Company structures nowadays can be very complex and include many different entities under one umbrella. We see mergers and acquisitions on a frequent basis which means that oftentimes, entities need to report on a consolidated basis. Consolidated financial statements can be a challenge for accountants, especially when it involves multiple entities. Between adjustments and elimination entries, the preparation process can get messy really quickly. In this article, we will demystify how to prepare consolidated financial statements.
In consolidated financial statements, the results of the entities subject to consolidation will be merged together making these entities appear like one single entity. In reality, these entities operate separately and are different companies, however, for the purpose of consolidation, there is no separate reporting prepared for each of the entities on an individual basis. The consolidated financial statements will be the only financial report issued which reflects the activities of all entities subject to consolidation as a whole.
There are multiple ways to consolidate financial statements. The method used depends on the ownership and control between the entities. The options are a full consolidation, proportionate consolidation and equity consolidation.
This method can be used when a parent company has full ownership and control (more than 50% ownership) into another entity. A full consolidation means the companies that are being consolidated merge 100% of their assets, liabilities, equity, income and expenses together.
The word proportionate is key in this method. When using proportionate consolidation, only a portion of another entity is consolidated rather than merge 100% of it. That portion is determined using the ownership percentage into the other entity. For example, if entity A owns 30% of entity B, then 30% of entity B gets consolidated into entity A. This method can be used by joint ventures or any types of relationships where there’s ownership from one entity into another (regardless of the ownership percentage).
In situations where investors do not have control but possess significant influence, equity consolidation can be used. Sometimes, an entity can own less than 50% of shares in another entity but still has significant influence over the entity. This method requires the investing company to record the initial investment at cost (number of shares x cost of each share). Then, any profit or loss from the investee company will be recorded in the investing company to adjust for the value of the investment based on their ownership.
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In order to prepare consolidated financial statements, there are recommended steps to remember. This ensures the process goes as smoothly as possible. Let’s look at these steps below.
Enough theory, let’s look at an example of full consolidation. We will be working on consolidating Big Inc. (“Big”) and Little Inc. (“Little”) as at 31 December. Big owns 100% of Little. The below represents the balance sheet and income statement of each entity.
| Balance sheet at 31 December | ||
| Big Inc. | Little Inc. | |
| Assets | ||
| Cash and cash equivalents | 52,000 | 66,000 |
| Accounts receivable | 15,000 | 32,000 |
| Due from Little Inc. | 21,000 | |
| Inventories | 12,000 | 73,000 |
| Property, plant and equipments | 34,000 | 65,000 |
| Investment in Little Inc. (100,000 shares) | 100,000 | |
| Total assets | 234,000 | 236,000 |
| Liabilities | ||
| Accounts payable | 2,000 | 10,000 |
| Due to Big Inc. | 21,000 | |
| Current portion of long-term debt due in 12 months | 5,000 | 1,000 |
| Long-term debt | 10,000 | 15,000 |
| Total liabilities | 17,000 | 47,000 |
| Shareholders’ equity | ||
| Equity shares (200,000 shares at $1 each) | 200,000 | |
| Equity shares (100,000 shares at $1 each) | 100,000 | |
| Retained earnings | 17,000 | 89,000 |
| Total shareholders’ equity | 217,000 | 189,000 |
| Total liabilities and shareholders’ equity | 234,000 | 236,000 |
| Income statement for the year ended 31 December | ||
| Big Inc. | Little Inc. | |
| Revenue | 12,000 | 150,000 |
| Revenue from Big Inc. | 14,000 | |
| Cost of sales | (6,000) | (54,000) |
| Gross profit | 6,000 | 110,000 |
| Rent income from Little Inc. | 36,000 | |
| Other income | 1,000 | 5,000 |
| Salaries | (17,000) | (40,000) |
| Administrative expenses | (5,000) | (10,000) |
| Rent expense to Big Inc. | (36,000) | |
| Profit before tax | 21,000 | 29,000 |
| Tax | (5,000) | (6,000) |
| Net profit | 16,000 | 23,000 |
To consolidate Big and Little, we will need to add their accounts together, eliminate intercompany transactions and eliminate any equity transactions between the entities.
