According to GAAP (Generally Accepted Accounting Principles), parent companies must prepare consolidated financial statements to report on the financial well-being of both the parent company and all its subsidiaries.
These statements are often prepared with the use of financial consolidation software which takes financial figures from each individual subsidiary and combines them into one overall report. Since each subsidiary also prepares its own standalone financial report, consolidated financial statements may seem to some to be an unnecessary extra step.
But is this really the case?
An analysis of the importance of consolidated financial statements reveals these statements offer several benefits to investors, financial analysts and others who may be evaluating the health of the parent company. In this article, we will review consolidated financial reports in more detail including the unique benefits they offer.
Who Prepares Consolidated Financial Reports?
Consolidated financial reports are prepared by any parent company that owns one or more subsidiaries. For example, it is common for one company to purchase smaller companies that can complement the primary business and make it even stronger. The smaller companies can help the profitability of the parent company while also continuing to operate as separate entities.
Each subsidiary must prepare its own financial statements including balance sheet, income statement, statement of cash flows and statement of retained earnings. This information for each subsidiary is then combined using consolidation software to create consolidated financial reports that represent the financial position of the parent company.
How Consolidated Financial Reports Are Prepared
Financial consolidation software is typically used to prepare consolidated financial reports because it is not as simple as adding up the financial statements from each subsidiary. In the consolidated report, the transactions among subsidiaries or a subsidiary and a parent company are eliminated to avoid double counting. For example, if a parent company purchases goods or services from a subsidiary, the parent company’s purchase and the subsidiary’s sale are both eliminated so this transaction doesn’t distort the final figures. It can be quite tedious to do this manually but consolidated software simplifies the preparation of the final reports.
Benefits of Consolidated Financial Reports
Consolidated financial reports are a GAAP requirement for good reason. Some of the many benefits of consolidated financial reports include:
Complete Overview – Consolidated statements allow investors, financial analysts, business owners and other interested parties to get a complete overview of the parent company. At a glance, they can view the overall health of the business and how each subsidiary impacts the parent company.
Reducing Paperwork – With consolidated financial statements, there is also less paperwork involved. If the parent company owns nine subsidiaries, there are 40 separate standalone financial reports to view i.e. the four basic financial statements for each subsidiary plus the parent company. Not only would it be hard to track down all these records, it would be extremely difficult to look over each of them and try to get an overall view of how the business is performing. Consolidated financial statements cut this pile of reports down to just four consolidated reports. This results in less paperwork and less effort being expended to assess a parent company’s financial health.
Simplification – Consolidation software cuts out all transactions that occur between subsidiaries and the parent company since, in the grand scheme of the business, these things cancel each other out. Eliminating these transactions gives a simplified view of business performance.
Updates to Consolidated Financial Statements – Over time, consolidated financial statements will continue to evolve to make the process of evaluating a parent company even more transparent. One of the reasons for this is that in the past some companies have used consolidated reports to hide losses and liabilities in special subsidiaries that were created specifically for hiding these financial problems. The Financial Accounting Standards Board and the International Accounting Standards Board regularly revisit the definitions and requirements for consolidated statements in order to make them more reliable and easier to use.
SUMMARY: Consolidated financial statements can be complex to prepare, especially for parent companies that include many subsidiaries. However, consolidation software has made preparation easier and standards boards like FASB and IASB regularly work to improve the process. Knowing all the important benefits of consolidated financial statements, it is easier to understand why GAAP requires them.
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.
What is the purpose of consolidation financial statements?
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.
When are consolidated accounts essential for buisnesses?
Consolidated financial statements are prepared by the parent company but include the records of its subsidairies. The specific accounting rules for consolidation are 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?
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.
Do subsidiaries need to be included in consolidated financial statements?
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.
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 circumstances, 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 circumstances, 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. 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.