Associate Company: Meaning, Legal Provisions, Characteristics, Pros & Cons

As more and more companies intertwine in the modern-day interdependent corporate world, corporations combine through various forms of alliances to maximize resources, hedge risks, and achieve an increased market presence. In this regard, one type of alliance is particularly noteworthy: "associate companies" allow one party to exercise control over another without complete control. Associate companies are among the most significant types of alliance that have gained great recognition in the global economy with the increasing interdependency between businesses. Legally and financially recognized, associate companies help expand business influence in markets and sectors while operating independently. Understanding what an associate company is, the legal structure governing such companies, and the importance of such structures and alliances can provide significant insight into corporate structures and alliances.

The article discusses a detailed overview of associate companies, including meaning, the legal provisions as contemplated under the Companies Act, major characteristics, and distinctions compared to subsidiary companies. More than that, it helps in answering some frequently asked questions, which most often aim at demystifying the concept of associate companies among corporate stakeholders and readers.

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What is an Associate Company?

Associate companies are where the investing company has the capability to make decisions concerning and influence such a firm to a sizeable extent, although in full control. On average, the percentage of voting shares acquired by an investing company falls in the 20%–50% range within associate companies. A shareholding percentage so earned would position the investing company to decide on such crucial management directions, policies, and strategic outlooks; this is never to have control over a firm completely.

The term "associate company" is very significant in accounting and reporting standards because it impacts the way investments are recognized, consolidated, and disclosed in financial statements. The share of the investing company in the associate's profits or losses is reported in its income statement under equity accounting principles.

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Definition of an Associate Company

The Companies Act, 2013 defines an associate company as a business enterprise in which another company has significant influence but not control over the affairs of such an enterprise. In other words, the act refers to a company in which another company has "significant influence," usually for holding a substantial share or through deciding board decisions without its absolute control.

Main points that are used for identifying an associate company:

  • High Impact: Normally, an associate is treated as a company if the investor has a shareholding between 20% and 50% of its voting power.

  • Equity Method of Accounting: The profit or loss of the associate appears in the books of accounts of the investing company on a proportionate shareholding basis.

  • Independent Operations: As opposed to subsidiaries, an associate company maintains independence in operations matters, though the investor exercises influence on them.

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Legal Provisions of an Associate Company (Companies Act, 2013)

Section 2(6) of the Companies Act, 2013 defines associate companies, provides regulations over them, and specifically prescribes guidelines on the reporting by companies and the management of the financial relationships between them.

  • Section 2(6) of the Companies Act, 2013 defines an associate company as any other company in which it has either a minimum percentage of total share capital at least to the extent of 20% or which exercises influence, but its shareholding does not form a majority shareholding, nor does the control lie in its management.

  • Significant Influence: There is a control of at least 20% of the total shareholding or of business decisions under an agreement, but not enough to control its management or policy-making entirely.

  • Equity Accounting: The equity method under the Indian Accounting Standards (Ind AS 28) must be used by the investing company in recording profits or losses attributed to its share in the associate company.

  • Section 129 of the Companies Act provides that an Act is mandatory to be framed for consolidated financial statements where any company has any interest in an associate company, where the investing company shall declare the shareholding proportion and financial interests.

These provisions ensure transparency over associate companies and encourage fair practices and the protection of the interests of minority shareholders.

Characteristics of an Associate Company

Several characteristics distinguish an associate company from other business structures, notably subsidiary forms:

  • Influence Rather Than Control: The investing company has a significant influence over the associate's operating and financing decisions but does not have control over its day-to-day operations or control in governance matters.

  • Ownership Percentage: The regular ownership percentage ranges between 20% and 50% of the voting shares; that is to say, sufficient influence is provided without the control to dictate the fate.

  • Legal Entity: As the associate wields its influence, this is an independent legal entity and not a subsidiary as such.

  • Management: Despite its affiliation with the parent company of the investing firm through strategic actions, the associate retains the self-management aspect.

  • Long-Term Investment: Firms invest in associates to realize long-term synergies from the investment. Common long-term synergies come through technology, market access, or complementary services.

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Why Are Associate Companies Established?

Companies establish associate companies for several strategic purposes, such as:

  • Market Entry: Collaboration with local businesses minimizes the risks involved when venturing into a new market.

  • Access to Technology and Resources: The sharing of newness, expertise, and other resources with the associate companies helps enhance the firms' capabilities.

  • Synergistic Gains: Associates generally associate themselves with core businesses to have synergies, which benefit them both.

  • Risk Diversification: The parent firm bears shares of the financial and operative risks of its associate firms but not the entire control.

  • Increased Income: Sharing profits through investment by associate firms increases the income of the parent firm.

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Accounting for Associate Companies: The Equity Method

The Equity Method is used to account for the financial implications of associate companies within the parents' financial statements. Here is a summary:

  • Equity Accounting: The parent would recognize its portion of the associate's net income instead of full consolidation.

  • Balance Sheet: Investment will be shown as a non-current asset with the effect of dividends received by the parent.

  • Income Statement: Profits or losses of the associate would appear in the income statement as an independent line item for transparency.

This accounting treatment prohibits inflation of assets and revenues with clear evidence of financial influence.

Regulatory and Disclosure Requirements

According to the Companies Act and accounting standards, there are disclosures regarding the associate companies, and that companies have to make

  • Disclosure in Financial Statements: These include disclosing investments in associates, share of profit or loss, and other related changes in ownership.

  • Board Report: There should be an association or description of associate company relations that reflects transparent governance practice.

  • Shareholding Disclosure: A change in shareholding will reflect any influence, wherein even if the influence reduces percentage-wise, changes shall disclose and inform shareholders.

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Advantages and Disadvantages of Associate Companies

These include market expansion and shared resources. However, there are disadvantages like lack of control and dependency on finances. The knowledge of the advantages and disadvantages makes one make the right investment decision.

Advantages of Associate Companies

  • Increases its influence in markets: Extend its influence.

  • Combination of resources: Synergy to share with regard to technology and experience.

  • Less Financial Risk: The group can create market access without full risk exposure.

  • Financial Performance Improved: Increased profits can be distributed using the same level of corporate freedom.

Disadvantages of Associate Companies

  • Less Control: The controlling company cannot fully have total control over an associate firm. Strategic decisions made for the parent might contradict those of the subsidiary firm.

  • Financial Dependence: Failure by the subsidiary will drag down the profitability of the parent company.

  • Complex Report: Regulatory requirements and filing obligations will burden administrative services.

Conclusion

These will, therefore, be termed associate companies. Associate companies are highly significant structures that have become a vital piece in the business ecosystem through strategic investment and influence, taking into consideration the autonomy enjoyed between them. These are bound by legal and financial rules. These improve growth capabilities and also allow collaborative synergies among industries. Now it is clear that knowledge regarding the associate companies will enable enterprises to exploit partnerships for more enlargement, innovation, and handling risks.

Associate Company FAQs

1. What is an associate company?

An associate company is a company with which another company has significant influence over voting power, normally above 20% and up to 50% without having control.

2. How is an associate company different from a subsidiary?

Whereas in a subsidiary, the parent has control due to its more than 50 percent ownership, in the case of an associate company, influence is significant but still short of control.

3. Accounting for associate companies in financial statements?

Associate companies are accounted for through the equity method, and the parent just reports its share of profit or loss without full consolidation.

4. What is the legal provision for associate companies in India?

As per Section 2(6) of the Companies Act, 2013, associate companies in India are defined with the significant influence criteria.

5. Why do companies form associate companies?

The purpose of forming associate companies is to expand market penetration, pool resources, disperse risk, and facilitate long-term growth through association.

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