Consolidated Financial Statements – Definition, Features, And More
Financial reports that give the overall financial well-being of an entire organization with all its sub-companies that help the investors, customers, analysts, etc. to arrive at informed decisions for the growth of the company are the reason these consolidated financial statements are prepared.
Introduction to Consolidated Financial Statements
The financial statements of a company with its different divisions or subsidiaries are called consolidated financial statements. Consolidated financial statements typically report all the revenue of the expenses of a company or group of companies, but many companies often use these statements to describe the aggregate report of an entire business including the subsidiaries. The Financial Accounting Standards Board also defines consolidated financial statements as reports of the financial health of an organization having a well-defined parent company and its many subsidiaries.
Small companies and start-ups do not always require financial statement reporting while large companies with various branches need to report financial statements in line with the Financial Accounting Standards Board’s Generally Accepted Accounting Principles (GAAP). And if the company has branches outside its home country, the guidelines made by the International Accounting Standards Board’s International Financial Reporting Standards (IFRS) should be followed.
Let’s Understand Consolidated Financial Statements
As mentioned earlier, consolidated financial statements entail the company merging and combining all of its financial accounting amounts together to put together a consolidated financial statement that shows results in the balance sheet, income statement, and cash flow statement reporting. A consolidated financial statement is eligible to be filed based on the percentage of ownership a parent company has on its subsidiaries. An ownership percentage of 50% or more of the parent company over its subsidiaries allows the parent company to include them in a consolidated financial statement. If the ownership percentage is less than 50, but the subsidiary’s management is very much in line with the decision-making process of the parent company, then also the subsidiaries can be included in the consolidated financial statement by the parent company. This type of statement is usually filed due to tax or other advantages that come with it and are usually filed on a year-to-year basis. An alternative for companies that do not include their subsidiary in a complex consolidated financial statement, is using the equity method or the cost method to account for the company’s subsidiary ownership.
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Let’s Discuss How These Financial Statements Can Be Used in Terms of the Income Statement, and Balance Sheet.
Consolidated Statement of Income:
In this report, the revenue, income of the parent company, income of the subsidiaries, and total expenses are covered. The details on the company’s overall assets, cash flows, liabilities, income, and equity are also included in the financial statement. Any revenue generated internally by the parent company, or its subsidiaries is not included in the consolidated statement of income. Although legally revenue generated by one group can balance out the expenses made in another, which means that the revenue generated, say, by the parent company at the expense of its subsidiary is not included in the consolidated statement of income.
Consolidated Balance Sheet:
This report includes the assets and liabilities of the parent company and its subsidiaries while excluding their accounts receivables and accounts payable details. The assets and liabilities are reported in an overall general way without giving specific details of which asset is owned by which group or which group owes a certain liability. Thus, the data reported in the balance sheet cannot be differentiated into groups or entities. The details of accounts payable and account receivable are not included to make sure that there is no distinction between the assets and liabilities of the company as a whole.
Overall, the data that we can find within these reports having details of the balance sheet, income statement, and cash flow statement can be considered to be the combination of aspects like:
Accounting guidelines and principles are followed while creating these reports, and their results are reflected in the financial statement. The use of such accounting guidelines makes the final financial report more stable, uniform, and comparable.
Written Down Facts:
All information collected from accounting records is considered recorded facts. The cash accounts, creditors, fixed asset accounts, debtors, and other such accounts are always maintained at their original cost, while the marketable values are not recorded. Thus, since all such accounts are the ones usually taken for the statements, the financial reports are reliable in that they represent the fiscal health of the organization very well.
There is a chance that the company might make some assumptions while recording financial transactions.
Even while following the accounting principles, there will be times when the analyst or accountant will need to make a judgment. These can be in terms of decisions to select an inventory calculation method, put off expenses, provision for debts, etc. These decisions of the accountant can also affect the final consolidated financial report.
Organizations that elect to prepare and submit consolidated financial statements with their subsidiaries will need a significant enough investment in any financial accounting infrastructure because of the accounting integrations required for the final consolidated financial reports. As such, there are some standards to be met when preparing consolidated financial statements. They are:
- The company cannot use any unfair tactics to reduce taxes like transferring revenue, assets, cash, and/ or liabilities among its subsidiaries. The standard for the amount of ownership required for a company or its subsidiary to be included in these financial statements will vary depending upon the accounting guidelines followed.
