Large enterprises are often groups of enterprises that include a parent company and subsidiaries. The creation of groups of enterprises opens up wide opportunities for the members of the group. So, for example, thanks to intra-group operations, there are opportunities for access to new technologies, expanding the scope of activities, and reducing financial and tax losses. Ultimately, the enterprises in the group can significantly increase profitability and technological level of production.
The downside is that the reporting of individual enterprises of the group cannot provide its users with the necessary information for a complete assessment of the group’s activities. This demands consolidation accounting and preparation of consolidated financial statements.
For accounting purposes, the group as a whole is considered as a single economic unit that prepares its financial statements together. Therefore, the main purpose of drawing up consolidated financial statements is to present the activities of parent and subsidiary companies as a single business organization. Thus, the process of compiling the financial statements of a company in a group is called consolidation accounting.
How it works
The consolidation accounting method is typically used when a parent entity has a significant influence over another entity. Significant influence occurs when an investor has a significant influence on the operating and financial policies of the company they invest in, which is typically considered having at least 50% of the shares. The ability to influence can be manifested in participation in the board of directors, in policy development, in the conclusion of large transactions between companies, in the exchange of management personnel, and so on.
The acquisition of more than 50% of the share capital makes it possible to establish control over the activities of the company. Control is defined as the ability of an investor to control the business and financial policies of the company in which they own the shares in order to obtain profit from its activities.
Consolidation accounting is a complex procedure aimed at consolidation and synchronization in the future of reports submitted by individual companies of a single group. This procedure is carried out in cases where it is required to obtain complex data on the financial position of consolidated organizations. The reporting package is submitted as one whole.
The smallest group consists of two companies. A group is created when one company (organized as a parent company) acquires a controlling interest in the share capital of another company (which will be called a subsidiary). There is no upper limit on the number of companies forming a group.
As a rule, the parent company prepares consolidated financial statements. The resulting summary report makes it possible to see objective and most accurate data for investors and managers. The requirement to prepare a consolidated report is quite justified since it is impossible to judge the real financial position of a group of enterprises only from the data of the parent company. Accordingly, consolidation accounting makes it realistic to assess the possible return on investment.
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The reports prepared as a result of consolidation accounting illustrate the degree of control over subsidiaries that a parent company has. Consolidation adds up all the assets, liabilities, and results of operations of all the business entities in the group so that the consolidated financial reports present general financial information about the group as a single business entity.
All the accounting standards must be adhered to when preparing these consolidated reports. The structure of such reporting includes the Balance sheet, data on the profit and loss of all the business entities, information on changes that have occurred in equity capital, data on cash flows. In addition, the report contains notes, which are explanations for the figures in different reports.
There are a few items you should pay special attention to during the consolidation accounting. First, this would be net income. You will be using a consolidated worksheet to combine the separately recorded revenues and expenses of the parent company with those of the subsidiary. At the same time, if the consolidation accounting is done as part of the acquisition, it is necessary to make adjustments because every company reflects its expenses based on their original book value and not the fair values the parent must recognize.
In addition, appropriate adjustments should be recorded to zero out the effects of transactions made between the companies in the group from the consolidated financial reports. Any corporate overhead that is allocated to subsidiaries should be charged to the subsidiaries. This also includes charging any payables and payroll expenses. Intercompany loans and interest income should also be properly allocated.
Finally, it is good practice to review the financial data provided by the subsidiaries as well as the parent company to ensure that all the records are corrected and all the necessary adjusting entries have been made before compiling one set of the financial statements for the whole group of the business entities.
Author: Charles Lutwidge