Consolidation Accounting
Consolidation accounting is a method used in financial reporting to combine the financial statements of a parent company and its subsidiaries into a single set of financial statements as if they were a single entity. This method is used when a parent company has controlling interest (typically more than 50% ownership) in one or more subsidiaries. The purpose of consolidation accounting is to provide a comprehensive view of the financial performance, position, and cash flows of the entire group, allowing stakeholders to assess the group’s overall financial health.
The main steps involved in consolidation accounting include:
- Combining the financial statements of the parent company and its subsidiaries line by line, adding together the corresponding assets, liabilities, revenues, expenses, and equity items.
- Eliminating intercompany transactions and balances, such as loans, payables, receivables, investments, and revenues or expenses between the parent company and its subsidiaries. This is done to avoid double counting and to present the group’s financial position and performance without the effects of transactions between its entities.
- Allocating the parent company’s investment in each subsidiary to the subsidiary’s assets, liabilities, and equity based on the parent’s ownership percentage. This ensures that the consolidated financial statements reflect the portion of the subsidiary’s financial position and performance that is attributable to the parent company.
- Adjusting non-controlling interests, which represent the portion of a subsidiary’s equity not owned by the parent company. Non-controlling interests are included as a separate component of shareholders’ equity on the consolidated balance sheet and are adjusted in the consolidated income statement to reflect the portion of the subsidiary’s net income not attributable to the parent company.
Consolidation accounting is required for publicly traded companies with subsidiaries and must be prepared in accordance with the relevant accounting standards, such as the International Financial Reporting Standards (IFRS) or the US Generally Accepted Accounting Principles (US GAAP). By using consolidation accounting, companies can provide a more accurate and complete picture of their financial performance and position, allowing stakeholders to make better-informed decisions about investing, lending, or conducting business with the group.
Example of Consolidation Accounting
Let’s consider a hypothetical example to illustrate the concept of consolidation accounting:
Parent Company M owns 100% of Subsidiary N and 75% of Subsidiary O. The individual balance sheets for the three companies as of December 31, 20XX, are as follows:
Parent Company M:
- Assets: $2,000,000
- Liabilities: $1,200,000
- Shareholders’ Equity: $800,000
Subsidiary N:
- Assets: $1,000,000
- Liabilities: $600,000
- Shareholders’ Equity: $400,000
Subsidiary O:
- Assets: $1,600,000
- Liabilities: $1,000,000
- Shareholders’ Equity: $600,000
To prepare consolidated financial statements using consolidation accounting, Parent Company M would follow these steps:
- Combine the balance sheets line by line:
- Total Assets: $2,000,000 (Parent Company M) + $1,000,000 (Subsidiary N) + $1,600,000 (Subsidiary O) = $4,600,000
- Total Liabilities: $1,200,000 (Parent Company M) + $600,000 (Subsidiary N) + $1,000,000 (Subsidiary O) = $2,800,000
- Eliminate any intercompany transactions and balances (assume there are none in this example).
- Allocate the parent company’s investment in each subsidiary to the subsidiary’s assets, liabilities, and equity based on the parent’s ownership percentage. In this example, Parent Company M owns 100% of Subsidiary N and 75% of Subsidiary O, so no further adjustments are needed for Subsidiary N. For Subsidiary O, 75% of its equity is attributable to Parent Company M.
- Adjust non-controlling interests, which represent the portion of a subsidiary’s equity not owned by the parent company. In this example, the non-controlling interest in Subsidiary O is 25% of its equity ($600,000 * 25% = $150,000).
The consolidated balance sheet would show:
- Total Assets: $4,600,000
- Total Liabilities: $2,800,000
- Shareholders’ Equity: $1,650,000 ($800,000 Parent Company M + $400,000 Subsidiary N + $450,000 (75% of Subsidiary O))
- Non-controlling interests: $150,000
By using consolidation accounting, Parent Company M provides a more accurate and complete picture of the group’s financial position, which helps investors, creditors, and other stakeholders make better-informed decisions about investing, lending, or conducting business with the group.
