The Importance of Consolidated Financial Statements

consolidated-financial-statements

Consolidated financial statements are the statements of a group or an entity in which the liabilities, assets, expenses, income, equity, and cash flows of multiple divisions and subsidiaries are presented as those of a single economic entity. Companies often use the word consolidated in financial statement reporting to refer to the aggregated reporting of their entire business collectively.  

However, consolidated financial statement reporting is defined by the Financial Accounting Standards Board as reporting of an entity structured with a parent company and subsidiaries. Each subsidiary contributes income and liability to financial strength. So, reporting only the financial report of the parent company is not enough. The requirement for financial statement reporting is very less for private companies, but in the case of public companies, they must report financials in line with the Financial Accounting Standards Board’s Generally Accepted Accounting Principles (GAAP). However, internationally working companies should follow the guidelines of the International Accounting Standards Board’s International Financial Reporting Standards (IFRS).

Understanding Consolidated Financial Statements:

  • In consolidated financial statements, the company is required to combine all of its accounting functions to create a report that shows results in the standard balance sheet, income statement, and cash flow statement reporting.
  • The consolidated financial statements with subsidiaries are made on a year-to-year basis due to the taxes or other advantages.
  • The amount of ownership a parent company has on a subsidiary decides the criteria for filing a consolidated statement.
  • Usually, the ownership of 50% or more defines a company as a subsidiary of the parent company, allowing it to include in the statements.
  • Some cases can also be seen, where less than 50% ownership is allowed to be included in the statements.
  • In the case of private companies, the decision to create consolidated or unconsolidated financial statements with their subsidiaries is heavily influenced by the tax advantages a company might get by filling in the subsidiary reports on an annual basis.

Purpose of Consolidated Financial Statements:

  • To grow a company, it usually requires to buy out the competition to gain the customers. Expanding business by adding new products, services, and technology can also help to grow a company.
  • Sometimes, purchasing smaller companies can also help expand the company.
  • The subsidiary companies usually continue to operate as separate companies, but now they are under the parent company.
  • According to the accounting rules, every subsidiary company is required to have its accounting records.
  • These separate reports are then combined or integrated with the parent company’s accounting records to give the consolidated finances.

Objectives of Consolidated Financial Statements:

  • It would be challenging for investors or financial analysts to gather the accounting reports from the parent company as well as the subsidiary companies to get the idea about the financial health of the entire company.
  • So, the companies are required to present the financial reports or financial data for all the subsidiaries as consolidated.
  • The parent company can present the reports of their finance, but that must be supported by the consolidated statement of all the branches or subsidiaries.

Pros and Cons:

  • The consolidated reports are easier to understand and analyze the company’s financial condition, which can help the investors, creditors, vendors, or anyone looking for information about the company.
  • These reports can also be manipulated in a way that can hide the financial position of a company as they do not give an accurate idea of the financial health of the company as the individual reports do not show up anywhere but in the notes section of the consolidated finance.
  • The fact that the reports from the subsidiaries only show up in the notes section makes it possible to hide the problems.
  • The Accounting Standards Board regularly visits this subject to correct definitions and requirements, which might create a problem for companies trying to hide their losses and liabilities.
  • The International Accounting Standards Board is also working to create some rules and definitions to make the evaluation easier and reliable while examining the financial reports of foreign companies and companies with offshore subsidiaries.

The Importance:

  • Without the consolidated financial reports, the evaluation of a company’s financial health would be long and complicated.
  • The investors or creditors might miss a valuable asset or liability when going through finances and reports.
  • These financial reports make everything more systematic as well as easy to understand from the investor’s perspective.
  • The investors, regulators, and customers find consolidated financial statements helpful to look after the entire entity as it makes the parent company and its subsidiaries as one single unit or entity.

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