This article has been written by Ms. Aarsha Prem, a 5th year LL.B. student from CLS GIBS college.
Associate Company
According to Section 2(6) of the Companies Amendment, 2017, an associate company is a business in which another business has a Substantial Impact but is not a subsidiary of the parent business. This includes joint venture businesses.
According to this, “substantial control” refers to the investment company’s control of at least 20% but not more than 50% of the total voting power or its control over or involvement in business decisions made according to an Agreement.
In the broadest sense, an associate company is one over which the parent business has significant control and has the authority to participate in decisions regarding the firm’s financial and operational policies in order to profit from its operations. The Affiliate company is one of the forms of inter-company investments, which are significant in business activity. A part of the associate company’s earnings (net of taxes) is included in the consolidated income statement, and the associate company is also included in the cash flow statement’s cash from operations section. The worth of an associate company is not factored into the computation of enterprise value, in contrast to minority stake. This is due to the fact that it reflects the claim on assets that have been merged into other businesses rather than assets that are actively involved in the investor company’s primary business operations.
The notion of the associate business is utilised in economics, accounting, taxation, securities, and other areas, therefore the exact definition differs significantly from jurisdiction to jurisdiction and across different industries.
Parent Company
In the broadest sense, an associate company is a business in which the parent company owns stock. As opposed to a subsidiary firm, in which the parent company often owns a majority stake, an associate company typically has a minority ownership by the parent company.
An associate enables organisations to follow rapid expansion strategies and enter into niche markets or business categories that would otherwise be inaccessible. Also, it enhances the parent’s financial performance.
Although not having a controlling position, the parent significantly affects the Associate’s business operations. A minimum of 20% and a maximum of 50% of the total voting rights in the associate must belong to the parent.
The parent’s consolidated balance statement should include the investments in the associate company as long-term investments. In the consolidated statement of profit and loss, the parent’s portion of the gains or losses from such investments should also be separately declared.
The Consolidated Financial Statement (CFS) of the parent will include the financials of the Associate Company, whether it is an Indian or foreign company. The percentage of ownership interest and, if different, the percentage of voting power held by the parent organization should also be disclosed.
Benefits of an Associate Company
The landscape of international business is always changing. To progress technology, businesses must diversify their asset base and expand into new markets and regions. posses sufficient liquidity to gain a competitive edge and extend the term of expansion.
This forces businesses to make inter-corporate investments (i.e., investments in other businesses), such as buying their shares, taking on their debt, or acquiring a company solely for technological growth.
Companies may occasionally desire partial ownership and may choose to hold a modest investment in the investee company while exercising significant influence, but not control, over its operations.
Investing in an associate company serves as a straightforward access point for businesses looking to expand into different markets and make foreign direct investments that might not otherwise be feasible.
It is occasionally possible for a corporation to buy a majority ownership in another business, particularly a rival. A wise investment decision is made by an Associate in this circumstance. The investing business also has the option to eventually raise its shareholding to a controlling percentage. The enterprises may gain jointly from increased production capacity, scientific and technical advancement, financial support, and other factors. As a result, an associate company helps its parent company be profitable while also adding value to that company.
Investor’s Concern
Over time, a firm’s multi-layered corporate structures, one of which is an Associate company, have become one of the main financial worries.
By creating intricate arrangements with the help of a partner company, money laundering or fund diversion has happened in some cases. This is primarily accomplished through parent company loans and investments in the affiliated business.
Some businesses make investments in overseas partners, particularly in nations like Singapore, Mauritius, and Panama. Most of the time, such foreign associates are questionable or lack independence. The parent can use the overseas associates to channel money while receiving tax benefits by lending to them and then writing off those loans as non-recoverable. Occasionally the parent may not give an accurate and fair representation of the associate company’s financials, misrepresenting the financial status of its group in the process.
All stakeholders, especially retail investors, are affected, as is.
Instances that illustrate how a lack of checks and balances in corporate governance causes some businesses to abuse the idea of Associates to drain or redirect money are provided.
1) Bhushan Steel– Of the overall fraud amount, the corporation advanced capital to its associate companies in the amount of around Rs 1770 crore. The parent then “adjusted” the receivables from 32 partner firms by moving money from the head Capital Advance to the head Capital Work In Progress in their books of accounts. Yet, these businesses didn’t report any expenses, income, or work completion in their financial statements from 2009–10 to 2014–15. Furthermore, the commercial activities were unknown to the corporate directors who had signed the balance sheets of the firms.
2)DHFL- The promoters of the housing finance organisation and its associate businesses have embezzled Rs 97,000 crore using bank loans. From 2009–10 to 2010–11, the parent made a capital advance payment to the Associate. Yet, over the aforementioned time period, these entities failed to indicate any expenses, revenues, or work completion in their financial statements with the affiliate.
Preventive Measures for investors
Investors should review and examine the related party transactions that the company occasionally publishes in order to prevent investing in such fraudulent companies. The operational financial transaction between the parent and the associate is stated here clearly.
Examine the parent’s exposure to its associate’s net worth. This covers exposure to equity and preferred stock, corporate guarantees for bank facilities, and loans and advances issued to such organisations.
The definition of Associate Company in the Companies Act, 2013 was introduced with the goal of addressing the flaws and offering a more logical and objective framework of associate relationships. The Accounting Standards pertaining to it as well as the numerous regulations must be followed by the Associate Company. In order to comply with accounting standards, a firm that has an associate company must prepare consolidated financial statements and adhere to accounting standards. Anyone looking for joint ventures in the Companies Act must look to Section 2(6) dealing to Associate Companies because the term is included in the definition. As a result, one must carefully examine Associate Company while taking into account all applicable enabling legislation, acts, and regulations.
Conclusion
The idea of an “Associate Company” has gained more significance and relevance in recent years in order to ensure that the companies’ promoters and/or directors run them honestly and do not roll over and use the funds acquired by one firm in its associate Companies. The statutory authorities are given a clear picture of the transactions carried out by a Company and are able to spot any financial misappropriation thanks to the consolidation of financial statements of a Company along with its Associate and Subsidiary Company. However, there is always a scope of fraud as has become common in the world of Corporate and investors must protect themselves by applying due diligence and companies must abide by the regulations laid down under the Companies Act to avoid heavy sanctions.
References
Definition of Associate Company~ https://www.elearnmarkets.com/blog/know-about-associate-company/
Investment~ https://companykayda.com/associate-company/
Parent company~ https://www.investopedia.com/terms/a/associate-company.asp
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