What are consolidated financial statements, and how are consolidated financial statements prepared? When reviewing an annual report, you come across the word “consolidated” everywhere!
When browsing the financial statements: Consolidated Statement of Income. Consolidated Balance Sheet. Consolidated Statement of Cash Flows. When reviewing the key metrics: Consolidated Net Sales. Consolidated Net Income. When reading the supplemental schedules: Consolidated Results of Operations. Consolidated Subsidiaries.

⏱️TIMESTAMPS⏱️
00:00 Introduction
00:33 Definition of consolidated financial statements
00:53 Examples of consolidated financial statements
01:49 Principles of consolidation
03:09 How to consolidate financial statements
03:42 Intercompany sales elimination
07:38 Intercompany ownership
09:09 Consolidation information in the annual report
09:42 Consolidation summary

Let’s start off with a definition of consolidated financial statements: the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. Let’s illustrate that definition with some examples.

When you review the consolidated statements of income of Walmart Inc, you are looking at the economic entity of the Walmart group, consisting of the parent company Walmart Inc and a list of consolidated legal entities.

When you review the consolidated balance sheets of Apple Inc, you are looking at the economic entity of the Apple group, consisting of the parent company Apple Inc and a list of consolidated legal entities.

When you review the consolidated statements of cash flows of Tesla Inc, you are looking at the economic entity of the Tesla group, consisting of the parent company Tesla Inc and seven pages’ worth of consolidated legal entities.

The big question here is: to consolidate or not to consolidate? Or more specifically: who to consolidate, and how to consolidate?

There is plenty of documentation on the subject of consolidation, that outlines the requirements for the preparation and presentation of consolidated financial statements. For US GAAP, ASC 810. For IFRS, IFRS 10. Let’s discuss the highlights.

Who to consolidate? The core concept here is “control”. Does the parent company have the power to direct activities of the subsidiary? Does the parent have exposure, or rights, to variable returns of the subsidiary? In other words, the obligation to absorb losses from, or right to receive benefits from, with returns that must vary and can be positive, negative, or both. Usually, there is control when ownership and voting rights exceed 50%. However, in certain unusual circumstances, control may exist with less than 50 percent ownership, when contractually supported. This concept is referred to as effective control. If control of a subsidiary is not established, then the investing company still needs to account for the investment, through methods other than consolidation, for example using the equity method of accounting, but that’s for a different video to discuss.

Let’s continue on the path of consolidation. After determining who to consolidate, the next question is how to consolidate. To a large extent, it is all one big summation. To prepare consolidated financial statements, combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries. In addition, there may be the need to eliminate intercompany transactions and intercompany ownership or financing positions. Here are two common examples that are discussed in detail in this video: intercompany sales between entities within the group, and intercompany ownership.

So where do you find information about consolidation in an annual report? Go to the notes to the consolidated financial statements, section “principles of consolidation”, and you will find both the “who” and the “how” of consolidation. For example, Walmart states that it consolidates variable interest entities where it has been determined that the Company is the primary beneficiary of those entities' operations, and that intercompany accounts and transactions have been eliminated in consolidation.

Philip de Vroe (The Finance Storyteller) aims to make accounting, finance and investing enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!