The possessor company in this case is known as a holding company and the company controlled as a subsidiary company.

The statement that the investment of a holding company in the securities of a subsidiary company is almost of the nature of a fixed asset may perhaps be challenged. As a practical matter, however, the very fact of such a concentration of the control of a company gives rise to this condition. The business, or part of the business, for which the holding company exists is to own and control the subsidiary company and operate through it. Further, the sale of such controlling interest must almost necessarily be made en bloc, for the reason that to retain a large holding without retaining control might be disastrous, while to attempt to sell so large a holding through the regular market channels at one time would demoralize the market-if, indeed, any free market existed in securities which had once been so concentrated.

It is not intended in this paper to offer any defence of the holding company, further than to say that in these times the seeming need of a defence for a practice does not necessarily imply more than that the practice is open to abuse in the same manner as, for example, political power or any other human activity.

With regard to the manner in which the accounts of holding companies should be stated, however, there is room for so much difference of opinion that discussion of the subject among accountants may with advantage be had with the object of establishing general principles which, while they may not be invariably enforceable, may at least serve as a standard to which accountants should endeavor to hold their clients.

Among the questions to be settled, the most important appear to be:

I. Is it good practice to present the accounts of a holding company independently, without incorporating in them. in any way the accounts of the subsidiary company or companies?

2. Is it legally defensible, and if so is it good accountancy practice, to introduce into the accounts of a holding company any so-called equity in the earnings of subsidiary companies?

3. Is it necessary to present individual accounts of each subsidiary?

4. Is it good practice to consolidate the accounts of holding companies and subsidiaries?

5. If the accounts are consolidated what amount of detail is necessary or advisable with regard to:

(a) The consolidated property account, particularly with reference to the difference which may exist between the cost and the par value of securities of subsidiaries owned?

(b) Inter-company accounts?

(c) The composition of the surplus account, with particular reference to surplus of subsidiary companies at the date of acquisition by the holding company, and to rights of minority stockholders in the surplus of subsidiary companies? These points accordingly will be discussed in more or less detail. The question of inter-company trading, which introduces difficulties with regard to capital expenditure and the valuation of inventories, will also be considered briefly in the latter part of this paper.

1. ACCOUNTS OF HOLDING COMPANY, qua se.

It must be admitted that from the technical point of view no objection can be raised to the publication of accounts dealing solely with the affairs of a holding company, without the incorporation in such accounts of any details of the operations or of the financial position of the subsidiaries. Such a treatment of the accounts is based upon the legal status of the holding company as a separate and distinct corporation. It fails, however, to recognize the practical nature of the relationship existing between the holding company and the subsidiaries.

Under this method, the securities of the subsidiaries are carried as investments; advances to the subsidiaries are shown as accounts receivable; dividends received and interest received or accrued from the subsidiaries are treated as income; and, in short, the accounts presented are those of the holding company as a distinct entity, as shown by the books of that company.

This treatment of the accounts is undoubtedly justified on legal and technical grounds. It is, however, a method which

is open to criticism from the viewpoint of the investor and lends itself to abuse at the hands of an unscrupulous management. If the matter be analyzed, however, it will be apparent that the only form of abuse or manipulation as to which the accountant's hands would be to some extent tied in dealing with accounts prepared in this manner lies in the possibility of the equalization of earnings of the holding company by the building up in good years of an undisclosed surplus in the subsidiary company, to be drawn upon in lean years. This is a practice in which the line between conservatism and manipulation may be so difficult to draw that it presents a real difficulty, in which unfortunately the accountant is not supported either by law or by custom.

It will, however, be shown that other forms of manipulation are not only capable of being checked by the accountant, but call imperatively for action, in which he will undoubtedly be sustained by the principles of law.

Let the case of a holding company with a subsidiary which is operating at a loss be considered. Is it not apparent that the asset or assets representing this investment require to be investigated as to value for balance sheet purposes in the same manner as other assets? To assume that the information upon which to base such a valuation is a sealed book and not to be rendered available to the accountant in preparing the balance sheet of the holding company is not logical, nor would such an assumption avail as a defence were the accuracy of the accounts called into question.

