Consolidated financial statements are a vital financial reporting tool that provides a unified overview of a parent company and its subsidiaries’ financial position, performance, and cash flows. This process involves combining the financial records of both parent and subsidiary entities as if they were a single entity. These statements help stakeholders better understand the financial health and operational scope of a company’s entire business group.
What is Consolidated Financial Statement?
A consolidated financial statement reflects the financial information of a parent company and all its subsidiaries as a single entity. This approach eliminates intercompany transactions and balances, showing only third-party transactions and providing an accurate view of a company’s entire financial picture. Consolidated statements are required under accounting standards when one company exercises control over another, often through majority ownership of shares.
Procedures to Prepare Financial Statements
To create consolidated financial statements, a systematic approach is required to ensure all relevant entities and transactions are correctly included. The main procedures are as follows:
Identify Subsidiaries and Determine Control
Determine if the parent company has control over a subsidiary, which is usually the case if it holds more than 50% of the subsidiary’s voting rights. Control can also exist through agreements or other means of exercising influence over decision-making.
Combine Financial Statements
Aggregate the assets, liabilities, income, and expenses of the parent and subsidiary companies. Ensure that all financial periods align, as consolidation requires all statements to cover the same reporting period.
Eliminate Intercompany Transactions
Remove any transactions between the parent and subsidiaries. For instance, if the parent company sells goods to a subsidiary, this sale must be eliminated from revenue and expenses to prevent inflation of actual performance figures.
Adjust for Minority Interest
If the parent company does not fully own a subsidiary, the share of net assets attributable to minority shareholders is reported separately within equity.
Account for Goodwill
Goodwill arises when the purchase price of a subsidiary exceeds the fair value of its net identifiable assets. This goodwill should be included as an asset on the consolidated balance sheet.
Choosing to Use Consolidated Financial Statements
Consolidated financial statements offer both advantages and some limitations, depending on the company’s structure and strategic objectives.
Advantages of Using Consolidated Financial Statements
- Holistic View: Consolidated financial statements ensure a single report for an entire business group, and such a report would support effective decision-making.
- Simplifies Analysis: It is easy for investors and analysts to analyze the performance and health of a corporate group using consolidated financial statements.
- Conforming: Several regulatory authorities require companies having subsidiaries to issue consolidated financial statements to maintain transparency.
Disadvantages of Using Consolidated Financial Statements
- Complexity: Preparation is complex, especially when dealing with international subsidiaries with different currencies and accounting standards.
- Loss of Granularity: Some specific details of subsidiaries’ performance might be lost, making it harder to assess individual subsidiary performance.
Consolidated Financial Statement Reporting Requirements
Reporting requirements for consolidated financial statements are governed by standards such as IFRS (International Financial Reporting Standards) and GAAP (Generally Accepted Accounting Principles). Under these standards, companies must follow strict guidelines for consolidation, including:
- Ownership Thresholds: In most cases, consolidation will be required when a firm has ownership over more than 50% of another company or if it can significantly influence that other entity by means of other arrangements.
- Uniform Accounting Policies: The companies within a consolidated group are expected to follow uniform accounting policies. As such, for instance, when a subsidiary uses a different method of depreciation, it would be obliged to adjust and become similar to that adopted by the parent company in preparation for consolidation purposes.
- Disclosure of Non-Controlling Interest: Companies have to separately disclose the interest that minority shareholders have popularly known as non-controlling interest. This makes things transparent, and interested parties understand who owns it.
- Elimination of Intercompany Transactions: Eliminate intercompany transactions and balances, such as loans or sales among the parent and subsidiaries. This would be overcounting income or expense artificially.
- Goodwill Impairment Testing: Goodwill identified during acquisition should be tested for impairment periodically. This is to ensure that the value reported for goodwill at the balance sheet date reflects its fair value, which will maintain the accuracy of the consolidated balance sheet.
Consolidated financial statements help companies with more subsidiaries and present a holistic picture to investors, regulators, and other stakeholders. Such a statement, although it demands complex procedures and adherence to strict reporting standards, has the advantage of presenting a company with several integrated views of a business’s financial health.
Consolidated Financial Statements FAQs
What is a consolidated financial statement?
It is a financial statement that presents the financial position of a parent company and its subsidiaries as a single entity, consolidating all income, expenses, assets, and liabilities.
Why are consolidated financial statements prepared?
They provide a complete and unified view of a company’s financial health, helping stakeholders understand the financial impact of all subsidiaries under the parent company.
When is consolidation required?
Consolidation is typically required when a company holds more than 50% of another entity’s shares or exercises significant control or influence over its operations.
How is goodwill treated in consolidated statements?
Goodwill is recorded as an asset and arises when the acquisition cost exceeds the fair value of the subsidiary’s net assets. It undergoes periodic impairment tests to ensure fair valuation.
What happens to intercompany transactions in consolidated statements?
Intercompany transactions and balances are eliminated to avoid inflating income or assets artificially within the consolidated financial statements.