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| Balance sheet at 31 December | |||||
| Big Inc. | Little Inc. | Sum of Big and Little | Eliminate intercompany transactions | Eliminate equity transactions | Consolidated balance sheet for Big Group |
| Assets | |||||
| Cash and cash equivalents | 52,000 | 66,000 | 118,000 | 118,000 | |
| Accounts receivable | 15,000 | 32,000 | 47,000 | 47,000 | |
| Due from Little Inc. | 21,000 | 21,000 | (21,000) | ||
| Inventories | 12,000 | 73,000 | 85,000 | 85,000 | |
| Property, plant and equipments | 34,000 | 65,000 | 99,000 | 99,000 | |
| Investment in Little Inc. (100,000 shares) | 100,000 | 100,000 | (100,000) | ||
| Total assets | 234,000 | 236,000 | 470,000 | 349,000 | |
| Liabilities | |||||
| Accounts payable | 2,000 | 10,000 | 12,000 | 12,000 | |
| Due to Big Inc. | 21,000 | 21,000 | (21,000) | ||
| Current portion of long-term debt due in 12 months | 5,000 | 1,000 | 6,000 | 6,000 | |
| Long-term debt | 10,000 | 15,000 | 25,000 | 25,000 | |
| Total liabilities | 17,000 | 47,000 | 64,000 | 43,000 | |
| Shareholders’ equity | |||||
| Equity shares (200,000 shares at $1 each) | 200,000 | 200,000 | 200,000 | ||
| Equity shares (100,000 shares at $1 each) | 100,000 | 100,000 | (100,000) | ||
| Retained earnings | 17,000 | 89,000 | 106,000 | 106,000 | |
| Total shareholders’ equity | 217,000 | 189,000 | 406,000 | 306,000 | |
| Total liabilities and shareholders’ equity | 234,000 | 236,000 | 470,000 | 349,000 |
| Income statement for the year ended 31 December | ||||
| Big Inc. | Little Inc. | Sum of Big and Little | Eliminate intercompany transactions | Consolidated income statement for Big Group |
| Revenue | 12,000 | 150,000 | 162,000 | 162,000 |
| Revenue from Big Inc. | 14,000 | 14,000 | (14,000) | |
| Cost of sales | (6,000) | (54,000) | (60,000) | (60,000) |
| Gross profit | 6,000 | 110,000 | 116,000 | 102,000 |
| Rent income from Little Inc. | 36,000 | 36,000 | (36,000) | |
| Other income | 1,000 | 5,000 | 6,000 | 6,000 |
| Salaries | (17,000) | (40,000) | (57,000) | (57,000) |
| Administrative expenses | (5,000) | (10,000) | (15,000) | (15,000) |
| Rent expense to Big Inc. | (36,000) | (36,000) | 36,000 | |
| Profit before tax | 21,000 | 29,000 | 50,000 | 36,000 |
| Tax | (5,000) | (6,000) | (11,000) | (11,000) |
| Net profit | 16,000 | 23,000 | 39,000 | 25,000 |
That was easy enough. Now what happens if Big owns 90% of Little and there’s a 10% non-controlling interest belonging to another entity? We will explore this situation below.
| Balance sheet at 31 December | ||
| Big Inc. | Little Inc. | |
| Assets | ||
| Cash and cash equivalents | 52,000 | 66,000 |
| Accounts receivable | 15,000 | 32,000 |
| Due from Little Inc. | 21,000 | |
| Inventories | 12,000 | 73,000 |
| Property, plant and equipments | 34,000 | 65,000 |
| Investment in Little Inc. (90,000 shares) | 90,000 | |
| Total assets | 224,000 | 236,000 |
| Liabilities | ||
| Accounts payable | 2,000 | 10,000 |
| Due to Big Inc. | 21,000 | |
| Current portion of long-term debt due in 12 months | 5,000 | 1,000 |
| Long-term debt | 10,000 | 15,000 |
| Total liabilities | 17,000 | 47,000 |
| Shareholders’ equity | ||
| Equity shares (200,000 shares at $1 each) | 200,000 | |
| Equity shares (100,000 shares at $1 each) | 100,000 | |
| Retained earnings | 7,000 | 89,000 |
| Total shareholders’ equity | 207,000 | 189,000 |
| Total liabilities and shareholders’ equity | 224,000 | 236,000 |
| Income statement for the year ended 31 December | ||
| Big Inc. | Little Inc. | |
| Revenue | 12,000 | 150,000 |
| Revenue from Big Inc. | 14,000 | |
| Cost of sales | (6,000) | (54,000) |
| Gross profit | 6,000 | 110,000 |
| Rent income from Little Inc. | 36,000 | |
| Other income | 1,000 | 5,000 |
| Salaries | (17,000) | (40,000) |
| Administrative expenses | (5,000) | (10,000) |
| Rent expense to Big Inc. | (36,000) | |
| Profit before tax | 21,000 | 29,000 |
| Tax | (5,000) | (6,000) |
| Net profit | 16,000 | 23,000 |
Similar to the 100% ownership from Big in Little, to consolidate Big and Little if Big owns 90% of Little, we will need to add their accounts together, eliminate intercompany transactions and eliminate any equity transactions between the entities. We will also need to account for the non-controlling interest of 10%.
