Definition
Consolidation accounting is a financial reporting method where a parent company’s financial statements include the subsidiaries it owns or controls as part of their accounting. Essentially, it aggregates the financials of the parent and its subsidiaries into one report. This method not only reflects the total earnings, but also displays the company’s overall health, and its ability to generate revenue and profits.
Key Takeaways
- Consolidation accounting is a method used by companies to merge the financials of multiple subsidiaries into their own financial statements. This process is based on the concept that the parent company and its subsidiaries are a single economic entity.
- The method involves adding up like items of assets, liabilities, revenues, and expenses of the parent company and its subsidiaries. Transactions and balances between the parent and subsidiaries are eliminated to avoid double counting.
- Under international financial reporting standards (IFRS) and generally accepted accounting principles (GAAP), a company is required to use consolidation accounting when it owns more than 50% of a subsidiary. This reflects the economic reality that the parent company controls the subsidiary’s operations and finances.
Importance
Consolidation Accounting is vital in the finance world because it provides an accurate overview of a company’s overall financial health.
When a company owns a significant share of another company, they must combine their financial statements in a process referred to as consolidation.
This accounting method helps to present a clearer overall picture of the entity’s operating results, financial position, and cash flows.
Without consolidation accounting, stakeholders such as investors and lenders would only see pieces of the entire financial puzzle, potentially leading to misinformed decisions.
Therefore, consolidation accounting not only ensures transparency but also compliance with generally accepted accounting principles (GAAP).
Explanation
Consolidation accounting is an essential method utilized in financial reporting to provide a comprehensive view of the overall health and performance of a parent company along with its subsidiaries. The primary goal is to present the financial condition of a consolidated entity as if the parent company and its subsidiaries are a single economic entity, despite being separate legal entities.
This approach effectively highlights the group-level performance by eliminating any intercompany transactions and balances, thereby giving the investors, creditors, and any other stakeholders accurate and meaningful insights into the company’s financial status. The application of consolidation accounting is also imperative when the parent organization owns more than 50% of a subsidiary’s voting shares and hence, have control over its affairs.
By using this method, the parent company is able to bring into its books not only its own financial operations but also that of its subsidiaries. This unified financial view helps in effective decision-making, considering the entire company’s profit, debt, and overall value – and not just distinct units.
Further, from a regulatory perspective, consolidation accounting is useful in ensuring compliance with accounting standards such as GAAP or IFRS, which mandate such a consolidation for majority-owned subsidiaries or for those where significant influence is exerted.
Examples of Consolidation Accounting
Acquisition of Pixar by Disney: In 2006, Walt Disney Company bought Pixar Animation Studios. Now if we look at Disney’s financial statements, you will see a consolidated picture of both Disney as well as Pixar. It’s a perfect example of consolidation accounting where Disney combines its own financial figures with Pixar’s financial figures.
Acquisition of WhatsApp by Facebook: When Facebook acquired WhatsApp in 2014, they started to include WhatsApp’s figures into their consolidated financial statements. This move allowed stakeholders and interested investors to see a complete picture of the new, larger company’s financial health.
Acquisition of LinkedIn by Microsoft: Microsoft acquired LinkedIn in December
Subsequently, in its financial statements, Microsoft began to include the revenues, expenses, assets, and liabilities of LinkedIn. By using consolidation accounting, Microsoft was able to provide a comprehensive financial view of the combined entities to their investors, creditors, and other stakeholders.
FAQ Section: Consolidation Accounting
What is Consolidation Accounting?
Consolidation Accounting is a method of combining the financial results of subsidiary companies into the combined financial results of the parent company. This process is essential for a clear portrayal of the parent company’s financial status.
When is Consolidation Accounting applied?
Consolidation Accounting is applied when a parent company owns more than 50% of the shares of another company and therefore has control over that company. The parent company is required to prepare consolidated financial statements presenting the financial position and operational results of the parent and subsidiaries as if they were a single entity.
How does Consolidation Accounting work?
To consolidate accounts, the financial statements of the subsidiary are added line-by-line to the parent company’s financial statements, eliminating any intercompany transactions. This results in a single set of financial statements that effectively reflect the financial position and performance of the parent and its subsidiaries as a single entity.
What is the purpose of Consolidation Accounting?
The main purpose of Consolidation Accounting is to provide a clear and accurate financial picture of a group of companies operating together as a single entity. It allows stakeholders to see how the entire group is performing, enabling them to make informed decisions about the business.
What challenges exist in Consolidation Accounting?
Consolidation Accounting can be complex due to several factors such as currency translation, fair value adjustments, and the handling of minority interest. The consolidation process requires careful planning, meticulous record keeping, and sound understanding of both local and international accounting standards.
Related Entrepreneurship Terms
- Subsidiary Ledgers
- Non-controlling Interest (NCI)
- Consolidated Financial Statements
- Parent Company
- Intercompany Transactions
Sources for More Information
- Investopedia – They provide a very comprehensive and beginner-friendly explanation of many financial terms, including consolidation accounting.
- AccountingTools – A great source for in-depth information on a variety of accounting concepts, principles and procedures.
- AccountingCoach – This site offers free information on a wide range of accounting topics, including consolidation procedures.
- Corporate Finance Institute – They offer various financial education resources, from beginner to advanced levels, including detailed information on consolidation accounting.
