Corporate group

A corporate group or group of companies is a collection of parent and subsidiary corporations that function as a single economic entity through a common source of control. The concept of a group is frequently used in tax law, accounting and (less frequently) company law to attribute the rights and duties of one member of the group to another or the whole. If the corporations are engaged in entirely different businesses, the group is called a conglomerate. The forming of corporate groups usually involves consolidation via mergers and acquisitions, although the group concept focuses on the instances in which the merged and acquired corporate entities remain in existence rather than the instances in which they are dissolved by the parent. The group may be owned by a holding company which may have no actual operations.

In Germany, where a sophisticated law of the "concern" has been developed, the law of corporate groups is a fundamental aspect of its corporate law. Many other European jurisdictions also have a similar approach, while Commonwealth countries and the United States adhere to a formalistic doctrine that refuses to "pierce the corporate veil": corporations are treated outside tax and accounting as wholly separate legal entities.

Economic motivation

Consolidation within any given industry is a natural process. A mature industry usually has a few players (Boeing and Airbus in the aircraft manufacturing business) whereas nascent industries may have thousands (internet companies). A company may seek to buy other players because of the following reasons:

Copying efficient business models to inefficient players
Access to new technologies
Access to new clients
Access to new geographies
Cheaper financing for a bigger company
Seeking for hidden or nonperforming assets belonging to a target company (e.g. real estate)
Bigger companies tend to have superior bargaining power over their suppliers and clients (e.g. Walmart)

There are three forms of business combinations:

Statutory Merger: a business combination that results in the liquidation of the acquired company’s assets and the survival of the purchasing company.
Statutory Consolidation: a business combination that creates a new company in which none of the previous companies survive.
Stock Acquisition: a business combination in which the purchasing company acquires the majority, more than 50%, of the Common stock of the acquired company and both companies survive.
Variable interest entity

Business group as a group of companies that does business in different markets under common administrative or financial control whose members are linked by relations of interpersonal trust on the basis of similar personal ethnic or commercial background. One method of defining a group is as a cluster of legally distinct firms with a managerial relationship.^[2]^[3] The relationship between the firms in a group may be formal or informal.^[4] A keiretsu is one type of business group. A concern is another.

Encarnation^[5] refers to Indian business houses, emphasizing multiple forms of ties among group members. Powell and Smith-Doerr^[6] state that a business group is a network of firms that regularly collaborate over a long time period. Granovetter^[4] argues that business groups refers to an intermediate level of binding, excluding on the one hand a set of firms bound merely by short-term alliances and on the other a set of firms legally consolidated into a single unit. Williamson^[7] claims that business groups lie between markets and hierarchies; this is further worked out by Douma & Schreuder.^[8] Khanna and Rivkin^[9] suggest that business groups are typically not legal constructs though some regulatory bodies have attempted to codify a definition. In the United Arab Emirates, a business group can also be known as a trade association.^[10] Typical examples are Adidas Group orIcelandair Group.

Consolidated financial statements are the "Financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent (company) and its subsidiaries are presented as those of a single economic entity", according to International Accounting Standard 27 "Consolidated and separate financial statements", and International Financial Reporting Standard 10 "Consolidated financial statements".^[1]^[2]

20% ownership or less — Investment

When a company purchases 20% or less of the outstanding common stock, the purchasing company’s influence over the acquired company is not significant. (APB 18 specifies conditions where ownership is less than 20% but there is significant influence).

The purchasing company uses the cost method to account for this type of investment. Under the cost method, the investment is recorded at cost at the time of purchase. The company does not need any entries to adjust this account balance unless the investment is considered impaired or there are liquidating dividends, both of which reduce the investment account.

Liquidating dividends : Liquidating dividends occur when there is an excess of dividends declared over earnings of the acquired company since the date of acquisition. Regular dividends are recorded as dividend income whenever they are declared.

Impairment loss : An impairment loss occurs when there is a decline in the value of the investment other than temporary.

20% to 50% ownership — Associate company

When the amount of stock purchased is between 20% and 50% of the common stock outstanding, the purchasing company’s influence over the acquired company is often significant. The deciding factor, however, is significant influence. If other factors exist that reduce the influence or if significant influence is gained at an ownership of less than 20%, the equity method may be appropriate (FASB interpretation 35 (FIN 35) underlines the circumstances where the investor is unable to exercise significant influence).

To account for this type of investment, the purchasing company uses the equity method. Under the equity method, the purchaser records its investment at original cost. This balance increases with income and decreases for dividends from the subsidiary that accrue to the purchaser.

Treatment of Purchase Differentials: At the time of purchase, purchase differentials arise from the difference between the cost of the investment and the book value of the underlying assets.

Purchase differentials have two components:

The difference between the fair market value of the underlying assets and their book value.
Goodwill: the difference between the cost of the investment and the fair market value of the underlying assets.

Purchase differentials need to be amortized over their useful life; however, new accounting guidance states that goodwill is not amortized or reduced until it is permanently impaired, or the underlying asset is sold.

More than 50% ownership — Subsidiary

When the amount of stock purchased is more than 50% of the outstanding common stock, the purchasing company has control over the acquired company. Control in this context is defined as ability to direct policies and management. In this type of relationship the controlling company is the parent and the controlled company is the subsidiary. The parent company needs to issue consolidated financial statements at the end of the year to reflect this relationship.

Consolidated financial statements show the parent and the subsidiary as one single entity. During the year, the parent company can use the equity or the cost method to account for its investment in the subsidiary. Each company keeps separate books. However, at the end of the year, a consolidation working paper is prepared to combine the separate balances and to eliminate^[2]^[3] the intercompany transactions, the subsidiary’s stockholder equity and the parent’s investment account. The result is one set of financial statements that reflect the financial results of the consolidated entity. There are three forms of combination: 1. horizontal integration:is the combination of firms in the same business lines and markets. 2. vertical integration: is the combination of firms with operations in different but successive stages of production or distribution or both. 3. Conglomeration: is the combination of firms with unrelated and diverse products or services functions, or both.