| Balance sheet at 31 December | |||||
| Big Inc. | Little Inc. | Sum of Big and Little | Eliminate intercompany transactions | Eliminate equity transactions | Consolidated balance sheet for Big Group |
| Assets | |||||
| Cash and cash equivalents | 52,000 | 66,000 | 118,000 | 118,000 | |
| Accounts receivable | 15,000 | 32,000 | 47,000 | 47,000 | |
| Due from Little Inc. | 21,000 | 21,000 | (21,000) | ||
| Inventories | 12,000 | 73,000 | 85,000 | 85,000 | |
| Property, plant and equipments | 34,000 | 65,000 | 99,000 | 99,000 | |
| Investment in Little Inc. (90,000 shares) | 90,000 | 90,000 | (90,000) | ||
| Total assets | 224,000 | 236,000 | 460,000 | 349,000 | |
| Liabilities | |||||
| Accounts payable | 2,000 | 10,000 | 12,000 | 12,000 | |
| Due to Big Inc. | 21,000 | 21,000 | (21,000) | ||
| Current portion of long-term debt due in 12 months | 5,000 | 1,000 | 6,000 | 6,000 | |
| Long-term debt | 10,000 | 15,000 | 25,000 | 25,000 | |
| Total liabilities | 17,000 | 47,000 | 64,000 | 43,000 | |
| Shareholders’ equity | |||||
| Equity shares (200,000 shares at $1 each) | 200,000 | 200,000 | 200,000 | ||
| Equity shares (100,000 shares at $1 each) | 100,000 | 100,000 | (100,000) | ||
| Retained earnings | 7,000 | 89,000 | 96,000 | (8,900) | 87,100 |
| Non-controlling interest | 18,900 | 18,900 | |||
| Total shareholders’ equity | 207,000 | 189,000 | 396,000 | 306,000 | |
| Total liabilities and shareholders’ equity | 224,000 | 236,000 | 460,000 | 349,000 |
| Income statement for the year ended 31 December | ||||
| Big Inc. | Little Inc. | Sum of Big and Little | Eliminate intercompany transactions | Consolidated income statement for Big Group |
| Revenue | 12,000 | 150,000 | 162,000 | 162,000 |
| Revenue from Big Inc. | 14,000 | 14,000 | (14,000) | |
| Cost of sales | (6,000) | (54,000) | (60,000) | (60,000) |
| Gross profit | 6,000 | 110,000 | 116,000 | 102,000 |
| Rent income from Little Inc. | 36,000 | 36,000 | (36,000) | |
| Other income | 1,000 | 5,000 | 6,000 | 6,000 |
| Salaries | (17,000) | (40,000) | (57,000) | (57,000) |
| Administrative expenses | (5,000) | (10,000) | (15,000) | (15,000) |
| Rent expense to Big Inc. | (36,000) | (36,000) | 36,000 | |
| Profit before tax | 21,000 | 29,000 | 50,000 | 36,000 |
| Tax | (5,000) | (6,000) | (11,000) | (11,000) |
| Net profit | 16,000 | 23,000 | 39,000 | 25,000 |
| Net profit attributable to Big Group | 22,700 | |||
| Net profit attributable to non-controlling interest | 2,300 |
In the example above where Big owns 90% of Little, we are introducing additional adjustments to account for the non-controlling interest in red font. In the balance sheet, we need to remove the retained earnings attributable to the non-controlling interest of 10% ($89,000 x 10% = $8,900). That portion of 8,900 in retained earnings is going to the non-controlling interest in addition to the cost of the investment (10% x $100,000 = $10,000).
