Informed decision-making is an absolute necessity in corporate finance, which is why consolidated financial statements are crucial. These statements provide a thorough understanding of a company's financial position, including their assets, expenses, and profits. This article answers some questions commonly asked about consolidated financial statements while covering how finance teams can best leverage financial consolidation software.
What Are Consolidated Financial Statements?
Consolidated financial statements are financial reports that combine the financial data of a parent company and its subsidiaries to portray them as a single economic entity. These reports consist of consolidated income statements, consolidated balance sheets, and consolidated cash flow statements.
The data used for financial consolidation include a company's total assets, liabilities, equity, income, expenses, and cash flows. These data points are sourced from the company's business units, subsidiaries, acquired entities, investments, joint ventures, and other controlling interests.
Who Must Prepare Consolidated Financial Statements?
The responsibility to prepare and present consolidated financial statements typically falls on companies that are parents at year-end. In other words, companies classified as parent entities at the end of the financial year often need to consolidate their financials. Other companies can also choose to prepare consolidated financials if their owners desire these reports to assess their performance.
What Are the Types of Consolidated Statements?
There are three main types of consolidation: full consolidation, equity consolidation, and proportionate consolidation.
What Is Full Consolidation?
The full consolidation method is used when a parent company owns a controlling interest (50% or greater) of the subsidiary company. In this case, all the assets, liabilities, account balances, and other financials of the subsidiary entity are combined with those of the parent company on a single financial statement. This effectively portrays the parent company and the subsidiary as a single entity.
What Is the Equity Method?
Equity consolidation is typically applied when the parent company owns 20-50% of the subsidiary—or less than 20% but with significant influence. The parent company treats its investment in the subsidiary as an asset on its balance sheet. This reflects the value of its ownership stake in the subsidiary.
What is Proportionate Consolidation?
Proportionate consolidation is used when a parent company jointly owns a venture with other organizations. In this method, the parent company reports only its proportionate share of the joint venture's trial balances.
It is of note, however, that the equity method is now being used by most companies in place of proportionate consolidation.**
What Regulatory Guidelines Impact Consolidated Financial Statements?
Consolidated financial statements must follow certain key principles, including accuracy, transparency, consistency, comparability, and sincerity. Reporting companies observe these principles by following regulatory guidelines like the Generally Accepted Accounting Principles (GAAP), the International Financial Reporting Standards (IFRS), and the Accounting Standards for Private Enterprises (ASPE).
GAAP is used by both public companies and some private entities in the United States. IFRS is used by international companies, while ASPE is used by private SMBs in Canada.
Why Are Consolidated Financial Statements Important?
Consolidated financial statements provide a holistic view of the financial results and cash position of a company and its business units rather than that of a single department. This feedback enables stakeholders to make informed decisions, ensuring efforts are directed toward the most critical business areas.
Additional benefits of consolidated financial statements include:
- Improved credibility and accountability: Consolidated financial statements can enhance a company's financial accountability. This is especially true when regulatory guidelines are applied.
- Better parent company supervision: Consolidated financial statements help ensure that subsidiary operations align with the parent's strategic goals.
- Increased corporate trust: By presenting a fair representation of the company's financial health, consolidated financials ensure trust among investors, board members, and regulators.
- Better risk assessment: Consolidated financial statements can help evaluate a company's risk exposure and manage it effectively.
How Are Consolidated Financial Statements Prepared?
To prepare consolidated financial statements, a company must first gather and map the financials of its business interests to a centralized chart of accounts. This data is then refined through specialized calculations, currency conversions, and intercompany eliminations, among other processes. The compiled financial data is then documented and presented as the consolidated financial statements.
Many companies use spreadsheets to compile consolidated financial statements. But this approach is being replaced with purpose-built financial consolidation software.
What Are the Steps Involved In Preparing a Consolidated Financial Statement?
The process of financial consolidation using automated software can follow these steps:
- The automated system sources financial information from the parent company, its subsidiary entities, and other business interests.
- The software performs a variety of data adjustments, including:
- Making error and inconsistency checks
- Performing currency conversions for balances recorded in foreign currencies
- Eliminating intercompany balances to prevent errors**
- Performing consolidation calculations based on regulatory guidelines
- Finance teams use the final, adjusted data to prepare consolidated financial statements.
What Are the Limitations of Consolidated Financial Statements?
Although consolidated financial statements are hugely beneficial for organizations, they're not without their limitations. Here are some of these common challenges faced by finance teams:
- Complexity: A consolidated financial statement may include complex information, especially when multiple divisions are being reported.
- Currency differences: Sometimes consolidation-related currency conversions may introduce foreign exchange risks and distort an entity’s true financial position.
- Differential reporting standards: Subsidiaries may operate under different accounting standards or principles. Consolidation requires aligning these differences, which can be challenging and result in a loss of comparability.
- Intercompany transactions: If intercompany transactions are not eliminated properly, it can lead to potential overstatement or understatement of revenues and expenses.
- Divergent interests: The interests of the parent company and its subsidiaries may not always align perfectly. Conflicts of interest or differences in strategic objectives can complicate the consolidation process.
- Loss of detail: Using consolidated financial statements, which offer a summarized perspective on financial performance, may potentially result in a decrease in granularity.
- Regulatory compliance: Preparing consolidated financial statements in compliance with accounting standards and regulations can be time-consuming and costly.
How Do You Address the Limitations of Consolidated Financials?
Below are some ways finance teams can mitigate challenges associated with consolidated financial statements:
- Document accounting methodology differences so they can be tracked and reported throughout the consolidation process.
- Enforce effective communication and reporting procedures throughout the organization.
- Enforce reporting schedules and ensure timely submission of financial data.
- Apply accounting best practices for translating foreign currencies.
- Stay up-to-date with regulatory guidelines.
- Incorporate supplementary disclosures, like disaggregated information.
- Use purpose-built consolidation software to streamline the consolidation process.
The Role of Consolidated Financials in Ensuring a More Accountable Financial Landscape
In conclusion, consolidated financial statements can provide an accurate picture of the financial position of an entire business group. Specific types of these statements include consolidated income statements, consolidated cash flow statements, and consolidated balance sheets. With Fluence's financial consolidation software, finance teams can prepare high-quality consolidated statements with ease. Talk to our experts today.
