A parent business must produce consolidated financial statements in order to present a complete picture of its current financial situation by merging the financial data from all of its subsidiaries. They include a balance sheet, an income statement, and a cash flow statement, which will in turn offer a comprehensive picture of the situation of a parent company and its divisions. Furthermore, without having to examine each entity separately, these statements help to inform the board, stakeholders, and investors of the company’s overall financial status. But, here is the real issue: “how do you go about preparing one?” Well, at the end of this post, that won’t be an issue. This article’s goal is to explain every detail regarding these kinds of statements, ranging from how to prepare them without stress to comparisons between combined and consolidated financial statements, with an example (Combined vs consolidated financial statements) and all it entails.
Overview
To sum up:
- Consolidated financial statements give a true and fair picture of an organization’s financial health across all divisions and subsidiaries.
- There are numerous restrictions and regulations to take into consideration, but they are necessary when one firm holds more than 50% of the outstanding common voting stock of another company.
Financial consolidation, put simply, is the act of combining all of a parent company’s subsidiary companies’ financial statements under the control of the parent company. In reality, it’s far more difficult than simply adding all the related data together. It refers to consolidating all group financials and integrating them into a single source for reporting purposes.
Consolidated Financial Statements: What Are They?
Consolidated financial statements, in simple terms, are the financial statements of a business having numerous divisions or subsidiaries.
Companies often refer to the aggregated reporting of their entire firm together when using the term “consolidated” in financial statement reporting.
Consolidated financial statement reporting, on the other hand, is defined by the Financial Accounting Standards Board as
“the reporting of an entity that is organized with a parent company and subsidiaries.”
While public firms must disclose financials in accordance with the Financial Accounting Standards Board’s Generally Accepted Accounting Principles, private entities have very few reporting responsibilities (GAAP). When a corporation reports on a global scale, it must also adhere to the International Financial Reporting Standards set out by the International
Accounting Standards Board (IFRS). As you can tell, both GAAP and IFRS have some unique criteria for corporations that want to produce consolidated financial statements with subsidiaries.
How Consolidated Financial Statements Work
In order to prepare consolidated financial statements that display outcomes in the conventional balance sheets, income statements, and cash flow statement reporting, a corporation must generally integrate and combine all of its financial accounting operations. The choice to file consolidated financial statements with subsidiaries is generally made annually and is often made due to tax or other benefits that may be present.
However, the percentage of ownership the parent business holds in the subsidiary determines whether or not a consolidated financial statement with subsidiaries is required.
The standard definition of a subsidiary is when a firm has 50% or more of another company's stock, which enables the parent company to include the subsidiary in a consolidated financial statement.
Meanwhile, in rare cases, less than 50 percent ownership may be permitted provided the parent business can demonstrate that the subsidiary’s management is closely linked to the parent firm’s decision-making procedures.
Basically, the cost method or the equity method are used to account for a company’s ownership of subsidiaries when it opts not to include the subsidiary in complex consolidated financial statement reporting.
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On the other hand, private businesses decide annually whether to combine their financial accounts to include their subsidiaries.
The tax benefits a business may receive by reporting a consolidated vs an unconsolidated income statement for a tax year generally have an impact on this annual decision. Also, for a longer length of time, public firms decide whether to produce consolidated or unconsolidated financial statements. A public business may need to submit a change request if it wants to switch from consolidated to unconsolidated.
Filing consolidated subsidiary financial statements is a long-term financial accounting decision because switching from consolidated to unconsolidated may also cause issues with auditors or investor concerns. However, there are specific cases, such as a spinoff or purchase, where a change in corporate structure may necessitate a change in the consolidated financials.
What Is the Process of Financial Consolidation?
The process of financial consolidation involves compiling financial data for reporting from several organizational departments or entities. This procedure includes merging data from the GL and other sources into a single chart of accounts, making sense of it, and then reporting on it.
In the long run, organizations can learn a lot about their performance from their consolidated financial statements.
What Are the Uses of Consolidated Financial Statements?
