What is a consolidated financial statement?
Consolidated financial statements pertain to the financial reports of businesses with multiple subsidiaries or divisions. Essentially, they involve creating a combined balance sheet, income statement, and cash flow statement.
These statements hold significant importance for investors, customers, and regulators alike, as they offer a comprehensive overview of the financial status of the entire enterprise, treating both the subsidiaries and the parent company as a unified legal entity.
Consequently, consolidated financial statements are essential for assessing the overall financial position of the business.
When would financial statements be necessary?
Consolidation involves the parent company incorporating the financial outcomes of its subsidiary as if it were its own. There are cases where even minority stakeholders can hold a controlling interest in a company. Consolidation is necessary when your company owns more than 50% of another company in small-business relationships. Despite the requirement for consolidation, the financial statements of the two companies can be prepared separately. However, those who intend to engage with external parties such as lenders, potential investors, government agencies, and others should opt for consolidation.
Does my business need to create consolidated financial statements?
According to UK law – specifically, the Companies Act 2006 (CA06) – medium-sized groups must prepare consolidated, or group, accounts. Small companies are exempt. To qualify as a small company, two of the following three conditions must be met:
- The business’s net turnover should not exceed £25.9m net, or £31.1m gross
- The business’s average number of employees should not exceed 50
- The business’s balance sheet total should not exceed £3.26m, or £3.9m gross
To present an accurate picture of your company’s finances, you may not need to consolidate all subsidiaries. If you don’t want to consolidate subsidiaries because:
- The interest of the parent company is held exclusively with the intention of a subsequent resale
- Obtaining the information required for the creation of a consolidated financial statement would require disproportionate expenses or cause undue delays
- Long-term restrictions are in place that stops the parent company from exercising rights over assets or management of the subsidiary
Remember that consolidated financial statements rules apply to foreign subsidiaries as well. So, in short, if your company is based in the UK, your subsidiaries must be consolidated.
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How to prepare consolidated financial statements
To create a consolidated financial statement for your company, it is necessary to follow these important guidelines:
1. Consistently apply accounting policies across all subsidiaries in the group.
2. Prepare financial statements for all group companies based on the same period-end for accounting.
3. When determining the acquisition date of a subsidiary, ensure it reflects the date when control is acquired (which may differ from the date stated in the legal agreement). In many cases, control is acquired later than the official agreement date.
Balance sheet
When consolidating financial statements, the parent company assumes ownership of all subsidiary assets, while the parent’s liabilities are reflected as liabilities. In situations where the parent pays a higher amount for a subsidiary than the net value of its assets (assets minus liabilities), the excess amount is recorded as “goodwill.”
For example, if you acquired a company for £100,000, which had assets valued at £220,000 and liabilities of £130,000, the net assets of the company would amount to £90,000. Therefore, £10,000 worth of goodwill would be included on the consolidated balance sheet.
What is “Goodwill”?
Goodwill is the surplus amount paid for an acquisition that exceeds the value of the net assets obtained. It signifies that the acquired business possesses a value greater than the sum of its individual components.
For example, if net assets valued at £100 million were acquired for a purchase price of £120 million, the goodwill would be calculated as £120 million minus £100 million, resulting in £20 million. This goodwill is presented as a distinct item in the group’s statement of financial position.
Equity
By merging the equity section of the balance sheet with the owners’ or shareholders’ equity statement, any equity related to subsidiaries is eliminated through the process of consolidation. Consolidation serves to remove equity associated with subsidiaries.
However, if the parent company possesses a smaller ownership percentage in a subsidiary, that portion of equity must be disclosed. For instance, if you acquire 80% ownership of a company valued at £90,000 for £100,000, the entirety of your balance sheet (including the £10,000 goodwill) would be incorporated. This would be recorded as a “minority interest” or “non-controlling interest” in both the equity section and the equity statement.
Other Statements
All revenues, expenses, losses, gains, and cash flows are combined and presented in the consolidated statements. The financial transactions between the subsidiary and the parent company are not reflected in the consolidated income and cash flow statements.
For example, if your company acquires a separate delivery service and utilizes their services for your deliveries, the payments made to the delivery service would not be recorded as expenses, revenue, or negative cash flow in the consolidated statements. These transactions pertain only to external suppliers or relationships, with no reporting of parent-subsidiary relationships in the consolidated statements.
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Statement of financial position: Summary
What does a financial statement look like?
ABC Ltd functions as the parent company, while XYZ Ltd operates as its subsidiary. Several years ago, ABC acquired XYZ for a sum of £1m, which coincidentally matched the net value of XYZ’s assets at that time. Hence, there existed no disparity between the amount paid for the acquisition and the value of the net assets obtained. Consequently, the ABC Ltd group’s financial statements reflect a goodwill value of £Nil.
Examining the following example:
The combined assets and liabilities of ABC and XYZ, along with the consolidated group figures, are provided above. The consolidated group statement demonstrates that the ABC group exercises control over a significantly larger magnitude of assets (£204m) than what ABC’s individual accounts imply (merely £4m). Furthermore, the group’s level of indebtedness surpasses what ABC’s accounts indicate. While ABC’s accounts reveal total liabilities of £3m, the consolidated group’s liabilities amount to £123m.
Benefits of consolidated financial statements
Monitoring the overall well-being of a business group becomes challenging when it comprises branches, subsidiaries, or sister companies. Questions may arise regarding the overall performance of the business or the individual performance of each branch. To address these inquiries and gain comprehensive insights, the creation of consolidated financial statements is crucial.
If you possess a long-term stake in the parent company, whether as a shareholder or creditor, consolidated financial statements hold significant importance. These statements provide a comprehensive overview of the collective resources of the combined entity, offering a clear and complete depiction of the business’s overall financial position.
Limitations of consolidated financial statements
When merging data from different time periods, it is essential to exercise caution as there is a risk of losing specific information. This concern becomes even more significant when combining data from companies that exhibit distinct operating characteristics.
Subsidiaries, being separate legal entities from their parent companies, have their own set of assets that are not accessible to their creditors or stockholders. Moreover, the profits generated by subsidiaries are not distributed or shared.
As a result, consolidated financial statements typically provide limited value to individuals seeking information about the assets, capital, or income of individual subsidiaries.
FAQ's
The creation of consolidated financial statements ensures an accurate and unbiased representation of an organization’s financial well-being. These statements are typically mandatory when a company possesses more than 50% of the common voting stock of another company.
Consolidated financial statements encompass the combined financial information of the parent company and its subsidiaries, portraying them as a unified economic entity. These statements encompass the assets, liabilities, equity, income, expenses, and cash flows of the entire group.
A Balance sheet is a record that details the financial position of a single company, whereas a Consolidated balance sheet is a statement that presents the combined financial status of multiple companies within the same group.