Consolidation accounting: A guide for FP&A teams

The term “consolidated” is used frequently for any reporting by a company that includes a collection of sources. However, this can get confusing when you’re trying to research consolidation accounting specifically.

Consolidation accounting is defined as reporting on financial entities composed of a parent company and its subsidiaries as if they were a whole. Let's dig deeper and find some clarity on what that means and why it’s so essential.

What is consolidation accounting?

Consolidation combines the assets, liabilities, and transactions of multiple companies to present them as a single entity—usually by consolidating subsidiaries into their parent company. Consolidation accounting refers to consolidating these financials into a single financial statement.

This is usually done for one (or more) of these reasons:

• Better visibility: Consolidation allows parent companies to have a more accurate idea of their financials by representing their stake in a subsidiary with the rest of their assets and liabilities.

• Tax advantages: Losses in one subsidiary can offset gains in another, allowing organizations to produce statements that are more advantageous tax-wise.

• Compliance: In some jurisdictions, organizations must produce consolidated statements if they meet certain requirements (like majority ownership of a subsidiary). Doing so keeps them compliant with laws and regulations.

Group accounts consolidation is a process that involves combining all the financial data from different subsidiaries into a single, unified set of financial statements. This process is crucial for FP&A teams as it provides a comprehensive view of the entire organization's financial health. It also allows for better financial planning and analysis, as well as improved decision-making.

When should you consolidate accounts?

A company should use consolidation accounting when it owns more than 50% of a subsidiary company, referred to as a controlling interest. In some cases, the percentage of ownership can be as low as 20%, such as when the two companies have tightly integrated decision-making processes. The decision to consolidate this way should be made each year, allowing for the companies to adapt to changes in tax requirements or the discovery of new opportunities. This should be done with the same frequency as your other financial reporting activities, quarterly and annually.

Consolidation vs. amalgamation

Consolidation is when two companies combine financial reporting to present as a single entity. Amalgamation is the actual combination of two companies to create a new corporate entity. Sometimes when discussing amalgamation—or mergers and acquisitions for that matter—the word consolidation is used synonymously, leading to confusion. When it comes to consolidated accounting, the definition is specific to the practice of presenting financial data as a single entity.

Consolidation accounting vs. financial consolidation

Consolidation accounting is a method that combines the financial statements of several entities into one. This process involves the parent company integrating the financials of its subsidiaries, treating them as a single entity for reporting purposes. This method is crucial for providing a comprehensive view of the company's overall financial health.

Financial consolidation refers to the consolidation of financial statements from subsidiaries into a single statement of the parent company. The two are not necessarily synonymous. Consolidated accounting is the larger subject, a part of which is consolidated financial reporting.

How does consolidation accounting work?

Consolidation accounting works by removing all the internal transactions within a group of entities owned by a single parent. By following one of the two models below, a parent company and its subsidiaries can create consolidated financial reports that present the aggregated entities as if they were one. These consolidated statements provide clarity into the financial standing of the whole group, improving transparency of the group's performance and facilitating more effective top-level strategy and direction.

Two models for consolidation accounting

There are two main models for these consolidations: the Voting Interest Entity model (VOE) and the Variable Interest Entity model (VIE). Each model is intended to be applied in different cases.

Variable interest entity (VIE) model

The VIE model will be used unless the entities are exempt from it or fail to meet one of the characteristics of a variable interest entity. If any of these are true, then the VOE model should be used. For example, an entity would be considered exempt from the VIE model if it is not-for-profit. The five characteristics of a VIE are intended to identify entities where it would be inadequate to look only at votes to determine control:

• When an entity is not capitalized sufficiently, the debt holders or other variable interest holders may have control.
• The equity holders do not have power over the entity’s essential activities.
• The voting rights of the equity holders are not proportionate to their economic interests.
• The fourth and fifth characteristic addresses those situations where the equity holders are not exposed to the residual losses or benefits that equity investors typically are.

Voting interest entity (VOE) model

If your business entity qualifies for consolidation accounting but does not meet the requirements for the VIE model, you will need to use the Voting Interest Entity (VOE) model. This model applies either because the reporting entity does not have one of the five characteristics of a VIE or because the reporting entity qualifies for an exemption from the VIE model. With this model, the major condition of ownership is determined by having more than 50% of voting shares in the subsidiary. There are several exceptions for this based on actual voting power, as well as in situations where the subsidiary is subjected to control by a government or judicial power (such as bankruptcy).

Equity method of consolidation

Though perhaps not a full consolidation accounting method the way VOE or VIE models are, the equity method can be used in situations where a company owns less than a controlling share in a subsidiary. In the equity method, the parent company’s stake in the subsidiary is expressed as a cost and adjusted based on the parent’s share in the subsidiary's earnings or losses.

Proportionate consolidation accounting

Proportionate consolidation is when the investors' proportionate—or pro-rata—share of a venture’s assets and liabilities are included in each line of the investor balance sheet, and the pro-rata outcomes of the venture’s operations are included on every applicable line item of its income statement.

This consolidation method is no longer used. Entities that don’t own a controlling interest in a subsidiary need to use the equity method instead.

Rules of consolidation accounting

The key regulators involved in consolidation accounting are the Generally Accepted Accounting Practices (GAAP), the International Financial Reporting Standards (IFRS), the Financial Accounting Standards Board (FASB), and the Accounting Standards Board (ASC), specifically ASC 810.

