Consolidation of accounts is one of the most important practices that help manage companies with branches and subsidiaries. It gives a consolidated report on a company’s financial position by integrating the figures of the parent and subsidiary companies.
In India, this is done with the help of Ind AS 110 (Indian Accounting Standard 110), which provides the principles and procedures for this activity.
This blog elaborates on how simple it is to make consolidated financial statements, and this guide is based on the accounting framework in India. From the definition of concepts to detailed planning, this guide intends to provide useful information and approaches for businesses, accountants, and students.
Introduction
The business environment of India is rapidly evolving and due to this many organizations increase their business activity through creating or acquiring subsidiaries, associates or affiliates. This growth requires the combining of financial information into one report that shows the group as one cohesive organization.
When companies grow and start buying other companies or assets, then the general performance of each company is important. Consolidated financial statements (CFS) serve this purpose. Consequently, instead of analyzing the company financial statements of individual parent and subsidiary companies, CFS offers the general status of the financial position, performance, and cash flows of the entire group.
The preparation of consolidated financial statements may appear to be a somewhat involving exercise because of the integration of data from a number of different entities.
Key Principles of Consolidation
Before going into the steps of consolidation of the statements, we have to understand the core principles that govern consolidation, which is essential. The principles are as follows –
Control and Its Implications
Taking that into consideration, the most basic measure used for consolidation is the idea of ‘control’. This is when a parent firm has the right to control the operations of the subsidiary firm, has the capacity to exercise that control and receives worthwhile consideration from the operations of the subsidiary firm. This is usually assumed if the total voting rights are more 50% which is owned by the parent. However, other things, such as contractual terms, can also create control.
Uniform Policies and Reporting Dates
The parent and subsidiary must adopt a set accounting policies and use the same reporting period. The policies and the reporting dates need to be made consistent with the group as much as possible, which means that any differences within them have to be brought to a similar level to the group’s requirements.
Transparency Through Elimination
There are some principles which should be followed in the process of consolidation, including a removal of intragroup transactions, balances and unrealised profits. This ensures that the consolidated statements reflect only external transactions and the true financial position of the group.
Steps to Prepare Consolidated Financial Statements
A consolidated financial statements are prepared in a systematic manner, and generally, it is several times to get proper accuracy and the requirement of the accounting standards. Detailed process is given below-
- Understand the Scope of Consolidation
Begin by identifying the entities to be consolidated. This includes subsidiaries where the parent has control, associates where significant influence exists (typically between 20-50% ownership), and joint ventures. Each type of entity contributes differently to the consolidation process.
- Prepare Standalone Financial Statements
Ensure that the parent and all subsidiaries prepare their individual financial statements. These should align to Ind AS and provide details of all assets and liabilities, revenues and expenses in detail. To achieve high consolidation success, it is pertinent to begin with correct standalone reports.
- Adjust for Uniformity in Policies
In addition, each entity’s accounting policies need to be considered. This is a useful point when the subsidiary of a company has differed, and this calls for adjustments in order to align the accounting policy of the subsidiary to that of the group. For example, when one entity applies the straight-line method and the other – declining balance method, the data of the second one are adjusted.
- Eliminate Intra-Group Transactions
One of the most complex aspects of consolidation is removing the effects of intra-group transactions. These may include-
- Sales between entities within the group.
- Loans or advances provided by the parent to subsidiaries.
- Dividends are paid within the group.
- Unrealized profits on inventory transferred between group entities.
For example, if any parent company sells goods to a subsidiary, the revenue recognized in the parent’s books and the expense recorded in the subsidiary’s books must both be eliminated.
- Account for Non-Controlling Interests
Non-controlling interests represent the share of equity in the subsidiary that is not owned by the parent. Calculate and present NCI separately in the consolidated financial statements. This includes their proportionate share of the subsidiary’s net income and net assets.
- Combine Financial Statements
On consolidation, add the financial statement of the parent right from line to line with those of its subsidiaries. This entails summing up the value of resources, obligations, revenues, costs, and all inter-group influences that have been eliminated.
- Adjust for Investments in Subsidiaries
Substitute the parent’s investment in subsidiaries with an amount of the subsidiary’s net assets plus goodwill (where applicable). Goodwill can be identified where the cost of acquisition is more than the fair value of the acquired assets. If it is lower, then the difference is credited to the capital reserve account.
- Review, Reconcile, and Finalize
After combining the data, thoroughly review the consolidated statements to ensure accuracy. Reconcile balances, cross-check eliminations, and confirm that all regulatory disclosures are included.
Common Challenges in Consolidation
While preparing consolidated financial statements, businesses often encounter challenges such as those given below-
- Accounting Data Problems- Subsidiary businesses may apply different sets of accounting records due to their operations in different industries or countries, hence numerous modifications needed.
- The complexity of Intra-Group Transactions- This mostly entails eradicating intra-group profits, balances, and transactions, which entail comprehensive knowledge of every member’s financial statements and considerable manipulation. Identifying and eliminating intra-group transactions can be time-consuming and prone to errors.
- Non-Controlling Interests- Accurately calculating and presenting NCI, especially in cases with multiple levels of ownership, requires significant expertise. Ensuring the accuracy of financial data from subsidiaries requires coordination and communication.
- Change in Ownership – This is a situation that makes the process even more challenging due to the required proportional adjustments and changes in the parent’s ownership percentage during the financial year.
To overcome the above challenges, there is a need to adopt a proper reporting system, use consolidation software, or consult a chartered accountant.
Conclusion
Preparing consolidated financial statements involves many complex procedures that call for attention to detail, full-fledged knowledge of the standards of accounting, and prudent planning. In this respect, adherence to Ind AS 110 ensures businesses make a proper and fair presentation of group-level financial performance.
A well-planned approach, beginning with the preparation of standalone financial statements, uniform policies, removal of intra-group transactions, and accurate calculation of non-controlling interests, makes the consolidation process much simpler for businesses. Consolidated financial statements are a necessity to provide transparency, boost investor confidence, and comply with the regulatory requirements despite the difficulty involved.
This will make it a consolidation exercise that, in reality, has little to do with compliance for businesses especially for businesses that operate in multiple industries. For businesses with diversified operations, mastering consolidation means more than just showing that the group is financially strong and unified.
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