What must dilty do to ready the subsidiarys financial statements for consolidation?

What Are Consolidated Financial Statements?

Consolidated financial statements are financial statements of an entity with multiple divisions or subsidiaries. Companies can often use the word consolidated loosely in financial statement reporting to refer to the aggregated reporting of their entire business collectively. However, the Financial Accounting Standards Board defines consolidated financial statement reporting as reporting of an entity structured with a parent company and subsidiaries.

Private companies have very few requirements for financial statement reporting but public companies must report financials in line with the Financial Accounting Standards Board’s Generally Accepted Accounting Principles (GAAP). If a company reports internationally it must also work within the guidelines laid out by the International Accounting Standards Board’s International Financial Reporting Standards (IFRS). Both GAAP and IFRS have some specific guidelines for companies who choose to report consolidated financial statements with subsidiaries. 

Consolidated Financial Statements

Understanding Consolidated Financial Statements

In general, the consolidation of financial statements requires a company to integrate and combine all of its financial accounting functions together in order to create consolidated financial statements that shows results in standard balance sheet, income statement, and cash flow statement reporting. The decision to file consolidated financial statements with subsidiaries is usually made on a year to year basis and often chosen because of tax or other advantages that arise. The criteria for filing a consolidated financial statement with subsidiaries is primarily based on the amount of ownership the parent company has in the subsidiary. Generally, 50% or more ownership in another company usually defines it as a subsidiary and gives the parent company the opportunity to include the subsidiary in a consolidated financial statement. In some cases less than 50% ownership may be allowed if the parent company shows that the subsidiary’s management is heavily aligned with the decision making processes of the parent company. If a company has ownership in subsidiaries but does not choose to include a subsidiary in complex consolidated financial statement reporting then it will usually account for the subsidiary ownership using the cost method or the equity method.

Private companies will usually make the decision to create consolidated financial statements including subsidiaries on an annual basis. This annual decision is usually influenced by the tax advantages a company may obtain from filing a consolidated versus unconsolidated income statement for a tax year. Public companies usually choose to create consolidated or unconsolidated financial statements for a longer period of time. If a public company wants to change from consolidated to unconsolidated it may need to file a change request. Changing from consolidated to unconsolidated may also raise concerns with investors or complications with auditors so filing consolidated subsidiary financial statements is usually a long-term financial accounting decision. There are however some situations where a corporate structure change may call for a changing of consolidated financials such as a spinoff or acquisition.

Key Takeaways

• Consolidated financial statements are strictly defined as statements collectively aggregating a parent company and subsidiaries.
• GAAP and IFRS include provisions that help to create the framework for consolidated subsidiary financial statement reporting.
• If a company doesn’t choose to use consolidated subsidiary financial statement reporting it may account for its subsidiary ownership using the cost method or the equity method.

Reporting Requirements

As mentioned, private companies have very few requirements for financial statement reporting but public companies must report financials in line with the Financial Accounting Standards Board’s Generally Accepted Accounting Principles (GAAP). If a company reports internationally it must also work within the guidelines laid out by the International Accounting Standards Board’s International Financial Reporting Standards (IFRS). Both GAAP and IFRS have some specific guidelines for entities who choose to report consolidated financial statements with subsidiaries.

Generally, a parent company and its subsidiaries will use the same financial accounting framework for preparing both separate and consolidated financial statements. Companies who choose to create consolidated financial statements with subsidiaries require a significant investment in financial accounting infrastructure due to the accounting integrations needed to prepare final consolidated financial reports.

There are some key provisional standards that companies using consolidated subsidiary financial statements must abide by. The main one mandates that the parent company or any of its subsidiaries cannot transfer cash, revenue, assets, or liabilities among companies to unfairly improve results or decrease taxes owed. Depending on the accounting guidelines used, standards may differ for the amount of ownership that is required to include a company in consolidated subsidiary financial statements.

Consolidated financial statements report the aggregate reporting results of separate legal entities. The final financial reporting statements remain the same in the balance sheet, income statement, and cash flow statement. Each separate legal entity has its own financial accounting processes and creates its own financial statements. These statements are then comprehensively combined by the parent company to final consolidated reports of the balance sheet, income statement, and cash flow statement. Because the parent company and its subsidiaries form one economic entity, investors, regulators, and customers find consolidated financial statements helpful in gauging the overall position of the entire entity.

Ownership Accounting: Cost and Equity Methods

There are primarily three ways to report ownership interest between companies. The first way is to create consolidated subsidiary financial statements. The cost and equity methods are two additional ways companies may account for ownership interests in their financial reporting. Overall, ownership is usually based on the total amount of equity owned. If a company owns less than 20% of another company's stock, it will usually use the cost method of financial reporting. If a company owns more than 20% but less than 50%, a company will usually use the equity method.

Company Examples

Berkshire Hathaway Inc. (BRK.A, BRK.B) and Coca-Cola (KO) are two company examples. Berkshire Hathaway is a holding company with ownership interests in many different companies. Berkshire Hathaway uses a hybrid consolidated financial statements approach which can be seen from its financials. In its consolidated financial statements it breaks out its businesses by Insurance and Other, and then Railroad, Utilities, and Energy. Its ownership stake in publicly traded company Kraft Heinz (KHC) is accounted for through the equity method.

Coca-Cola is a global company with many subsidiaries. It has subsidiaries around the world that help it to support its global presence in many ways. Each of its subsidiaries contributes to its food retail goals with subsidiaries in the areas of bottling, beverages, brands, and more.

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