How to consolidate financial statements

The consolidation accounting process can be broken down into the following steps, applicable in most situations.

1. Establish the goal and scope of the consolidation. This includes identifying which companies will be included in the consolidation and defining the method to be used.
2. Collect all financial information from the companies involved.
3. Adjust for intercompany transactions. Removing all transactions between the companies leaves the final statement with only transactions outside of the consolidated entity.
4. Present non-controlling interests. If the parent company owns a non-controlling share of a subsidiary, the minority interest needs to be identified in the final statements.
5. Produce consolidated financial statements. The consolidated balance sheet, income statement, and cash flow statement will reflect the financial position and performance of the entire group as if it were a single business entity.

Consolidation of financial accounts

The steps for the consolidation of financial accounts are similar.

1. As above, determine the scope and goal of the consolidation, this will guide future choices.
2. Identify the entities that will be included in the consolidation, and their relation to each other.
3. Collect the information necessary to consolidate from the appropriate entities.
4. Remove intercompany transactions.
5. Make the appropriate adjustments for unrealized intercompany losses or gains.

Once those steps are completed, the remaining financial information can be consolidated.

Consolidation of a journal entry

Consolidation entries are the accounting processes that combine the financial data of subsidiary companies into the parent company's records. These entries are essential for providing a comprehensive view of the entire group's financial position and performance. They involve eliminating intercompany transactions, adjusting for differences in accounting policies, and recognizing the parent company's investment in each subsidiary.

A high-level consolidation process

Let’s go through a quick step-by-step overview of the consolidation process with a parent company that owns more than 50% of a subsidiary.

1. Record intercompany loans from the subsidiaries to the parent. This includes interest income related to any consolidated investments down to the subsidiaries.
2. Charge corporate overhead. If the parent has been allocating corporate overhead to its subsidiaries it must be charged accordingly.
3. Charge payables. If the parent is using a consolidated payables operation, make sure that all accounts payable apply to the appropriate subsidiaries.
4. Charge payroll expenses. If the parent has been using a common pay system for all employees in the consolidating group, make sure the correct payroll expenses have been applied to the subsidiaries.
5. Complete adjusting entries. Record any adjustments made to correct revenue or expense transactions.
6. Investigate asset, liability, and equity account balances. For each of these, the parent and subsidiary entries must agree. A financial performance platform like Prophix One can streamline this process by providing you with real-time data.
7. Review subsidiary financial statements. Each subsidiary is responsible for reviewing, investigating irregularities, and adjusting its own financial statements before providing them to the parent company to consolidate.
8. Remove intercompany transactions. Any transactions between parent and subsidiaries should be reversed from the parent side to remove them from the final consolidated presentation.
9. Review parent company statements. The financial statements for the parent should be reviewed and adjusted.
10. Record income tax liability. For both the parent and the subsidiary, if a profit was recorded, also record an income tax liability. Tax specialists may need to be involved in this step which can cause delays.
11. Close subsidiary books. Depending on how you are processing the consolidation, the subsidiary books may need to be closed before the parent company.
12. Close parent company books. This prevents additional transactions being recorded which would confound the consolidated report. A platform like Prophix One allows you to breeze through your financial close, meaning you can get to your final statement much faster.

Once both books are closed, you’ll be able to provide consolidated statements presenting the parent and subsidiaries as a single entity.

What should you avoid in consolidation accounting?

1. Inaccurate data and human error: Poor quality data accumulates over time and causes delays when it's time to close the books. These kinds of delays can best be avoided by automating as much of the process as possible.
2. Insufficient tools and systems: Accounting tools that don’t provide sufficient support for these kinds of activities and will hinder the process. Complicated, disparate software might be used improperly, leading to incorrect records. Making sure you have the right tools for the task is essential.
3. Shifting financial reporting requirements: Any changes in tax and compliance regulations will slow you down if you have to adapt in the middle of a consolidation. Industry-specific tools help keep you and your finance teams up to date, avoiding any surprises.
4. Planning and delegation: Some of these steps must be completed by either the parent or the subsidiary, or require specialist skills, all of which will take time to arrange and complete. Proper foresight of what needs to be done and by whom goes a long way.

What does consolidation look like with the right platform?

Inter Cars is one of the largest importers and distributors of automotive parts in Central and Eastern Europe. With 35 subsidiaries involved in consolidating profit and loss statements, balance sheets, and cash flow statements, manual consolidation involved a ton of manual work and took weeks.

With Prophix One, they were able to automate financial consolidation and create the necessary consolidated statements in a fraction of the time. They also use Ad Hoc Analysis from Prophix One to determine the profitability of their products, vendors, and business segments.

Read the full case study here.

Get fast & accurate consolidation accounting with Prophix One™

Prophix One is a fully integrated Financial Performance Platform that streamlines every stage of consolidation accounting, from account reconciliation to financial close, as well as processes like financial planning and analysis. Get up-to-date data at your fingertips, rely on a full audit trail to chase down any discrepancies, and collaborate with finance teams dynamically without spreadsheets.

Organizations around the world rely on Prophix One for consolidation, budgeting, forecasting, and more:

• USA Properties prepares operating budgets that are 50% more accurate with Prophix One.
• Boulay achieved a 1% variance actuals to forecast through customized dashboards and reports.
• Encore Electric improved days sales outstanding by 40 days with better tracking and reporting.
• SoundOff Signal improved their forecasting accuracy by 16.7%