the majority composition of its Board of Directors with the

sole object of controlling its management; or

(b) if that other company holds more than half in nominal value of its equity share capital; or

(c) in the case of a private company in respect whereof the preference shareholders and equity

shareholders may enjoy similar voting rights, if that other company is itself an independent

private company and holds more than half of its total voting power; or

(d) if it is a subsidiary of any other company which is that other company’s subsidiary. For

example: If company B is a subsidiary of company A and company C is a subsidiary of company

B, company C will become a subsidiary of company A by virtue of this clause. If company D is a

subsidiary of company C, company D will be a subsidiary of company B and consequently also

of company A; and so on.

The purpose of consolidated financial statements

The purpose of consolidated financial statements is to present, primarily for the benefit of the

owners and creditors of the parent, the results of operations and the financial position of a parent

and all its subsidiaries as if the consolidated group were a single economic entity.