According to GAAP (Generally Accepted Accounting Principles), parent companies must prepare consolidated financial statements to report on the financial well-being of both the parent company and all its subsidiaries.
These statements are often prepared with the use of financial consolidation software which takes financial figures from each individual subsidiary and combines them into one overall report. Since each subsidiary also prepares its own standalone financial report, consolidated financial statements may seem to some to be an unnecessary extra step.
But is this really the case?
An analysis of the importance of consolidated financial statements reveals these statements offer several benefits to investors, financial analysts and others who may be evaluating the health of the parent company. In this article, we will review consolidated financial reports in more detail including the unique benefits they offer.
Who Prepares Consolidated Financial Reports?
Consolidated financial reports are prepared by any parent company that owns one or more subsidiaries. For example, it is common for one company to purchase smaller companies that can complement the primary business and make it even stronger. The smaller companies can help the profitability of the parent company while also continuing to operate as separate entities.
Each subsidiary must prepare its own financial statements including balance sheet, income statement, statement of cash flows and statement of retained earnings. This information for each subsidiary is then combined using consolidation software to create consolidated financial reports that represent the financial position of the parent company.
How Consolidated Financial Reports Are Prepared
Financial consolidation software is typically used to prepare consolidated financial reports because it is not as simple as adding up the financial statements from each subsidiary. In the consolidated report, the transactions among subsidiaries or a subsidiary and a parent company are eliminated to avoid double counting. For example, if a parent company purchases goods or services from a subsidiary, the parent company’s purchase and the subsidiary’s sale are both eliminated so this transaction doesn’t distort the final figures. It can be quite tedious to do this manually but consolidated software simplifies the preparation of the final reports.
Benefits of Consolidated Financial Reports
Consolidated financial reports are a GAAP requirement for good reason. Some of the many benefits of consolidated financial reports include:
Complete Overview – Consolidated statements allow investors, financial analysts, business owners and other interested parties to get a complete overview of the parent company. At a glance, they can view the overall health of the business and how each subsidiary impacts the parent company.
Reducing Paperwork – With consolidated financial statements, there is also less paperwork involved. If the parent company owns nine subsidiaries, there are 40 separate standalone financial reports to view i.e. the four basic financial statements for each subsidiary plus the parent company. Not only would it be hard to track down all these records, it would be extremely difficult to look over each of them and try to get an overall view of how the business is performing. Consolidated financial statements cut this pile of reports down to just four consolidated reports. This results in less paperwork and less effort being expended to assess a parent company’s financial health.
Simplification – Consolidation software cuts out all transactions that occur between subsidiaries and the parent company since, in the grand scheme of the business, these things cancel each other out. Eliminating these transactions gives a simplified view of business performance.
Updates to Consolidated Financial Statements – Over time, consolidated financial statements will continue to evolve to make the process of evaluating a parent company even more transparent. One of the reasons for this is that in the past some companies have used consolidated reports to hide losses and liabilities in special subsidiaries that were created specifically for hiding these financial problems. The Financial Accounting Standards Board and the International Accounting Standards Board regularly revisit the definitions and requirements for consolidated statements in order to make them more reliable and easier to use.
SUMMARY: Consolidated financial statements can be complex to prepare, especially for parent companies that include many subsidiaries. However, consolidation software has made preparation easier and standards boards like FASB and IASB regularly work to improve the process. Knowing all the important benefits of consolidated financial statements, it is easier to understand why GAAP requires them.