Consolidated financial statements: Guide & requirements
One of the most significant financial challenges companies face, particularly those managing multiple entities, is getting a comprehensive view of their financial health. When a company owns several subsidiaries, it becomes difficult to assess overall performance using standalone reports from each entity.
Consolidated financial statements provide a solution by combining the financial data of both the parent company and its subsidiaries into a cohesive set of documents. This unified view is essential for understanding total financial performance and making informed decisions that maintain transparency for stakeholders, auditors, and investors.
What are consolidated financial statements?
At their core, consolidated financial statements are reports that aggregate the financial data of a parent company and its subsidiaries, presenting the information as though the entire group were a single entity. This process, known as financial consolidation, eliminates redundancies, adjusts for non-controlling interests (the portion of the subsidiary that is not owned by the parent company), and offers a holistic view of the company’s financial status.
These reports include key documents such as the consolidated income statement, balance sheet, and cash flow statement, which provide an overall view of liabilities, assets, cash flow, and more. The goal is to provide stakeholders with a clear understanding of how the company is performing as a whole, including any subsidiaries or related entities.
A typical consolidated income statement shows the combined revenues and expenses of all subsidiaries, giving investors a clear picture of the company's profitability. This type of reporting is particularly crucial for businesses with complex organizational structures, as it ensures that all financial activity is captured and reported consistently. It’s also essential for meeting legal and regulatory requirements, such as generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS), which mandate the preparation of consolidated financial reports for companies with significant control over subsidiaries.
How to consolidate financial statements
The process of consolidating financial statements involves several steps to ensure accuracy and compliance. Below is a step-by-step guide to help businesses effectively prepare their consolidated financial reports:
Step 1: Organize finances across all entities
To make the financial reporting process easier, companies should start with good financial hygiene and accounting best practices. This ensures that a company’s financial data is always clean, accurate, and readily available for reporting.
Financial management software (also referred to as spend management) can make a dramatic difference. For example, some great ways to improve financial data accuracy are to implement a reliable system for expense reports, use tech-enabled corporate cards to help track spending, and find ways to automate the categorization and entries into the company’s general ledger (GL) to reduce manual errors.
Step 2: Identify all subsidiaries and entities
The official first step in consolidating financial statements is identifying all subsidiaries and related entities that need to be included in the consolidated financial reports. Any entity the parent company has control or significant influence over must be part of the consolidation process. Control is typically defined as owning more than 50% of the voting stock, but entities with joint control or significant influence may also need to be considered.
Step 3: Collect and align financial statements
Once all entities have been identified, the next step is to gather financial statements from each subsidiary. These statements must be aligned in terms of the reporting period and accounting standards to ensure consistency. For instance, if a parent company uses IFRS but its subsidiaries report under GAAP, adjustments will need to be made so that all data can be consolidated under one framework.
Step 4: Eliminate intercompany transactions
A crucial step in consolidation is eliminating intercompany transactions. These are transactions between the parent company and its subsidiaries or between subsidiaries themselves. For example, if one subsidiary sells goods to another, this transaction must be removed from the consolidated reports to avoid overstating revenues or expenses. Eliminating these internal transactions ensures that the consolidated financial statements accurately reflect external operations.
Step 5: Adjust for non-controlling interests
In cases where the parent company holds less than 100% of a subsidiary, adjustments need to be made for non-controlling interests. Non-controlling interests represent the portion of the subsidiary that is not owned by the parent company. These adjustments ensure that the consolidated financial statements accurately reflect the parent company’s ownership equity, while the portion belonging to external shareholders is reported separately.
Step 6: Combine financial data into a single statement
Once all adjustments have been made, the financial data from each subsidiary is combined into a single, unified consolidated financial report. This report should include the consolidated income statement, balance sheet, and cash flow statement. The goal is to present an accurate and comprehensive picture of the company’s overall financial standing.
Step 7: Review and audit for accuracy
Before finalizing the consolidated financial statements, it's important to review and audit them for accuracy. This step ensures that all intercompany transactions have been properly eliminated, non-controlling interests have been accurately represented, and all financial data is correctly aligned. Many companies choose to have an external audit to ensure compliance with GAAP, IFRS, or other relevant accounting standards.
Step 8: Monitor changes and update statements regularly
Financial consolidation is not a one-time process. Companies must regularly update their consolidated financial statements to reflect any changes in their subsidiaries or entities. This includes acquisitions, mergers, or structural changes that affect ownership or financial control. Maintaining up-to-date financial reports is crucial for ensuring compliance and providing accurate financial data to stakeholders.
