Meaning of Consolidated Financial Statements
The financial statements of a company that has numerous divisions or even subsidiaries are called consolidated financial statements. In financial statement reporting, companies frequently use the term "consolidated" to refer to the aggregated reporting of the entire business of the firm. Consolidated financial statement reporting, on the other hand, is defined by the Financial Accounting Standards Board as reporting of an entity with a parent company and subsidiaries.
In general, financial statement consolidation necessitates an integration of all of its financial accounting operations in order to produce consolidated financial statements that display results in the conventional balance sheets, income statements, and cash flow statement reports. The choice to file consolidated financial statements with subsidiaries is typically taken on a year-to-year basis and is frequently motivated by tax or other benefits.
Because they must exclude the impact of any transactions between the organisations being reported upon, these statements take a lot of time to prepare. As a result, if a parent company's subsidiaries sell items to each other, the inter-company sale must be excluded from the consolidated financial statements. When a parent company pays interest income to subsidiaries whose cash is being used to fund investments, this interest income must be excluded from the consolidated financial statements.
The following are the primary entities that are used to produce consolidated statements
- A parent company and all of its subsidiaries make up a group.
- A subsidiary is a corporation that is under the control of its parent.
Did You Know?
Consolidated financial statements show the combined financial results of an organisation and all its subsidiaries. This helps the stakeholders to know the exact asset and liabilities of a company.
Also read: Profit and Loss Account & Statement
Why are Consolidated Financial Statements prepared?
The reasons for the preparation of the consolidated financial statements are as follows:
- It is compulsory to prepare Consolidated Financial Statements in many countries around the world.
- When a corporation owns a majority of another firm's outstanding common stock, financial statements must be consolidated.
- Shareholders are interested in learning about the overall success of the company, as well as the performance of its constituent companies.
- Separate entities are also required by law for a variety of reasons, the most important of which is taxation.
- It is a means of diversifying risk as the parent company acquires a subsidiary of a different industry.
Steps Involved in the preparation of Consolidated Financial Statements
There are certain things that need to be kept in mind while preparing the consolidated financial statements:
- It is critical to integrate and match all of the components between the parent company and its subsidiary to arrive at the total while drafting the statement.
- Liabilities, assets, expenses, shares, and income should all be included by the parent firm.
- The parent company's investment in its subsidiaries, as well as the parent's ownership stake in its subsidiaries, should be eliminated.
- The extra cost incurred by the parent company in relation to the subsidiary, in addition to the investment in equity shares, should be recorded as goodwill on the day the subsidiary is funded.
- When the parent company's investment in the subsidiary is less than the parent company's equity portion in the subsidiary, the date of the investment should be noted as the capital reserve.
- A small portion of the consolidated subsidiary's net earnings for the reporting period must be acknowledged, regulated against the group's earnings, and credited to the owner or parent organisation.
- A minor amount of interest in the consolidated subsidiary's net earnings for the reporting period must be acknowledged and included in the consolidated balance sheet.
Also read: What is the List of Accounting Standard
Example and Format of Consolidated Balance Sheet
There are two companies owned by Mr Max, namely Max Electronics and Max Hardware. Mr. Max wants to prepare the consolidated financial statements for the same for analysing the financial position of the group. The same has been shown in the images below:
The above details clearly indicate the individual balance sheets of Max Hardware and Max Electronics as well as the consolidated balance sheet of the group the Max Group of Companies.
Advantages of preparing the Consolidated Financial Statements
It might be tough to keep track of the health of your company if it has several branches, subsidiaries, or sister firms. You could be curious about how your company is doing overall or how your various divisions are doing. Consolidated financial statements will help you find answers to all of these and other issues.
Consolidated financial statements are essential if you have a long-term stake in the parent firm (parent's shareholders or creditors). This is due to the fact that these financial statements provide a clear view of the merged entity's overall resources.
Limitations in the preparation of the Consolidated Financial Statements
- When temporal data sets are aggregated, any bit of information might be lost. This is especially true when the data is compiled from organisations with vastly varied operational characteristics.
- Because subsidiaries are legally distinct from their parents, a subsidiary's creditors and shareholders typically have no claim against the parent, and the subsidiary's stockholders do not share in the parent's earnings.
- As a result, people looking for information on the assets, capital, or revenue of particular subsidiaries will find the consolidated financial statements to be of limited use.
Situations where consolidated financial statements are not prepared
There are various situations where the consolidated financial statements are not prepared. These are as follows:
- If the parent company's stock or debt isn't listed on any public market, such as a stock exchange or an over-the-counter market, the parent business isn't required to submit consolidated financial statements.
- The presentation of consolidated statements is not needed if the parent firm is a wholly or partly owned subsidiary. However, this is dependent on the owners not questioning the parent firm for failing to represent the consolidated statements.
- If any parent produces the consolidated statements in accordance with the mandate of International Financial Reporting Standards (IFRS), then no consolidated statements for public use are required.
- If the parent business is about to file its financial statements with a security commission in order to issue any sort of public market instrument, the parent company will not be obliged to produce a consolidated balance sheet.
The consolidated financial statements reflect the direction in which a group of firms is headed. It provides a clear image of the firm and its future to existing and potential investors. But they never assist unless you take a thorough approach. To study the transaction and understand why the entry was recorded, look at the notes in the financial statement. This will assist you in gaining a thorough understanding of a firm. We hope this article has given you the relevant information about the consolidated financial statements in detail including the reasons for preparing it, the benefits and limitations of the consolidated financial statements, and also the example and format of the consolidated balance sheet.
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