In a broad sense, consolidation is defined as the action or process of combining things into a more effective or coherent whole. In accounting, the definition of financial consolidation can be summarised as:
“Combining the assets, liabilities and other financial items of two or more entities into one consolidated entity.”
That involves the consolidation of financial statements, where all subsidiaries report under the umbrella of the parent company.
Even if the subsidiaries are separate legal entities to the parent company, and therefore record their own financial statements, they are still included in the consolidated group financial statement. It is also possible to have consolidated financial statements for a portion of a group of companies. For example, some groups may produce consolidated financial statements for one of their subsidiaries and those other entities owned by that particular subsidiary.
Watch this 2-minute Financial Consolidation overview video from AccountsIQ's AIQ Academy.
Their importance to businesses
Consolidated financial statements give a high-level overview of the company’s financial performance. This is essential information for management teams, shareholders, investors, lenders and financial journalists. Auditors also use these statements to ensure the organisation is complying with legislation and regulations.
In a wider sense, accurate and timely consolidated financial reporting is about much more than the consolidated financial statements needed for compliance. Consolidated data on a range of KPIs plays a crucial role in ensuring important business decisions are based on evidence rather than gut feel or guesswork. It gives leadership teams a detailed view of, for example, the best and worst-performing business units or products, and can help them to identify risks and opportunities.
Consolidation reporting requirements
Consolidated financial statements are prepared by the parent company but include the records of its subsidairies.The specific accounting rules for consolidationare based around the type of business and amount of ownership they have over other firms. Typically, if a parent company has more than 50% ownership of a subsidiary, it must be included in consolidated financial statements.
What is included in a consolidated financial statement?
Consolidated financial statements include reports of all the financial activity and positioning of a group of commonly-owned businesses. Typically this includes statements of: income, financial position, cash flow and funds.
Typically, a consolidated financial statement would include:
- Consolidated statement of income: showing income and expenditure
- Consolidated statement of financial position: showing assets, funds, and liabilities
- Consolidated statement of cash flows: from operating and investing activities
- Consolidated statement of changes in funds.
Cost and Equity Methods
Financial statements for the subsidiary are prepared in the same way as for the parent company and included in the consolidated accounts. There can be some exceptions to this. For example when:
- The parent company does not have a controlling stake in the subsidiary
- The subsidiary is privately held.
If you’re unsure about the compliance and reporting requirements for your group or for specific subsidiaries, you should seek professional advice.
If a company has ownership in subsidiaries but chooses to exclude them from their consolidated financial statements, then they will usually account for their ownership of the subsidiary using the cost or equity method.
Read more about: ‘How to consolidate subsidiary accounts’
Can companies choose between consolidated and unconsolidated financial statements?
Reporting requirements vary between public and privately held companies and across different international jurisdictions. However, in most circ*mstances, private companies can make the decision to produce unconsolidated or consolidated financial statements on an annual basis.
Public companies normally make this decision on a longer-term basis, as changing from filing consolidated to unconsolidated financial statements may raise concerns with investors or cause complications with auditors. They may also need to file a change request. In some circ*mstances, such as a spinoff or new acquisition, the parent company may call for a change in consolidated statements.
What are the benefits of consolidated financial statements?
The main purpose of consolidated financial statements is to portray an accurate picture of the group’s financial position, including assets, expenses, profits and equity. Some of the benefits of this are:
- Potential investors can judge the financial health of the group and its subsidiaries
- It reduces the burden of preparing separate financial statements for all subsidiaries
- Inter-company transactions can be properly accounted for.
Financial consolidation software helps you create consolidated financial management reports. This data is essential to make informed business decisions and can help in producing consolidated financial statements.
