Financial Consolidation or consolidated financial statements are those that combine the balance sheets and income statements of two or more companies. These businesses may be subsidiaries, parent-subsidiary combinations, joint ventures, or other types of business partnerships. The purpose of these financial statements is to give an investor a single document that shows the financial health of all entities under one common ownership.
Because consolidated financial statements are more complex than basic company documents, they often present readers with a challenge when reviewing them, but they are actually fairly easy to understand. Once you know the rules and regulations involved with consolidation reporting, preparing consolidated financial statements isn't much different than preparing a normal financial statement.
This article covers everything you need to know about consolidated financial statements so that you can understand, interpret, and prepare them if necessary.
What is the definition of a consolidated financial statement?
A consolidated financial statement is a single document that presents a company's balance sheet and income statement for all related entities under common ownership. This means that both the assets and liabilities from various subsidiaries are combined with those of the parent company to create a consolidated financial statement.
Consolidated financial statements are usually prepared at the end of each fiscal year to include information from the parent company and all subsidiaries that are under common ownership. However, not all parent companies need to prepare consolidated financial statements. There are specific times when it's necessary to do so, but other times, a combined financial statement will suffice.
Why would you prepare consolidated financial statements?
Companies are often part of a larger parent-subsidiary chain where the parent owns at least 80% of the subsidiary. Consolidated financial statements are used to increase transparency and provide investors with a clearer picture of the parent company’s overall financial health.
Companies controlled by a parent company can also be involved in a joint venture or be part of a business partnership where each company is equally owned. In situations like these, consolidated financial statements can be used to show the overall financial health of the partnership.
Consolidated financial statements also account for any investment properties owned by the subsidiary. In this case, the parent company's investment property is reported as an asset on the consolidated financial statements. The consolidated financial statements also reflect any current liabilities and the amount due to the parent company by the subsidiary.
When is consolidation of financial statements required?
There are certain situations when consolidating financial statements is optional and other times when it is required by law. In general, there are four specific circumstances under which a company must absolutely consolidate its financial statements in order to remain compliant with financial and legal regulations.
A company must prepare consolidated financial statements if it meets any of the following conditions:
1. The parent company owns at least 80% of another company.
2. The parent company owns all shares of another company.
3. The parent company owns 80% of a joint venture.
4. The parent company holds an equal interest in a partnership with another company.
When a parent company holds less than 80% of the shares of a subsidiary, but the two companies are related to each other, then the parent company must prepare combined financial statements instead of consolidated financial statements. Related entities are those businesses that are controlled by the same parent company.
The same set of rules applies if the parent company holds an equal interest in a partnership with another company. If a company holds less than 80% of the shares of a subsidiary, or a parent company holds an equal interest in a partnership, the company must prepare combined financial statements.
When is consolidation of financial statements not required?
The parent company does not have to consolidate financial statements with a subsidiary when the subsidiary is engaged in a different line of business. If the parent company has an investment in a subsidiary that is engaged in a different line of business, or if the company has an investment in a partnership, then the parent company must prepare combined financial statements.
What is the difference between consolidated and combined financial statements?
The main difference between consolidated and combined financial statements is that consolidated statements always include the parent company and its subsidiaries. Combined financial statements only include the parent company and do not include the subsidiaries.
When preparing consolidated financial statements, the parent company adds the assets and liabilities of its subsidiaries to its own balance sheet. When preparing combined financial statements, the parent company adds the assets and liabilities of its subsidiaries to its own balance sheet but does not include them on its income statement.
Who can audit consolidated financial statements?
Consolidated financial statements are audited by a company's external auditor. The external auditor is responsible for verifying that all financial information on the consolidated financial statements is correct and that the amounts are reported in accordance with GAAP guidelines. The external auditor also reviews the procedures used by the parent company to consolidate its financial statements. In addition, the external auditor verifies that the correct standards have been followed by the parent company.
Conclusion
Consolidated financial statements are a bit more complicated than normal financial statements, but they aren't all that different. The main distinction between the two is the consolidated financial statements account for not only the parent company but also any subsidiaries, partnerships, and joint ventures. As such, the financial assets and records for these auxiliary entities need to be reconciled and accounted for when you are preparing consolidated financial statements.
That said, if you have accurate financial records for all of the subsidiaries, then it’s not actually that hard to copy the information over and add it into a consolidated financial statement. Fortunately, financial consolidation is usually only required once per year, and only under very specific circumstances such as are outlined above. Sometimes you may need to prepare combined financial statements rather than consolidated financial statements, which is an easier and less tedious process.
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