Consolidation Accounts: Group Financial Statements

It's common for companies to operate as part of a larger group, comprising a parent company and subsidiaries. While each entity within the group prepares its own individual financial statements, these alone don't provide a complete picture of the group's overall financial health and performance.

This is where consolidation accounts come into play.

It transforms a collection of individual financial reports into a single, cohesive view of the entire economic entity.

What are Consolidation Accounts?

Consolidation accounts are the financial statements of a group presented as those of a single economic entity. They combine the financial positions and performances of a parent company and its subsidiaries, eliminating the effects of intra-group transactions and balances.

The core idea: if one company (the parent) controls another (the subsidiary), then for reporting purposes, they should be treated as one single enterprise.

Why is Consolidation Necessary?

Consolidation serves several vital purposes:

1. True Economic Picture: Without consolidation, stakeholders would only see fragmented financial data. Consolidated statements provide a holistic view of the group's financial position and performance, reflecting its true economic substance.
2. Informed Decision-Making: Investors can better assess the overall risk and return of investing in a group. Lenders can evaluate the group's collective ability to repay debts.
3. Regulatory Compliance: Many jurisdictions and accounting standards (like IFRS) mandate the preparation of consolidated financial statements for groups that meet specific criteria.
4. Elimination of Intra-Group Dealings: Individual financial statements might show transactions between group members (e.g., a subsidiary selling goods to its parent). If these weren't eliminated, they would artificially inflate revenues and expenses, distorting the group's true performance.
5. Assessment of Synergies: Consolidation helps management and external parties understand the collective performance and potential synergies achieved by operating as a unified group.

The Foundation of Consolidation

The fundamental principle governing consolidation under International Financial Reporting Standards (IFRS) is control. Per IFRS 10: Consolidated Financial Statements, an investor (parent) controls an investee (subsidiary) when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.

This definition goes beyond just majority ownership. While owning more than 50% of the voting rights often indicates control, it's not the sole determinant. Control can also arise through:

• Power over more than half of the voting rights by virtue of an agreement with other investors.
• Power to govern the financial and operating policies of the entity under a statute or agreement.
• Power to appoint or remove the majority of the members of the board of directors or equivalent governing body.
• Power to cast the majority of votes at meetings of the board of directors or equivalent governing body.

If control exists, consolidation is generally required.

Key Principles and Adjustments in Consolidation

The consolidation process involves combining the individual financial statements of the parent and its subsidiaries line-by-line, followed by a series of crucial adjustments to present them as a single entity. Here are the core principles and common adjustments:

1. Elimination of the Parent's Investment in the Subsidiary:
   • The parent's investment in the subsidiary (an asset on the parent's balance sheet) is cancelled against the subsidiary's share capital and pre-acquisition reserves (equity on the subsidiary's balance sheet).
   • This is where Goodwill or a Gain from a Bargain Purchase arises, reflecting the difference between the cost of the investment and the fair value of the identifiable net assets acquired at the acquisition date (IFRS 3: Business Combinations).
2. Recognition of Non-Controlling Interests (NCI):
   • If the parent does not own 100% of the subsidiary, the portion of the subsidiary's equity not owned by the parent is presented as Non-Controlling Interest (NCI) within the equity section of the consolidated statement of financial position.
   • The NCI's share of the subsidiary's profit or loss and other comprehensive income is also separately presented in the consolidated statement of profit or loss and other comprehensive income.
3. Elimination of Intra-Group Balances:
   • Any receivables and payables between group entities (e.g., Parent owes Subsidiary £100,000) are cancelled out. If not eliminated, they would artificially inflate both group assets and liabilities.
4. Elimination of Intra-Group Transactions and Unrealised Profits:
   • Sales and Purchases: All revenues and expenses from transactions between group members (e.g., Parent selling goods to Subsidiary) are eliminated from the consolidated statement of profit or loss.
   • Unrealised Profits in Inventory/Assets: If one group company sells assets (like inventory) to another group company, and those assets are still held by the buying company at the reporting date, any profit made on that intra-group sale must be eliminated. This is because from a group perspective, the profit hasn't been realised with an external party yet. This adjustment typically affects inventory values on the balance sheet and cost of sales/profit on the income statement.
   • Intra-group Dividends: Dividends paid by a subsidiary to its parent are eliminated in consolidation, as they represent a transfer within the same economic entity.

The Consolidation Process: A Simplified Overview

While the specifics can be complex, the general steps for preparing consolidated financial statements are:

1. Determine the Group Structure: Identify the parent and all subsidiaries, and their respective ownership percentages.
2. Obtain Individual Financial Statements: Gather the separate financial statements for the parent and each subsidiary.
3. Standardize Accounting Policies: Ensure all group entities use consistent accounting policies for similar transactions and events, as required by IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors. If not, adjustments must be made.
4. Perform Consolidation Adjustments: Apply the eliminations and adjustments discussed above.
5. Combine Line-by-Line: Add the adjusted balances of assets, liabilities, equity, revenues, and expenses from the parent and all subsidiaries.
6. Present Consolidated Financial Statements: Prepare the consolidated statement of financial position, statement of profit or loss and other comprehensive income, statement of cash flows, and statement of changes in equity, along with relevant notes.

Relevant IFRS Standards Beyond IFRS 10

While IFRS 10 is the core standard for consolidation, other standards are intrinsically linked:

• IFRS 3: Business Combinations: Governs the accounting for the initial acquisition of a subsidiary, including the determination of goodwill.
• IAS 27: Separate Financial Statements: Provides guidance on accounting for investments in subsidiaries, associates, and joint ventures in an entity's separate financial statements (i.e., the parent's individual financial statements).
• IAS 28: Investments in Associates and Joint Ventures: Dictates the use of the equity method of accounting for investments in associates and joint ventures (where the parent has significant influence or joint control, but not control). While these are not consolidated, their results are integrated into the consolidated financial statements via the equity method.

Conclusion

Consolidation accounts are a tool for gaining a true understanding of a group's financial performance and position. By presenting a unified financial picture, they enable more accurate analysis, better decision-making, and enhanced transparency for all stakeholders.