Consolidating Financial Statements: Requirements and Examples

Consolidating financial statements involves merging the financial reports of several entities to present a unified financial statement. 

This practice is essential, particularly for parent companies with multiple subsidiaries. It ensures more transparent financial tracking and superior governance.

For instance, if Company A owns Companies B and C, the parent firm must include the financial outcomes of both B and C in their reports. It's like considering the identities of B and C as an integral part of A without eliminating their independence.

This article will dive into the requirements for creating consolidated financial reports and present real-world examples.

Must-read: How To Categorize Expenses: 4 Tips For SaaS Startups

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What are Consolidated Financial Statements?

Consolidated Financial Statements (CFS) can be seen as a 'fold-together' of the financial documents from various firms into a singular report. It is not just a typical addition but involves complex accounting processes.

These statements thoroughly represent a company's financial health, including all the assets, liabilities, equity, income, expenses, and cash flows.

Two critical standards that regulate and guide companies in preparing CFS are General Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). These frameworks originated from the United States and the International Accounting Standards Board.

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What are the Criteria for Consolidated Financial Statements?

Consolidating financial statements is sometimes optional, sometimes obligatory. Four specific instances necessitate a company to consolidate its financial statements for legal and financial compliance:

• The parent company owns at least 80% of another company.
• The parent company holds 100% shares of another firm.
• The parent company owns 80% of a joint venture.
• The parent company shares equal partnership interest in another company.

When a parent company owns less than 80% of a subsidiary's shares or has an equal partnership interest, yet the entities share common control, the company must prepare combined, not consolidated, financial statements.

For example, suppose Corporation X owns less than 80% of Corporation Y, and there is shared control.

Each firm's finances must be combined and analysed parallelly instead of a traditional consolidation.

Take another scenario: say Corporation Z and Corporation A share an equal partnership. Although they're separate entities, they have common control. 

Here, the financial data of both entities should be separate but prepared jointly for comparison. These are just some instances when a business's consolidated and combined financial statements are necessary.

When to make consolidated statements is another critical aspect. Such reports should be produced annually, but most entities prefer to prepare semi-annual or quarterly reports.

For example, conglomerates like Google and Amazon often release quarterly consolidated financial statements. These regular reports help investors and other interested parties better judge these entities' financial health and growth potential. On the other hand, OMV, an Austrian integrated oil and gas company, prepares an annual report that includes its subsidiaries. 

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What are the Reporting Requirements for Consolidated Statements?

Here are eight detailed steps required for the creation and processing of consolidated financial statements:

1. Identify parent and subsidiaries: The first step is defining the parent company and its subsidiaries. This identification helps to understand which companies' financial operations need to be factored into the final statement.
2. Assemble relevant financial documents: Gather all necessary documents from the parent and subsidiaries.
3. Consolidate similar items: Combine comparable line items like assets, equity, liabilities, and incomes.
4. Eliminate intercompany transactions: Rectify any sales or purchases to avoid report duplication.
5. Standardise accounting policies: Ensure that all firms adhere to the same principles. This uniformity creates a seamless consolidation process.
6. Calculate non-controlling interest: This represents the portions of a subsidiary's net assets that the parent company does not own. It is subtracted from the total comprehensive income.
7. Combine statement of cash flows: Add up all the cash flows from investing, financing, and operational activities.
8. Create consolidated financial statements: Prepare the final consolidated list, including all necessary details from the previous steps. Ensure you double-check accuracy and that the statements align with required accounting standards.

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Ownership Accounting: What Method Should be Applied?

Cost and equity accounting methods are commonly employed when a parent company owns a subsidiary. 

When a parent company owns more than 50% but less than 100% of a subsidiary, the remaining shares held by other investors are addressed using the equity method. 

The cost method, conversely, only considers the original expense of the investment regardless of the subsidiary's future earnings or losses. 

Whether to use cost or equity accounting fundamentally depends on the country's accounting regulations and the parent company's ownership share in the subsidiary.

Related reading: Tax Form 1120 - What It Is? Your Complete Guide

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Actual Examples of Consolidated Financial Statements

Most companies, from multinational corporations like Walmart to technology giants like Microsoft, produce consolidated financial statements.

These statements aid in unmasking the financial position, enabling stakeholders like investors, shareholders, and lenders to make informed decisions.

For instance, Walmart's consolidated statement includes the financial activities of Walmart U.S., Walmart International, and Sam's Club. On the other hand, Microsoft's consolidated financial statements provide information beyond its software services, including its cloud-based services and personal computing.

Another example is Amazon, which is well-known as an online marketplace. Still, its consolidated statement also encompasses subsidiaries like Audible and Whole Foods, revealing a more comprehensive picture of its overall financial standing.

These examples illustrate how consolidated financial statements provide an invaluable lens, offering more profound insights into a corporation's diversity of operations and wealth of resources. Since various businesses, market trends, and financial factors blend into these reports, end users receive the informational advantage to capitalise on investment decisions, capital structuring, and strategic planning.

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Conclusion

Consolidating financial statements can be a complex process—but with modern accounting software like Inkle Books—managing your financial figures becomes much easier and more streamlined.

This software simplifies the tracking and management of expenses and revenues over time; no matter how many subsidiaries you have. 

It streamlines the creation of both consolidated and combined financial statements so that businesses can focus on what matters: their financial health and strategic planning. 

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