How to Prepare Consolidation of Financial Statements: Step-by-Step Guide with Examples

Introduction

Consolidation is the process of combining the financial information of multiple entities into a single set of consolidated financial statements. This helps companies gain a better understanding of their overall financial performance and position by presenting an accurate picture of the entire group. It also provides investors, creditors, and other stakeholders with an accurate assessment of the company’s financial health.

The benefits of consolidating financial statements include improved visibility of group performance, increased transparency, and improved analysis and insights. By preparing consolidated financial statements, companies can more accurately assess their financial standing and make informed decisions about their future.

Step-by-Step Instructions on How to Create Consolidated Financial Statements

Creating consolidated financial statements involves several steps, including choosing a starting point, determining the scope of consolidation, identifying controlling interests, preparing the consolidating worksheet, making adjustments, and calculating consolidated totals.

Choose a Starting Point

The first step in creating consolidated financial statements is to choose a starting point. This typically includes selecting the parent company, which is the company that controls the other companies in the group. The parent company is responsible for preparing the consolidated financial statements.

Determine the Scope of Consolidation

After choosing the parent company, the next step is to determine the scope of consolidation. This involves deciding which companies are included in the financial statements and which are excluded. Companies may be excluded for various reasons, such as if they are not owned or controlled by the parent company.

Identify Controlling Interests

The next step is to identify controlling interests. This involves determining who has control over the other companies in the group. This can be done by looking at the ownership structure and voting rights of each company. Generally, the parent company will have a majority stake in the other companies in the group.

Prepare the Consolidating Worksheet

Once the scope of consolidation has been determined, the next step is to prepare the consolidating worksheet. This worksheet combines the financial information of all the companies in the group into a single set of consolidated financial statements. It should include all relevant data, such as assets, liabilities, and equity.

Make Adjustments

Once the consolidating worksheet has been prepared, the next step is to make any necessary adjustments. This may involve adjusting for intercompany transactions, different accounting principles, goodwill, and minority interests. These adjustments ensure that the consolidated financial statements are accurate and complete.

Calculate Consolidated Totals

The final step is to calculate the consolidated totals. This involves adding up the totals from the individual companies in the group and arriving at a single set of consolidated totals. This total is then used to create the consolidated financial statements.

Common Challenges Associated with Consolidation and Solutions

Consolidation can be challenging for many companies due to the complexity of the process. Here are some of the most common challenges associated with consolidation and their solutions.

Eliminating Intercompany Transactions

One of the most common challenges associated with consolidation is eliminating intercompany transactions. This involves removing any transactions between the companies in the group so that the consolidated financial statements accurately reflect the performance of the group as a whole. To do this, companies must adjust the entries in the books of each company in the group.

Adjusting for Different Accounting Principles

Another challenge associated with consolidation is adjusting for different accounting principles. Each company in the group may use different accounting principles, so it is important to adjust the entries in the books of each company to ensure that the consolidated financial statements accurately reflect the performance of the group as a whole.

Adjusting for Goodwill

Goodwill is the difference between the fair value of a company and its book value. When consolidating financial statements, it is important to adjust for goodwill to ensure that the consolidated financial statements are accurate and complete. This can be done by calculating the difference between the fair value of the company and its book value.

Calculating Minority Interests

When consolidating financial statements, it is important to account for minority interests. This involves calculating the percentage of ownership held by minority shareholders and adjusting the consolidated financial statements accordingly. This ensures that the consolidated financial statements accurately reflect the performance of the group as a whole.

Examples of Consolidated Financial Statements from Real-World Businesses

To better understand how to create consolidated financial statements, let’s take a look at some examples from real-world businesses.

Example 1

Apple Inc. is a multinational technology company that produces consumer electronics, computer software, and online services. Apple Inc. has several subsidiaries, including Apple Retail Stores, Apple Europe, and Apple Asia Pacific. Apple’s consolidated financial statements include the financial information of all these entities.

Example 2

Microsoft Corporation is a multinational technology company that develops, manufactures, licenses, and supports a range of software products and services. Microsoft has several subsidiaries, including Microsoft Japan, Microsoft Canada, and Microsoft India. Microsoft’s consolidated financial statements include the financial information of all these entities.

Example 3

ExxonMobil Corporation is a multinational oil and gas corporation. ExxonMobil has several subsidiaries, including ExxonMobil Exploration and Production, ExxonMobil Refining and Supply, and ExxonMobil Chemical. ExxonMobil’s consolidated financial statements include the financial information of all these entities.

Comparison of Different Methods of Consolidation

There are several different methods of consolidation, each of which has its own advantages and disadvantages. Let’s take a look at three of the most commonly used methods.

Proportional Consolidation

Proportional consolidation is a method of consolidating financial statements in which the results of the subsidiary companies are proportionally combined. This means that the financial information of each company is weighted based on its ownership percentage. This method is often used when the parent company owns less than 100% of the subsidiary companies.

Statutory Consolidation

Statutory consolidation is a method of consolidating financial statements in which the results of the subsidiary companies are completely combined. This means that the financial information of each company is combined without regard to ownership percentage. This method is often used when the parent company owns 100% of the subsidiary companies.

Equity Method

The equity method is a method of consolidating financial statements in which the results of the subsidiary companies are combined according to the parent company’s ownership percentage. This means that the financial information of each company is weighted based on the parent company’s ownership percentage. This method is often used when the parent company owns less than 100% of the subsidiary companies.

Implications of Consolidation for Decision-Making and Performance

Creating consolidated financial statements has several implications for decision-making and performance. Here are some of the most important ones.

Improved Analysis and Insights

By preparing consolidated financial statements, companies can get a better understanding of their overall financial performance and position. This enables them to make more informed decisions about their future by improving their analysis and insights.

Increased Visibility of Group Performance

Consolidation also increases the visibility of group performance. By combining the financial information of all the companies in the group into a single set of consolidated financial statements, it is easier to get an accurate assessment of the group’s financial health.

Improved Transparency

Finally, consolidation improves transparency. By providing a more detailed and accurate picture of the group’s financial performance, companies can more easily identify areas of improvement and take action to address them.

Conclusion

Consolidation is a powerful tool that can help companies gain a better understanding of their overall financial performance and position. By preparing consolidated financial statements, companies can improve their analysis and insights, increase the visibility of group performance, and improve transparency. Although the process of consolidation can be complex, with the right approach, it can be done efficiently and effectively.