Before the financial reports are combined to create a consolidated financial statement, a parent business and its subsidiaries will each separately report their finances when compiling a company’s financial statement. A company’s consolidated financial statement is viewed as a barometer of its overall financial health by investors, market authorities, and financial analysts.
Consolidated Statement of Income
In general, a parent company’s and its subsidiaries’ costs, receipts, and income are included in a consolidated statement of income.
On the other hand, the assets, liabilities, cash flows, income, and equity of a corporation and its divisions are listed in this financial statement.
However, the parent company’s or its subsidiaries’ internal revenues are not included in the consolidated statement of income. In a legal sense, the income from one entity balances the costs of another entity. As a result, a parent company’s revenue which is a subsidiary’s expense is not included in the consolidated statement of income.
Consolidated Balance Sheet
As earlier mentioned, a parent company’s and its subsidiaries’ assets and liabilities are listed on a consolidated balance sheet, but their accounts payable and receivable are not included.
When assets and liabilities are reported, they are done so objectively and in a broad manner without mentioning which entity owns particular assets or which entity has which liabilities. As a result, the balance sheet components are highlighted and not differentiated from one business to another.
There is no distinction between the companies’ or entities’ assets and liabilities thanks to the abolished account receivable and account payable balances.
Requirements for Reporting
A specific protocol must be followed when reporting a consolidated financial statement. The following are the primary reporting requirements for consolidated financial statements:
- A consolidated financial statement must adhere to accepted accounting principles or standards. The principles of GAAP must be properly followed.
- The parent company’s and the subsidiaries’ accounting practices must be consistent.
- Retained earnings, the balance of accounts receivable and payable, common stock, and other equity accounts must all be eliminated from the financial statements.
- The subsidiaries’ accounts must be revised to reflect the current market value of all of their assets.
Example of Consolidated Financial Statements
Here is an example to show you what consolidated financial statements look like.
For example, let’s say the assets shown in ACME’s financial statements are $500,000 and their income is $1,000,000. On the other hand, ACME is also in charge of two companies, each of which generates $3 million in revenue and has a $1 million asset base.
Simple reporting of the main company’s $1,000,000 in sales would be unreliable because it also manages the subsidiaries. Consolidated financial statements fill this need by combining the financial data from the main company and the subsidiaries to create a complete and accurate view of the business’s financial position.
Let’s look at a more detailed example of consolidated financial statements;
Assume NEP is an electric utility with a stock exchange for trading its common stock. NEP purchases all of Midwest Gas Corporation’s shares (MGC). NEP and MGC are still two distinct legal entities. MGC is a subsidiary of NEP, which is the main corporation.
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These corporations all continue to run their individual businesses and will each produce their separate financial reports. However, the financial condition and operational performance of the group of businesses (also known as the economic entity), made up of the combination of NEP and MGC will be useful to investors and potential investors in NEP.
All of the revenues generated by external clients by the group of enterprises are reported in the consolidated income statement of NEP. (When the income statements of NEP and MGC are combined to form the consolidated income statement, the sales of electricity from NEP to MGC and the sales of gas from MGC to NEP are excluded because they are not earned outside of the group of firms.)
Furthermore, all costs incurred outside of the group of firms will also be included in the consolidated income statement.
The cash, receivables, plant, and other assets of the group of companies will all be included in the consolidated financial sheet of NEP (the economic entity). All of the economic entity’s liabilities will also be disclosed. (In the consolidated balance sheet, the sum of the due and receivable between NEP and MGC is removed.)
How to Prepare Consolidated Financial Statements
The following cover all you should know about preparing consolidated financial statements.
#1. Identify the Companies That Are Treated as the Parent Company’s Subsidiaries
Any company in which the parent corporation holds the majority of the shares falls under this category. Other investments would be regarded as subsidiaries if the parent business had the following powers:
- Majority voting rights
- The ability to cast the majority of votes
- Control over the majority of the board, or
- Authority to administer the subsidiary.
After you have determined which entities must be taken into account, collect all of their financial statements.
#2. Check the Fiscal Periods to Make Sure They Line Up
Although this generally happens during the acquisition, it is not always the case. If an entity employs a different timeline from the parent firm, it is prudent to alter the entity to reflect the parent company.