Therefore, the non-controlling interest has a total of $18,900 in Big Group. On the income statement side, we determine the net profit attributable to the non-controlling interest by multiplying their ownership in Little with the net profit of Little (10% x $23,000 = $2,300). The net profit attributable to Big Group can be calculated as a balancing figure ($25,000 – $2,300 = $22,700). To prove that this number is accurate, we can also do it the long way by multiplying the ownership of Big in Little with the net profit of Little, then add the net profit of Big and remembering to remove any intercompany transactions between the two entities ((90% x $23,000) + $16,000) – $14,000 + $36,000 – $36,000 = $22,700).
We used a very simplified example to illustrate full consolidations. In reality, things could get a little more complicated but if you go step by step with consolidation concepts, you will always end up with a completed consolidation.
Let’s go through an example of a proportionate consolidation and equity consolidation. For the purpose of this example, we will assume Big owns 30% of Little. We will use a very simplified version of the balance sheet and income statement for our example.
| Balance sheet at 31 December | |||||
| Pre-consolidation | Proportionate consolidation | Equity consolidation | |||
| Big Inc. | Little Inc. | Calculate Big’s portion in Little (30%) | Add Big and 30% Little | Account for the investment | |
| Assets | |||||
| Cash and cash equivalents | 52,000 | 66,000 | 19,800 | 71,800 | 52,000 |
| Accounts receivable | 15,000 | 32,000 | 9,600 | 24,600 | 15,000 |
| Investment in Little | 21,900** | ||||
| Total assets | 67,000 | 98,000 | 96,400 | 88,900 | |
| Liabilities | |||||
| Accounts payable | 2,000 | 10,000 | 3,000 | 5,000 | 2,000 |
| Long-term debt | 10,000 | 15,000 | 4,500 | 14,500 | 10,000 |
| Total liabilities | 12,000 | 25,000 | 19,500 | 12,000 | |
| Shareholders’ equity | |||||
| Equity shares | 50,000 | 60,000 | 21,900* | 71,900 | 71,900 |
| Retained earnings | 5,000 | 13,000 | 5,000 | 5,000 | |
| Total shareholders’ equity | 55,000 | 73,000 | 76,900 | 76,900 | |
| Total liabilities and shareholders’ equity | 67,000 | 98,000 | 96,400 | 88,900 |
*The amount of $21,900 is obtained by multiplying the 30% ownership in Little with the total shareholders’ equity of $73,000 in Little (30% x $73,000 = $21,900). This is because 30% of the total shareholders’ equity belongs to Big and is accounted for in the equity shares. We do not adjust the retained earnings, leaving them as it is originally in Big.
**In the equity consolidation, you can see that we are not aggregating the accounts from Big and Little together. Contrary to full consolidation or proportionate consolidation, we simply account for an investment, recorded in assets, equal to the percentage ownership in Little’s shareholders’ equity (30% x $73,000 = $21,900).
Now let’s look at the effect on the income statement.
| Income statement for the year ended 31 December | |||||
| Pre-consolidation | Proportionate consolidation | Equity consolidation | |||
| Big Inc. | Little Inc. | Calculate Big’s portion in Little (30%) | Add Big and 30% Little | Account for the equity income | |
| Revenue | 80,000 | 150,000 | 45,000 | 125,000 | 80,000 |
| Cost of sales | (6,000) | (54,000) | (16,200) | (22,200) | (6,000) |
| Gross profit | 74,000 | 96,000 | 102,800 | 74,000 | |
| Salaries | (17,000) | (40,000) | (12,000) | (29,000) | (17,000) |
| Administrative expenses | (5,000) | (10,000) | (3,000) | (8,000) | (5,000) |
| Equity income | 13,800*** | ||||
| Net profit | 52,000 | 46,000 | 65,800 | 65,800 |
***The equity income derives from the ownership in Little (30%) multiplied by the net profit of Little (30% x $46,000 = $13,800).
Preparing consolidated financial statements can be easy just as it can be tricky. Consolidating small entities that have few transactions and standard structures can be a piece of cake. On the other hand, multinationals with enormous company structures can be a headache. The important thing is to remember the basics behind consolidation. Identifying relationships between entities, choosing a consolidation method and making sure any redundant transactions that would be considered double accounting is removed. It requires a lot of practice and being familiar with the structure chart.
