A subsidiary is a company that is in some way controlled by another company, known as a parent company. The term refers to control, usually through share ownership and voting rights, rather than size. A large company can be a subsidiary of a small company. While the definition of the term varies depending on context, from a financial and legal standpoint there are three key thresholds.
Parent Company Owns Up to 20 Percent of Subsidiary
In this situation, the parent company does not prepare accounts relating to the subsidiary. It must list its transactions relating to the subsidiary in its own accounts using the cost method. This means transactions are listed at the time the money changes hands. The key transactions for these purposes are the expense in buying the stock, which brings about an asset increase and the revenue from dividend payments.
Parent Company Owns 20 to 50 Percent of Subsidiary
In this situation, the subsidiary is formally known as an associate company. The parent company must list its transactions relating to the subsidiary under the equity method. This means that dividends are not classed as income but rather withdrawals from the company's investment.
Meanwhile, the parent company must include account entries relating to the profit made by the subsidiary. For example, if the parent company owns 35 percent and the subsidiary makes a profit of $1 million, the parent company must add $350,000 to its listed income.
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Parent Company Owns More Than 50 Percent of Subsidiary
This situation is the strictest definition of the term subsidiary. When this happens, the parent company is required to prepare consolidated financial statements: that is, financial statements that contain the combined totals for both companies, such as combined income, expenses, assets and liabilities.
The two companies can also produce separate documents, but the consolidated financial statements are required under accounting rules.
Wholly Owned Subsidiary
This exists were the parent company owns 100 percent of the voting stock in the subsidiary. The accounting rules are the same as with a parent company that owns between 50 and 99 percent of the voting stock. The main significance of the 100 percent threshold is that if the companies are listed on the NASDAQ, the parent company can apply to have itself and the subsidiary classed as one company for fees purposes.