Indirect control in consolidated financial statements: how vertical ownership affects full consolidation

Indirect control requires full consolidation even in the absence of direct shareholding.

When a parent company owns a subsidiary that itself owns another entity, the parent may exert control over the second-tier entity without holding its shares directly. This configuration is known as indirect control, and under both IFRS and US GAAP, it has the same accounting consequences as direct control: the indirectly held entity must be included in the consolidated financial statements.

This applies especially in vertical group structures, where control flows through successive layers of ownership. The legal form of the shareholding does not override the substance of the control relationship.

A chain of ownership creates effective control through intermediate subsidiaries.

Even without direct equity, full control is present if each link in the chain is controlled.

Consider the following case:

• ParentCo owns 100% of SubCo1

• SubCo1 owns 80% of SubCo2

Although ParentCo holds no direct interest in SubCo2, it controls SubCo1, which controls SubCo2. As a result, ParentCo is deemed to control SubCo2 indirectly. Both IFRS 10 and ASC 810 require that SubCo2 be fully consolidated in ParentCo’s financial statements.

Control is assessed based on three key elements:

• Power over the investee

• Exposure or rights to variable returns

• The ability to affect those returns through power

These elements may be satisfied without direct ownership, as long as control is exerted through the consolidated chain.

Example: how indirect control affects consolidation entries.

Parent must consolidate the indirect subsidiary and calculate non-controlling interest.

Assume the following group structure:

• ParentCo owns 100% of SubCo1

• SubCo1 owns 90% of SubCo2

At the group level, ParentCo must consolidate SubCo2 even though it does not appear in ParentCo’s books. The 10% held by external shareholders in SubCo2 must be recorded as non-controlling interest (NCI).

Consolidation entries at acquisition date:

• Dr. Common stock (SubCo2)

• Dr. Retained earnings (SubCo2)

• Dr. Any fair value adjustments

• Cr. Investment in SubCo2 (on SubCo1’s books)

• Cr. Non-controlling interest

These entries eliminate the intra-group investment and recognize SubCo2’s assets and liabilities at fair value.

Non-controlling interest reflects both direct and indirect ownership gaps.

The consolidated group must report residual interests not owned by the parent.

When ParentCo consolidates SubCo2, the NCI must reflect both:

• The share held by outsiders in SubCo2

• The portion of SubCo2 indirectly held by minority shareholders of SubCo1

If ParentCo owns 80% of SubCo1, and SubCo1 owns 90% of SubCo2, then:

• ParentCo's effective interest in SubCo2 = 80% × 90% = 72%

• NCI in SubCo2 = 28%, made up of:▸ 10% directly in SubCo2▸ 18% indirectly via 20% NCI in SubCo1

This NCI must be shown in equity and adjusted each reporting period for the share of net income and dividends attributable to minority holders.

IFRS and US GAAP both require indirect subsidiaries to be included in consolidation.

The control principle takes precedence over the legal form of ownership.

Under IFRS 10, the definition of control is principle-based and does not require any specific ownership threshold. What matters is whether the parent can direct the relevant activities and benefit from returns. The same applies to ASC 810 under US GAAP, especially in non-equity scenarios like variable interest entities (VIEs), where control may arise from contractual rights rather than voting shares.

As long as the parent can demonstrate effective power over the entire group structure, all entities—direct or indirect—must be included in the consolidation perimeter.

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