Consolidated Financial Statements – Definition

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Consolidated Financial Statements

Consolidated financial statements refer to a parent company’s combined financial statements and its subsidiaries. They present an overall look at the parent company’s financial position, including its subsidiaries. It also shows a real picture of the entire group of companies’ overall health as opposed to a standalone position of one company.

A Little More on What are Consolidated Financial Statements

The construction of a consolidated financial statement requires a considerable amount of effort because they must not include the impact of any given transactions between entities under report. What this means is that, if there is any sale of products between a parent company’s subsidiaries, it must be removed from the consolidated financial statements.

An intercompany elimination might also occur when the parent company pays interest income to subsidiaries because it is using its money to invest. Such interest income must be eliminated in the consolidated statements.

The consolidated financial statements typically report the total of separate legal business entities. Note that a parent company can function separately from its subsidiaries. As they operate independently, each one of them prepares and reports its financial statements.

However, since subsidiaries form a single economic entity, a consolidated financial statement is always beneficial to people, such as regulators, investors, and customers, for it enables them to gauge the entity’s overall position quickly.

Consolidation Example

Let’s assume that XYZ Company is an international company and has a revenue worth $5,000,000 and assets worth $3,000,000, which appears in its financial statements. However, the XYZ as five subsidiaries under its control, which happens to have a revenue worth $50,000,000 and assets worth $82,000,000. In this case, it will a very misleading idea to only show the financial statements the parent company, whereas its consolidated results disclose that the company is worth $55,000,00 and controls assets of approximately $85,000,000.

Consolidated Financial Statements Preparation Basic Procedure

There are two fundamental procedures to follow when preparing a consolidated financial statement. First, you must cancel every item accounted for as a liability to another and an asset in a single company. After that, you are free to add all the things not canceled. Note that there are two major types of items in the financial position’s consolidated statement that cancel each other out.

  • We have an investment in subsidiary companies. This investment is considered an asset in the parent company, and it is usually canceled out by what we call “share capital,” which is an account in the statement of a subsidiary. In this case, only the shares capital of the parent company will be in the consolidated report.
  • Also, the payables of one company undergo cancellation by another company’s receivable, if trading between different companies in a single group takes place.

Consolidated Statement of Income

When it comes to the consolidated statement of income, what you reis only reported is the expense and income activity from outside of the economic entity. If a parent company earns revenue, it becomes a subsidiary’s expense left out from the financial statements.

The reason is that there is $0 in the financial statement’s net change because the revenue realized from one legal business entity counterbalances expenses in another. The move prevents overinflation.

Consolidated Balance Sheet

Here there is the elimination of certain account receivables as well as account payable balances from the consolidated balance sheet. The amount that has been removed relates to the amount owed from or to subsidiary entities or parent company. It reduces the balances reported because the net effect is $0. All receivables, cash, including other assets, are indicated on the consolidated statements, and the entire liabilities owed to eternal business entities.

Requirements for Reporting

The preparation of consolidated financial statements must use a similar accounting method across all the subsidiary entities and the parent company. If possible, the subsidiaries and the parent company must be accounted for using the GAAP (generally accepted accounting principles), if the consolidated financial statements are not as per the GAAP.

All subsidiary equity accounts, like retained earnings and common stock, must be removed. A non-controlling interest account, if not wholly-owned, may be used in the subsidiary. Also, during the preparation of consolidated financial statements, you should adjust the subsidiary balance sheet accounts to financial assets’ current fair market value.

Ownership Calculation Methods

There are three ways of calculating ownership interest between companies. Companies that are included are in the consolidated financial statements are those that they own. If a company owns below 20% of the stock of another company, it uses the cost method to report its finances. If the company owns above 20%, but below 50%, it can use the equity method to report its financial status. Note that consolidated financial statements are no allowed under both models.

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