#3. Create Your Reports in Excel
This is done by opening them and adding tabs for each sheet, such as one for the income statement, another for the balance sheet, and so on. To help organize each part, such as cash, inventory, etc., copy the totals from each entity and paste them, labeling the rows as you go.
#4. Rows for the Consolidation of Debit or Credit Transactions Must Be Included
It will be challenging and time-consuming to find the errors later in the process, so check the data you entered twice before integrating them into your consolidated financial statements.
#5. Your Consolidated Balance Statement Should Reflect the Amounts Previously Determined
Apply the intercompany elimination procedures now to any entities that engage in business together. Create the consolidated income statement and cash flow statement using this information.
Once finished, carefully go through each sheet to make sure there are no duplicate values, including intercorporate assets, liabilities, and money that moves between the two.
Combined vs Consolidated Financial Statements
Understanding your corporation’s alternatives for financial statements and reporting is crucial if you are a parent corporate owner. You must be aware of the information the financial statements provide about your company and the controlled subsidiaries. You’re more likely to be a competent corporation owner the more you understand financial accounts.
Combined Financial Statements
In contrast to a consolidated financial statement, a combined financial statement treats each subsidiary as a separate legal entity, just as it does in real life. The main company’s financials are reported separately in the consolidated financial statement along with those of its subsidiaries. The financial statements of the parent and the subsidiaries continue to be separate within the same document.
In general, it is simpler to prepare combined financial statements than consolidated financial statements.
Investors and potential investors gain by being able to monitor the performance of each company, including the parent and any subsidiaries that may be corporations, LLCs, or both. When compared to a consolidated financial statement, this division is less obvious. A combined financial statement rather than a consolidated financial statement is useful for an investor to see if they want to know how each particular company is doing.
Combined vs Consolidated Financial Statements: Which Financial Statement Type Should I Use?
Basically, it’s a good idea to ask your financial advisor or accountant which one they suggest when determining whether to prepare a combined financial statement or a consolidated financial statement. You will, however, be forced to file a consolidated financial statement if the parent business owns more than 50% of a subsidiary.
Consider filing a consolidated financial statement if you are a director of the parent corporation or LLC and the general public is more familiar with your parent firm and its brand than with the subsidiaries.
The investing public won’t be as concerned with the subsidiaries as independent legal entities if they can sing the jingle to your main business or recite the commercial word for word but haven’t heard of your subsidiaries. The parent company’s fiscal viability and overall health are all that the investor needs to know.
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On the other hand, the combined financial statement may be more appropriate if the ability to evaluate each organization or company on its own merits—rather than as a component of the unified whole—is more significant.
Furthermore, because each entity’s financial statement must be prepared separately, as was already said, the combined statement is significantly simpler to create. A combined statement also makes sense when there is common control over two or more firms but no parent corporation.
Whichever story you want to tell—in this case, evaluating the parent and subsidiaries as a whole vs. evaluating the individual components—will help you decide which financial statement format is best for presenting your information, as it does with a lot of reporting that is done specifically for a business.
What Distinguishes Condensed From Consolidated Financial Statements?
Both a consolidated financial statement and a condensed financial statement give a general picture of how a company is doing. A consolidated financial statement provides information about a business and all of its subsidiaries in a single document, but they diverge on a crucial point. In contrast, a shortened version condenses everything into a few lines. A simplified financial statement is substantially shorter and more to the point as a result.
Consolidated Financial Statements FAQs
What consolidated financial statements?
Financial statements of a business having numerous divisions or subsidiaries are called consolidated financial statements. Companies frequently refer to the aggregated reporting of their entire firm together when using the term “consolidated” in financial statement reporting.
What Are Consolidated Financial Statements What Is Their Purpose?
Financial statements that are presented as belonging to a single economic unit are known as consolidated financial statements. These statements are helpful for examining the financial situation and performance of all firms that are held jointly.
What is the difference between financial statement and consolidated financial statement?
The primary distinction between standalone financial statements and consolidated financial statements is that standalone financial statements present these findings as a separate entity, whereas consolidated financial statements present all activities of a company and its subsidiaries as a combined entity.
