assets at the date of acquisition might be represented by a balance on profit and loss account or by reserve funds or surpluses on other accounts, and it would be within the power of each of the subsidiary companies to declare dividends out of such surpluses. These dividends in the hands of the holding company are not earnings and should be credited in reduction of the cost of the shares acquired. In short, as far as earnings of subsidiary undertakings are concerned, the holding company can only make profits and declare dividends out of those arising subsequent to the date of purchase. There is an illustration of this in the example in Appendix I in the case of Subsidiary B., where it will be seen from the balance sheet of that company that a dividend was paid out of the profits earned before the date of purchase of the shares by the holding company, and, consequently, in the hands of the latter this dividend is a reduction of the cost and has been so treated.

It is of the utmost importance when examining a balance sheet of a holding company at any date that this point should be investigated. It should be seen that the total surpluses of all subsidiary undertakings, no matter on what account, in existence at the time of their purchase (after making due allowance for dividends since paid and credited in reduction of cost of shares as mentioned above) are still available to an amount not less than that total. If this is not so, it will be due to subsequent losses and reference should be made thereto on the balance sheet or in the statement regarding subsidiary companies attached thereto and/or in the auditor's report if the circumstances of the case so require.

In investigating the position, if, for example, an old reserve of one subsidiary company has been used and treated as income by the holding company, no exception would necessarily be taken to this provided it is offset by profits made subsequent to the date of purchase and not distributed in the case of other subsidiaries. That is to say the subsidiary undertakings should be regarded as a whole and not treated separately, subject,

however, to the comments made later under the heading of "Balance Sheets of Subsidiaries show Losses since Acquisition."

Where negotiations for the purchase have extended over several months, and it is finally arranged to date the purchase back and base it upon the balance sheet at the close of the last financial year on the understanding that the earnings for the current period are to belong to the purchaser, difficulties occasionally arise in ascertaining the surplus of subsidiaries which from the standpoint of the parent company are to be regarded as capital. Profits (or losses) will have accrued meanwhile, and it is then a question of fact how far, if at all, these profits have entered into the price finally agreed upon. It would not seem unreasonable to treat the earnings for the current year as income of the purchaser unless they have been included in the purchase price and consequently paid for by him. Cases are not unknown where the articles of association of companies formed to acquire shares in other companies in such circumstances contain clauses providing for the payment of dividends out of profits earned prior to incorporation.

Where interest is paid upon the amount of the consideration, as, for example, from the date of the prior balance sheet, it must, of course, be charged against the profits of the current year belonging to the purchaser.

Sometimes difficulties also arise where the different subsidiaries prepare their balance sheets on different bases (e.g. in regard to stock valuations, income-tax provisions, etc.) or where the basis of the balance sheet valuations has been altered since the acquisitions. Here again each case requires investigation before the directors of the holding company can determine whether the combined surpluses of the subsidiaries remain intact.

Shareholdings in Balance Sheet shown "At Cost "

How often one finds in a balance sheet the item investments or shares in subsidiary companies, or holdings in and advances

to subsidiary companies "at cost." The question naturally arises can exception be taken to the item being stated" at cost"? The answer to this can only be given after the facts of each case have been investigated and considered.

It is seldom that there are market quotations for the shares. Even if such quotations exist they are usually nominal, and it would hardly be fair to value the shares at these prices for the reason that no such value would probably be obtained for so large a block at any one time. Indeed, it is unlikely that they would be put on the market for sale. Recognition must be given to the fact that there are exceptions to this, and occasionally one finds that no difficulty would be experienced in disposing of a large block of shares privately to an interested party or undertaking at the nominal quotation or at almost any price within reason which might be asked. As a rule, however, market quotations are no guide as to the value of the shares.

Another point which might be considered of importance is the amount of the dividends received from subsidiary companies. These dividends might be regarded as showing a sufficient yield on the total holdings to justify the "at cost" in the balance sheet. This is not necessarily a justification, however, as naturally the dividends received would only be from those undertakings which are in a flourishing condition, while considerable losses may have been incurred by other concerns and may not have been provided for by the holding company.

A fairer way is to regard the subsidiary undertakings as if they were branches of the holding company, and from this point of view no exception would in normal circumstances be taken to "at cost," provided it could be shown that the position of the subsidiary concerns, taken as a whole, has not changed for the worse since they were acquired. For example, that losses have not been incurred other than those for which provision has been made by the holding company-that the total surpluses in existence when the shares were acquired are

still available, and, generally, that so far as it is possible to say, the properties and other assets of the subsidiary undertakings have not deteriorated in value. In this connection earning capacity is generally the real test, that is to say the extent to which the aggregate earnings of the subsidiaries (after deducting losses) represent a fair return on the total cost figures which appear in the balance sheet. The absence of such a fair return may indicate that the shares have been purchased at an excessive price having regard to subsequent experience. There are many other reasons which in the light of later information may make it obvious that "at cost" is an excessive figure for the balance sheet.

Examination of Balance Sheets of Subsidiaries

To determine whether the " at cost " basis is suitable in any particular case naturally involves an inquiry into the balance sheets of the subsidiary companies in order to obtain the necessary information. This is sometimes rendered difficult by the fact that the directors and auditors of the holding company do not necessarily act respectively as directors and auditors of the subsidiary undertakings, or that the subsidiary concerns have not adopted a uniform basis of accounting. In such cases the directors and auditors of the holding company may have before them only the certified accounts of the subsidiaries, supplemented by such other information as they are able to obtain from inquiries.

In this connection the following points should be borne in mind and investigation should be made to ascertain whether there are any errors of principle in the subsidiary companies' balance sheets looked at from the standpoint of the parent company or the consolidation as a whole, whether the subsidiary companies have prepared their stock valuations, etc., on comparable bases, whether dividends have been paid by a subsidiary company without making adequate provision for reserves or for depreciation of plant, etc., having regard to the price paid

by the holding company for the shares, whether there are any contingent liabilities of the holding company for guarantees, such as of a note issue or bills of a subsidiary undertaking, and so on.

The necessity for making depreciation provisions on a basis which takes into account the price paid by the holding company for shares in subsidiaries is important. The fixed assets of a subsidiary are sometimes found to be carried in its balance sheet at values less than those at which they were assessed in fixing the price paid by the holding company for the subsidiary company's shares, i.e. the cost of the fixed assets to the combine. From the standpoint of the combined business this cost should be taken into account in fixing the depreciation charged in computing the profits of the holding company available for dividend.

After the purchase of the shares by the holding company, the subsidiary concern may have made no adjustment in its balance sheet values to bring them into accord with the revaluations, and in arriving at the profits available for dividend to the holding company the subsidiary may have properly continued to charge provisions for depreciation calculated on the old book values.

From the standpoint of the combine as a whole these pro-. visions might in some cases be insufficient. In such cases some portion of the dividends received from the subsidiary companies might be set aside in the holding company's accounts as a reserve for additional depreciation on the capital assets of those concerns.

The directors of the holding company in considering the amount which should be carried to a reserve of this character would be entitled to view the combine as a whole and to set off any excessive depreciation provisions made by other subsidiary companies.

The liability of the holding company under guarantees also requires special consideration.

It is not unusual to find that the dividend on the preference shares of one or more of the operating companies has been