Consolidated Financial Statements

Consolidated financial statements are the financial statements prepared by a company (the parent) which has investments in more than 50% of the common stock of other companies (called subsidiaries). Consolidated financial statements are prepared by combining the parent’s financial statements with the subsidiary’s.

When an investor acquires less than 20% outstanding common stock of another company, it shows the investment using the fair value method (also called cost method). When the ownership interest is in the range of 20-50%, the investor adopts the equity method. As soon as the 50% ownership is acquired, the investor is required to prepare consolidated financial statements. It is because at 50% or more ownership, the investor controls the business and financing decisions of the investee effectively making the investee (now called subsidiary) just its own extension. In accordance with the substance over form principle of accounting, the parent and the subsidiary must be presented as a single economic entity.

The accounting procedures be adopted for preparation of consolidated financial statements depends on a number of factors:

• The extent of ownership: whether the subsidiary is wholly owned i.e. the parent owns 100% of the subsidiary’s voting rights;
• The purchase consideration paid i.e. the amount transferred to subsidiary against the stock acquired: i.e. whether any goodwill arises;
• The structure of the group: the number of subsidiaries and whether the subsidiary has a sub-subsidiary;

Consolidation of wholly-owned subsidiaries

When the parent acquired 100% of the outstanding common stock of the subsidiary, the consolidation process is pretty simple. You need to take the following steps:

1. Determine the acquisition date i.e. the cut-off date on which the control is effective;
2. Determine the fair value of the (purchase) consideration transferred whether in the form of cash or stock of the parent, identify contingent consideration, if any;
3. Determine the acquisition date fair value of the net identifiable assets of the subsidiary;
4. Compare the purchase consideration with the fair value of net identifiable assets: if the purchase consideration is higher, the difference represents the goodwill arising on acquisition, if the purchase consideration is lower, the acquisition is a bargain purchase;
5. Combine the subsidiary’s assets and liabilities at their fair values with the parent’s assets and liabilities and determine the additional depreciation and amortization is attributable to the difference between the acquisition date fair value and historical cost carrying value of the subsidiary’s assets and liabilities;
6. Eliminate any intra-group unrealized gains or loss on inventory and fixed assets transactions, any intra-group balances, etc.;
7. Remove the subsidiary’s shareholders’ equity balances as they appear in the subsidiary’s financial statements with the investment in subsidiary balance that appears in the parent’s individual financial statements;
8. Combine the revenues and expenses of the parent with the post-acquisition revenues and expense of the subsidiary to arrive at the consolidated net income;
9. Determine the consolidated retained earnings.

Consolidation when there is non-controlling interest

When the parent doesn’t hold 100% of the outstanding common stock of the subsidiary, it means that some portion of the subsidiary is held by outside investors. The interest accruing to such outstanding investors is called non-controlling interest (previously also called minority interest).

When non-controlling interest exists, the consolidation process as discussed above changes a little:

• The sum of the fair value of purchase consideration and the fair value of the non-controlling interest is compared with fair value of net identifiable assets; any excess is recognized as goodwill which is allocated to the parent and the non-controlling interest;
• The consolidated net income is allocated between the parent and the non-controlling interest in proportion of their interest;
• The consolidated balance sheet contains the amount of non-controlling interest, i.e. the shareholder’s equity attributable to the outside investors;
• The consolidated retained earnings is calculated differently because now it excludes the subsidiary’s retained earnings attributable to minority interest;

A consolidation worksheet is a very useful tool in the consolidation process.

by Obaidullah Jan, ACA, CFA and last modified on Nov 2, 2020