Sometimes referred to simply as an associate, an associate company is a business that has a significant amount of interest in another company, but not enough to actually have control of that company. In general, a business may be considered an associated from an accounting standpoint if the amount of interest exceeds 20% but is less than 50%. Should the amount of interest held by the associate company exceed 50% at some point, the partner is no longer considered an associated, but the controlling party.
Defining the associate company is very important from an accounting standpoint. Since an associate is not considered to be a fully consolidated business entity, this means that profits and losses are recorded in the business records separately, rather than included with the profit and loss detail of the main company. Therefore, on the group balance sheet that is created when companies are working together on a joint venture, the detail for each entity is presented as separate line items, even as the total detail found on the balance sheet may be treated as a single investment.
While the concept of an associate company is found throughout the world, local traditions and trade regulations impact how the accounting process documents this type of business relationship. Often, the equity method is often used to track the activity related to the investment. This means that the entries into the financial records treat the dividends as returns on capital. As a result, the dividends do not have to be recognized as equity income on the income statement of the investor.
The identification of legal standing as an associate company is also important during the course of mergers and acquisitions. This is because understanding the amount of interest held by each associate is extremely important to those who are seeking to acquire a given business, either as a new investment or with plans to merge that business with companies already owned by the prospective buyers. The interest of each associate must be considered in turn, and details worked out that protect the interests and thus secure the loyalty of those associates.
In practical terms of operation, recognizing the greater interest held by an associate company is very important to the business that issued the shares. Typically, cultivating strong ties with investors who hold more than a 20% interest makes it easier to obtain permission and approval when there is a need to settle matters of profound importance to the future of the business. This is especially true in the face of a hostile takeover attempt, since the interest held by major investors can often determine whether or not that takeover bid is ultimately successful.