Financial consolidation is when a parent company and its subsidiaries combine all of their financial information – including assets, liabilities, net assets/equity, revenue, expenses, and cash flows – into a single financial statement. The process becomes more difficult for companies as they expand across multiple entities and have a larger number of intercompany transactions.
How to consolidate financial statements
In order to prepare consolidated financial statements efficiently, there are three main steps that should be followed: combination of assets, offset, and removal of intragroup transactions.
Combination of assets
Firstly, all financial data will be collected independently at the subsidiary level and then mapped out to the parent company. At this stage, any foreign exchange rates will need to be addressed and converted to the appropriate currency. Then, every balance sheet from across the parent company's subsidiaries must be combined so all of the financial information is sealed into one thorough document.
Offset
Offset occurs when you balance out the investment a parent company has in its subsidiaries. Any related equity that the parent company holds in its subsidiaries needs to be raised and removed from the final financial statement.
Removal of intragroup transactions
Finally, intercompany financial transactions between entities of the same economic group need to be removed. These will be tackled one by one and will need an elimination entry to be applied in order to zero out the activity.
Who is required to prepare consolidated financial statements?
Parent companies are required to prepare consolidated financial statements, although there are a few exceptions. Under the Companies Act, small groups don’t need to prepare consolidated financial statements. For this reason, the size of parent companies and groups needs to be determined correctly.
What issues can occur during financial consolidation?
Consolidating financial statements is a complex process and therefore it’s not uncommon for issues to arise. Some of the obstacles that may be encountered during consolidation include:
- Low quality or inaccurate data: when consolidating financial statements, data is often manually inputted by employees working across various company locations and using different databases. Unfortunately, this means there’s a risk of human error. If there are mistakes in the reports, it can massively impact the overview of a company's performance. Due to this, processes may need to be introduced to keep records as accurate and reliable as possible. Companies can opt to create their reports using financial consolidation software to minimise the risk of input mistakes.
- Different currencies: if subsidiaries are located in different countries, the currency needs to be converted, so all the data can be accurately combined into the finalised report.
- Changing reporting requirements: accounting consolidation reporting guidelines and requirements are continually being updated. As companies grow, it’s important to keep on top of changes to the process to achieve best practice in consolidation.
- Mixed approaches across subsidiaries: issues can arise if divisions or subsidiaries prepare their reports using different methods or software. This is why it’s best if companies adopt a single-system approach – so all subsidiaries have a standardised reporting procedure.
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