Companies with consolidated financial statements
Many large corporations are required to prepare consolidated financial reports due to their ownership of multiple subsidiaries. Let’s take a look at a few well-known companies:
- Amazon: With numerous subsidiaries such as Amazon Web Services (AWS), Whole Foods, and Zappos, Amazon needs to consolidate its financial data to present a complete financial picture. One of the biggest challenges Amazon faces is aligning diverse financial data from subsidiaries that operate in various industries and regions. Additionally, it must eliminate a wide range of intercompany transactions to avoid overstating revenue.
- Alphabet (Google): As the parent company of Google, Waymo, YouTube, and other businesses, Alphabet relies on consolidated financial statements to give a clear picture of its financial health. Alphabet's main challenge is managing a large number of transactions between its subsidiaries and accurately representing non-controlling interests for investors.
- Procter & Gamble (P&G): P&G manages dozens of brands, each operating as a subsidiary in different parts of the world. To ensure a transparent financial view for its investors, P&G must prepare a consolidated income statement and other financial reports. Given its global presence, P&G faces challenges such as currency conversion, aligning international accounting standards, and eliminating intercompany sales.
Combined vs. consolidated financial statements: Key difference
It's essential to understand the difference between combined vs consolidated financial statements. While they may seem similar, the distinction is critical for financial reporting purposes:
- Combined financial statements include the financials of both the parent company and its subsidiaries, but they are all reported separately. The financial statements for each subsidiary and parent company remain distinct, but are reported in the same document. This is particularly helpful when a company owns many subsidiaries and finance teams or investors want one place where they can analyze the financial health of each entity individually.
- Consolidated financial statements, on the other hand, merge the financial data of the parent company and its subsidiaries into a single report. In doing so, intercompany transactions are eliminated to avoid double-counting revenue or expenses. The benefit of consolidation is that it offers a more accurate and complete view of the company's overall financial performance, making it the preferred method for regulatory reporting and investor relations.
Financial statement reporting requirements
Both GAAP and IFRS set the framework for preparing consolidated financial statements. Adhering to these standards ensures consistency and accuracy across all financial reports. Here are some key requirements to consider:
- Ownership threshold: A company must consolidate the financial statements of any entity in which it holds more than 50% ownership or exercises control.
- Intercompany transactions: These transactions must be removed from the consolidated income statement and other financial reports to ensure the data reflects only external business activities.
- Non-controlling interests: If a company does not fully own a subsidiary, the portion of that subsidiary not owned by the parent company must be disclosed in the financial statements.
By following these guidelines, businesses can produce transparent and compliant consolidated financial reports that meet the expectations of regulators, auditors, and stakeholders.
Simplify financial consolidation with Rippling
Financial reporting and spend management can be complex, but Rippling Spend simplifies the process by:
- Automating financial hygiene: Rippling streamlines financial reporting with its corporate cards, bill pay, expense management, and accounting integrations with Netsuite, Xero, QBO, Intacct, and others. The automatic tracking and syncing reduce the possibility for manual errors that could delay or misrepresent financial reporting.
- Eliminating intercompany transactions: Natively supports multi-entity and multi-subsidiary company structures, so it can directly track and eliminate intercompany expenses for a clean consolidated report.
- Supporting compliance readiness: Creates complete audit histories and audit trails for every expense and transaction processed through Rippling.
Simplifying payroll and expense management: Integrates payroll with financial consolidation, ensuring that employee-related expenses are automatically captured in total company expenses.
FAQs on consolidated financial statements
What are consolidated financial statements typically?
Consolidated financial statements typically combine the financial data of a parent company and its subsidiaries into a single report. They eliminate intercompany transactions and offer a unified view of the company’s overall financial health, including ownership stakes and non-controlling interests.
How do you know if financial statements are consolidated?
You can tell financial statements are consolidated when they include the financial results of both the parent company and its subsidiaries. These reports will adjust for intercompany transactions and reflect non-controlling interests.
What is the difference between separate and consolidated financial statements?
Separate financial statements report the financial performance of individual entities, while consolidated financial statements merge the financial data of a parent company and its subsidiaries into a unified report. Consolidated statements eliminate internal transactions, providing a comprehensive view of the entire group.
This blog is based on information available to Rippling as of October 25, 2024.
Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.