Methods of Consolidating Financial Statements
In recent decades, the developments in company law, and the issue of national and international accounting standards, has increased the amount of information that needs to be disclosed in financial statements. However, users of the financial statements should bear in mind the limitations of consolidated financial statements resulting from the legal requirements, accounting policies and limits on the information available at the time the financial statements were prepared.
Users of consolidated accounts should be aware of the laws and accounting conventions under which the accounts have been compiled, as these may affect the figures in the financial statements. For example, such consolidated accounts normally use more than one method to consolidate the results of subsidiaries, associates which are not controlled, and portfolio shareholdings. The user should be acquainted with the particular method of accounts preparation used in the jurisdiction whose laws and regulations are applicable.
The results of a subsidiary company would be consolidated with the results of the parent company. A subsidiary company would normally be defined as one which is controlled by the parent company of the group, by reason of shareholding above 50%, voting power or some other factor. This means that the assets and liabilities of the subsidiary would be incorporated with those of the rest of the group on the balance sheet, and the revenue and expenses consolidated in the group profit and loss account, with adjustments for intragroup revenue and expenses.
However, a company in which the parent company has significant influence, but does not have control, for example an associated company in which the parent company has at least a 20% shareholding, would normally be included in the consolidated financial statements using the equity method. Under this method, the investment in the associate would be initially recorded at cost, and then adjusted for the changes in the group’s net share of the assets of the company. There would not be full consolidation of the income, expenses and assets of the associated company with the group.
For those companies in which the parent company has less than a 20% shareholding, and does not have significant influence, only the investment made in the company would be shown on the balance sheet, and dividends from that company would be recorded in the profit and loss account as they arise, with no further consolidation.
Differences in methods of consolidation could give rise to a different result in terms of the profit and loss account and balance sheet. The user of the consolidated financial statements should therefore check the accounting policy, or the standard under which the financial statements have been compiled. There may, for example, be cases where the group has a less than 20% holding in a company, but consolidates using the equity method, as it nevertheless has significant influence in that company.