It is admitted that accounts of holding companies are frequently published which entirely ignore the status of subsidiaries. Two of the cases falling within the experience of the writer may be quoted. In one instance a railroad company owning the entire capital stock of a company operating a line of steamers on the Great Lakes, and obliged to make heavy advances to the subsidiary in order to make good the depletion of assets caused by operating losses incurred by that company, continued for several years to carry both investment and advances in its balance sheet at face value.

In another instance, a large mining and smelting corporation, which controlled a majority of the stock of a mining corporation which was steadily losing money, failed to bring into

consideration in stating its own profit and loss account any proportion of the loss of the subsidiary company.

In the first case cited, the books of the companies were kept in different offices, but the lake transportation company was necessarily entirely under the control of the railroad company, and its losses resulted in a large measure from the proportion in which inter-company freight earnings were divided. The accounts in this case were not regularly audited. In the second case mentioned, the accounts of the two companies were kept in the same office, and were certified by the same auditors. The losses of the subsidiary company were incurred in the mining of ore sold to the holding company. The accounts were not closed upon the same date nor were they published simultaneously, however.

It surely will not be contended that in either of these cases the fact of the failure to consolidate the accounts of the subsidiary company with those of the holding company was the only cause for the falsity of the accounts of the holding company which were issued to the stockholders and the public. To the extent to which the subsidiary company's assets had been depleted by losses in operation, the investment of the holding company in the securities of the subsidiary company had been depreciated, and this fact should have been reflected in the accounts of the holding company.

A question might arise as to whether this depreciation of the investment should necessarily be applied against the value of the investment as such or as a reserve against the advances, if any, by the holding company to the subsidiary company. This consideration, however, is closely related to a further point, which will now be discussed.

In the case of many subsidiary companies, particularly those in which the entire stock is owned by the holding company, the company frequently is incorporated for a comparatively nominal amount, leaving the additional capital actually required for the enterprise to be furnished in the form of loans by the holding company. It is, as a general rule, not intended that the subsidiary company shall seek credit to any material extent, and consequently the ratio of current assets to current liabilities is not a matter of importance. On the other hand, any borrowing which is done by the holding company is possibly facilitated by the fact that ownership of the subsidiary company is shown

rather in the form of loans, which are treated as current assets, than in the form of investments, which are perhaps somewhat more critically regarded by lenders.

The question accordingly arises: Does the balance sheet of a holding company, as such, present a true statement of the position of the company if advances to subsidiaries are carried as current assets, regardless of the assets by which such advances are represented in the accounts of the latter companies? It would appear that, in the absence of any statement published simultaneously with the accounts of the holding company, which would in effect enable a lender or an investor to determine the actual position for himself, it is the duty of the accountant in preparing the balance sheet of a holding company to divide the item of advances to subsidiaries in such a way as to indicate the extent to which such advances could be liquidated out of the current assets of the subsidiaries and the extent to which such advances must necessarily be regarded as fixed capital of the subsidiaries.

To state this in actual figures, let it be assumed that a holding company has advanced to a subsidiary company as a loan the sum of $500,000. The accounts of the subsidiary company show that it has current assets of $750,000 and current liabilities, including the advance by the holding company, of $1,000,ooo. In this case it would appear that the advance by the holding company should be shown in the balance sheet of that company in two amounts of $250,000 each, the one described as an advance to the subsidiary company represented by fixed assets and the other as an advance to the subsidiary company represented by current assets.

If, therefore, the accounts of the subsidiary company show a deficit and the depletion of current assets resulting therefrom necessitates advances by the holding company, the same test will serve to determine whether the depreciation of the investment is to be deducted from the investment account or from the advance account. If there is still a surplus of current assets in the subsidiary company's balance sheet, the advance can be stated to be represented by current assets, and the depreciation resulting from the losses of the subsidiary company will be applied against the investment account. If there is no surplus of current assets, but the capital of the subsidiary company is not