Demystifying consolidation of financial statements
Consolidation of financial statements involves merging the financial data of a parent company and its subsidiaries to create a unified set of financial statements. It provides a comprehensive picture of the financial performance and standing of the entire group of companies rather than just the parent company.
Consolidation of financial statements: When and Why
Consolidation of financial statements is typically done at the end of each reporting period, which is usually a fiscal year or a quarter. However, the specific timing for the consolidation process may vary depending on the accounting standards and regulations in the relevant jurisdiction.
Consolidation of financial statements is done for several reasons, such as:
- To provide a comprehensive view of the group's financial performance
- To eliminate intercompany transactions and balances
- To facilitate decision-making
- To provide information to stakeholders
- To comply with accounting standards and regulations
Requirements for consolidation of financial statements
The requirements for consolidating financial statements may vary by country and accounting standards. However, some common requirements include the following:
Control: The parent company must have control over the subsidiaries.
A significant influence: If the parent company does not have control over the subsidiary but has substantial influence over its financial and operating policies, the subsidiary must be included in the consolidated financial statements.
Common reporting period: The financial statements of the parent company and its subsidiaries must be prepared using a common reporting period.
Consistent accounting policies: The accounting policies employed by both the parent company & its subsidiaries must be consistent. Eliminating intercompany transactions and balances: Any intercompany transactions and balances must be eliminated in the consolidation process to avoid double-counting.
Minority interests: The portion of the subsidiaries not owned by the parent company must be adjusted for minority interests.
Disclosures: The consolidated financial statements must disclose information such as the basis for consolidation, the percentage of ownership in each subsidiary, and any changes in the ownership structure during the reporting period.
Compliance with accounting standards: The consolidated financial statements must comply with accounting standards and regulations (e.g., IFRS and GAAP) in the jurisdiction they are prepared.
Steps for consolidation of financial statements
The following are the steps involved in the consolidation of financial statements :
Step-1: Determine which subsidiaries must be included in the consolidated financial statements. It includes all companies over which the parent company has control or significant influence.
Step-2: Collect the financial statements of the parent company and its subsidiaries, including balance sheets, income statements, and cash flow statements.
Step-3: Eliminate any intercompany transactions and balances, such as intercompany loans, sales, and purchases. This is necessary to avoid double-counting assets and liabilities and to present an accurate and fair view of the consolidated financial statements.
Step-4: If the parent company does not own 100% of the subsidiaries, the portion of the subsidiaries not owned by the parent company must be adjusted for minority interests.
Step-5: The consolidated financial statements can be prepared once all adjustments have been made. These typically include a consolidated balance sheet, income statement, and cash flow statement.
Step-6: Provide additional information in the notes to the financial statements, such as the basis for consolidation, the percentage of ownership in each subsidiary, and any changes in the ownership structure during the reporting period.
Step-7: Review and audit the consolidated financial statements to ensure that they comply with accounting standards and regulations and provide an accurate and fair picture of the financial performance and position of the group.
Exemption from the consolidation of financial statements
Exemptions from the consolidation of financial statements may vary by jurisdiction and accounting standards. However, some common exemptions include the following:
- In some jurisdictions, a parent company that is not a public company may be exempt from preparing consolidated financial statements.
- If the subsidiaries are immaterial to the group, they may be exempt from inclusion in the consolidated financial statements.
- If the control over a subsidiary is temporary and is expected to last for a short period, the subsidiary may be exempt from consolidation.
- In some jurisdictions, foreign subsidiaries may be exempt from consolidation if the cost of preparing the consolidated financial statements outweighs the benefits.
- If the parent company has already prepared consolidated financial statements for another jurisdiction, it may be exempt from preparing additional consolidated financial statements.
Example of Consolidation of financial statements
Here is an example of how the consolidation of financial statements might work:
Suppose Company A owns 100% of Company B, which in turn owns 80% of Company C. Company A would need to consolidate the financial statements of all three companies to present a complete picture of the financial performance and position of the group.
To begin the consolidation process -
- Eliminate intercompany transactions: Company A would need to eliminate intercompany transactions between the companies. For example, if Company A sold goods to Company B, that transaction would need to be eliminated from the financial statements since it was an internal transaction.
- Adjust for differences: Next, Company A would need to adjust for any differences in accounting policies between the companies. For example, if Company B uses a different depreciation method than Company A, that difference would need to be adjusted for in the consolidated financial statements.
- Combine the financial statements: Finally, Company A would need to combine the financial statements of all three companies to create a single set of consolidated financial statements. This would involve adding the revenues, expenses, assets, and liabilities of all three companies and presenting them as if they were a single entity.
The resulting consolidated financial statements provide a complete picture of the financial performance and position of the group of companies.
Key takeaways for the consolidation of financial statements
Consolidation of financial statements represents the companies' financial results as a single entity.
It allows investors, creditors, and other stakeholders to understand better the risks and opportunities associated with the group's financial performance.
Further, consolidation of financial statements is a must for compliance with accounting standards and regulations.
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