- The parent company and all its subsidiaries must follow the same accounting guidelines to form an accurate consolidated version.
- The reports must be by the GAAP guidelines, and if working internationally, reports must be by IFRS.
- Certain accounts like accounts receivable balance, accounts payable balance, equity accounts, common stocks, etc. are not to be included in financial statements.
- All accounts of subsidiaries must meet the present market value with all their assets, and these accounts can be readjusted to meet the same.
- As these reports are the aggregate results of the company, the final financial statements such as the balance sheet, income statement, and cash flow statement should remain the same. The company or each subsidiary’s own legal body will create the financial statements, and these statements are merged comprehensively by the parent company to create the final consolidated reports. Since the report will have details of all sub-companies and its parent, it’s very easy to determine the financial position of the organization as a whole, by the investors, regulators as well as customers.
Alternatives methods – Cost and Equity
As mentioned above, companies can also choose cost and equity methods for their financial reporting. The cost method is used for financial reporting if the company owns less than 20% of another company or subsidiary’s stock. This will typically report the dividend income and asset value of an investment. The equity method is preferred if the company owns more than 20% stock but less than 50%. This report includes the share of the company’s earnings. All-in-all, ownership will be based on the total amount of equity owned.
Why are Consolidated Financial Statements important?
While some may consider it extra work for each subsidiary company to create its financial report, and then merge it all with that of the parent company, there are still several reasons why this method is preferred and remains important in the industry. Some major points are:
- As the financial statements in its consolidated version report, mainly, the overall financial health of the organization with all its sub-groups, and also show in detail how each sub-groups of the company had contributed to increasing the impact of the parent company, this offers much more insight into the company. And this is critical information for owners, analysts, prospective investors, and even customers.
- If each sub-group had presented its financial report separately without consolidating, there is a chance that some key information or asset details be missed by the investors or anyone else.
- Also, without a consolidated report, anyone who wants to know the financial status of an organization will need to go through multiple documents, and that can be around 10, 20, or even 35 documents in total, depending on the number of sub-groups of the parent company. For the consolidated financial report, only a single document needs to be prepared which makes it easier to go through the data and understand the overall state of business.
- This also ensures transparency in the business. With a consolidated report, details such as balance sheet and income statement are available in a single report, while it can be hard to understand and compare these details from standalone financial reports of sub-groups.
- Consolidated financial reports will only have the major details necessary for analysis and decision-making. Details like any transactions within a subsidiary that pretty much cancelled out the one already present in the parent company are excluded. This also ensures that the report is much more simplified but systematic.
Features of Consolidated Financial Statements
Some of the Key Features of Consolidated Financial Reports Are:
Easy to Understand:
Since the consolidated financial reports can be accessed by even customers, who may only have the most basic knowledge of finance and accounting, the information should be presented in a simple and easy-to-understand manner from which they can draw accurate conclusions about the company. At the same time, no crucial information should be missed out or avoided, even if such details can be complex and hence, harder to understand. Every important piece of information should be considered.
The financial reports should only contain information important for analysis and decision-making. The information can be confirmatory, predictive, or both, and should help analysts to assess past, present, or future events. Information about asset structure is also included.
All these pieces of information will be useless if it’s not reliable or from a trustworthy source. The data can only be considered reliable if it is free of errors, and included without any bias (material or personal).
To better understand the financial state of the company, to do trend analysis, and eventually help in making important investment decisions, the data in a financial statement should be able to compare the data of a few years. But this need to make the data comparable should not eradicate any key points, or present the accounts details in less than the best possible way. The analysts and other people working on the financial statement should be aware of any changes or updates in accounting guidelines, especially any changes that will have a material effect on financial statements.
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Advantages and Disadvantages of Consolidated Financial Statements
- Details on overall profitability – since the consolidated version will have details of the profitability of not only the parent company but also its subsidiaries, it makes it easier to make judgments of probable investment.
- Financial health can be easily understood – due to the inclusion of details on assets and liability of the organization, the overall financial position of the company can be known easily.
- The value of shares can be identified easily, by both the parent company and its sub-groups.
