Consolidated Financial Statements
Consolidated financial statements show a group of companies’ overall financial position and results. They combine the financials of a parent company and all the subsidiaries it controls.
What are Consolidated Financial Statements?
When a company owns other companies, called subsidiaries, consolidated financial statements combine all their separate financials into one set of statements. This gives a complete picture of the economic health of the whole corporate group. Consolidated financial statements include the balance sheet, income statement, cash flow statement, and statement of retained earnings for the parent company and subsidiaries.
Only companies the parent controls are consolidated. “Control” usually means owning over 50% of a subsidiary’s stock. Companies with significant influence but not control, like owning 20-50% of shares, use a different method called the equity method instead of consolidation.
The Consolidation Process
Accountants go through several steps to consolidate financial statements:
- Combine all line items from each company’s separate statements
- Remove overlapping transactions and account balances between companies in the group
- Remove the parent’s investment in subsidiaries
- Show the equity owned by outside investors, called non-controlling interest
This process can get complex with many subsidiaries, partial ownerships, and transactions between group companies. Accounting rules give detailed requirements for how to handle different situations.
Why Consolidate Financial Statements?
Companies consolidate financial statements to show a clearer and more complete financial picture of their overall business. Key benefits of consolidation include:
A Unified View
Consolidated statements show the whole group’s total financial position, performance, and cash flows. This helps investors, lenders, regulators and other stakeholders assess the overall size, health, and prospects of the business.
Simplified Analysis
With one set of consolidated numbers, it’s much easier to calculate key financial ratios, compare results to prior periods, and benchmark against other companies. You don’t have to hunt through multiple separate statements.
Better Disclosure
Details like sales, profits, assets, and liabilities are easier to interpret at the consolidated level. Consolidation also requires disclosing related party transactions within the group.
Comparability
Most large companies have subsidiaries, so consolidated statements let you compare companies more directly. Seeing just the parent company’s solo results can be misleading.
Limitations of Consolidated Statements
Despite their benefits, consolidated financial statements have some key limitations to keep in mind:
Lost Detail
Consolidation by definition combines a lot of information into totals and net amounts. This can bury important details about the subsidiaries, since you only see the consolidated numbers.
Accounting Complexity
As simple as the final statements look, the process to get there involves complex accounting with many technical rules and gray areas. This opens the door for errors and inconsistencies.
Overstated Results
If a subsidiary with minority owners is fully consolidated, 100% of its sales/profits are included even though the parent doesn’t get 100% of the economic benefit. This can overstate the group’s results.
Issues in Consolidating Financial Statements
Intercompany Transactions
The most common issue in consolidation is dealing with transactions between the consolidated companies. These include:
- Sales of goods or services from one company to another
- Loans between group companies
- Dividends paid from subsidiaries to the parent
- Transfer of assets between companies
These intercompany transactions have to be removed in consolidation. Otherwise, they could overstate the group’s overall sales, assets, etc. There are often timing differences where one company has recorded a transaction but the other hasn’t yet.
Non-Controlling Interests
When a parent owns less than 100% of a subsidiary, the other shareholders are called non-controlling interests (NCIs) or minority interests. Consolidation has to factor out the NCI share of the subsidiary’s equity and profits.
The consolidated balance sheet splits out the equity belonging to NCIs. The income statement shows the allocation of profit between shareholders of the parent and the NCIs. There are two methods for showing this allocation.
Foreign Subsidiaries
For subsidiaries in different countries, their local financial statements have to be translated into the parent’s reporting currency before consolidation. This involves:
- Translating all assets and liabilities at the current exchange rate
- Translating income statement items at the average exchange rate for the period
- Putting all resulting translation gains/losses into a special equity account
The rules are complex, especially if the subsidiary’s local currency is its functional currency.
Changes in Ownership
Companies often buy and sell stakes in their subsidiaries over time. Each time this happens, the consolidation process changes. When control is gained or lost, it triggers recognizing gains/losses and changing reporting methods. Ownership changes also affect the calculation of goodwill from acquisitions.
Other Issues and Complexities
Many other issues come up in preparing consolidated financial statements:
- Subsidiaries with different fiscal year-ends
- Subsidiaries in specialized industries like banking or insurance
- Complex group structures with multiple layers of ownership
- Subsidiaries held for sale
- Equity method investments and joint ventures
All of these involve special accounting rules and extensive disclosures.
How to Read Consolidated Financial Statements
When looking at consolidated statements, focus on:
Subsidiary Details
Check the notes to the financials for a list of major subsidiaries, ownership percentages, and key details about their contributions and results. Watch for changes from prior periods.
Intercompany Transactions
Make sure material intercompany transactions have been properly removed. Look for related party disclosures showing amounts and types of transactions within the group.
Non-Controlling Interests
Note how much of the equity and profit belongs to NCIs. Higher amounts can signal more potential conflict of interest with minority shareholders.
Ratio Calculations
Check that key ratios and metrics are calculated using consolidated data. Using parent-only numbers can dramatically skew common ratios like return on equity, debt to equity, etc.
Segment Reporting
Consolidated reports often come with details breaking down results by business segment and/or geography. Use this to understand the drivers of the consolidated performance better.