- Minority interest can also be known – it also shows the minority interest by the outsider shareholders of sub-groups.
- Gives a complete overview – potential investors, financial analysts, etc. can get a piece of utterly transparent information from this type of financial statement.
- The exact financial position of sub-groups can be difficult to make out – since it’s consolidated information, there is a chance that any poor or average performance of the parent company may get concealed by the performance of the sub-groups. Thus, sometimes, the statement is sugarcoated.
- Financial information can be manipulated or concealed to reduce the risk of taxes owed by the parent company. Like this, any major/ minor financial details can be withheld from the investors. Elevated sales details can be shown if too many cross-transactions have happened between the parent and the sub-groups. But this is not accurate data.
- Possibilities of fraud by the parent company can lead to misinterpretation among clients.
Process Flow of Consolidated Financial Statements
As discussed earlier, the consolidated financial statements will be consisting of the income statement, balance sheet, and cash flow of the company and its subsidiaries.
The Process Involved in Making This Consolidated Statement is as follows:
- Recording intercompany loans – All intercompany loans made by sub-groups to the parent company must be recorded, especially if the subsidiary’s cash balance is consolidated into an investment account by the parent company. Also, the interest income collected from consolidated investments is allotted to subsidiaries from the parent company.
- Charging payroll expenses – Payroll expenditures should be checked that it is rightly allotted to all subsidiaries if the parent company uses a single payroll/ paymaster order to pay all its workers.
- Investigating the balances of equity, asset, and liability accounts – Accuracy of all details included for accounts of asset, liability, and equity should cover both the parent company and all of its sub-groups. If needed adjustments and readjustments can be made.
- Eliminating intercompany transactions – Any intercompany transactions that have happened must be reversed at the parent company level to eliminate any impact they can have on the final consolidated statements of finance.
- Accounting of the parent company is closed – To show that no more transactions have happened at the time, the accounting period of the parent company is closed.
And as for the format of these statements, the consolidated statements of finance are shown in 2 parts, with assets and liabilities as one part, and equity as the other. The asset and liability accounts are again classified as current and non-current.
The Criteria to Be Labeled as Current Asset/ Liability is as follows:
- It is mainly for the trading purpose
- It is expected to be sold or consumed or settled in any normal cycle of operations
- It is expected to be settled in twelve months from reporting time
If none of these criteria is met, asset/ liabilities are labelled as non-current.
The consolidated income statement gives details on the finance of the business, aggregates that give a clearer view of the results of manufacturing activities, as well as the impact of taxation like:
- EBIT (earnings before interest and tax)
- Contribution margin
- Net results before non-controlling interests
- Overall net result, etc.
The consolidated cash flow statement can show various types of cash flow as instructed by international accounting standards.
- Let’s say a company ABC has mentioned in its financial statement INR 8,000,000 of income along with assets worth INR 5,000,000. It also has several subsidiaries with an income of INR 30,000,000 with assets worth INR 70,000,000. Thus the parent company might be concealing the consolidated outcomes when it is an INR 45 million company with over INR 75 million worth of assets.
Frequently Asked Questions (FAQs)
Q1. When should we opt for consolidated financial reports?
This type of report is usually considered when the parent company has more than 50% of the ownership of its subsidiaries.
Q2. What is the main aim of such financial statements?
Consolidated financial reports give an overall transparent view of the finance of the company and its sub-groups in a nutshell that is easy to understand.
Q3. What is the major difference between standalone financial statements and consolidated financial statements?
The major difference is that while consolidated financial reports contain reports of all financial details of the parent company and its subsidiaries, standalone financial reports will only have the financial detail of one single company or entity.
Q4. Are there any particular rules regarding the period to be considered for financial statements?
No, while there are no particular rules dictating the period to be considered for financial statements, it is generally prepared for the entire year be it the financial year or the normal calendar year. But they can also be prepared for 6 months or any period as per the company’s requirement.
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Financial statements, consolidated or not, are one of the most important documents an organization needs to prepare. Since the details contained within these reports are the decision-making points regarding plans for investment and the overall growth of the company. This also serves to give the already existing and future investors an insight into the company and its profitability. There is various accounting software now that makes it easier but these statements are generally prepared by efficient accountants and evaluated by auditors.