Consolidation accounting: A guide for FP&A teams

Prophix ImageProphix May 23, 2024, 8:00:00 AM

The term “consolidated” is used frequently for any reporting by a company that includes a collection of sources and can get confusing when 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 means combining the assets, liabilities, and transactions of multiple companies to present them as a single entity. In consolidation accounting, that same idea is applied to the finances of subsidiaries and their parent company to present a singular financial statement that encompasses the aggregate group of companies as if they were one.

Why is consolidation important in business?

The consolidated statements that are produced by this method of accounting create a standard view of all your group’s key financial data. This accelerates analysis and decision-making processes, as well as facilitates reporting, compliance, transparency, and accountability.

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 encompasses all accounting activities in a consolidated group of companies. 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 to be considered use 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.

Proportionale Konsolidierung

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 theGenerally 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.

What are consolidated financial statements?

The FASB has defined consolidated financial statements as reporting on financial entities composed of a parent company and its subsidiaries. These consolidated statements, by the removal of intercompany activities, provide clarity when evaluating the financial situation of the combined companies, which facilitates decision-making, transparency, and compliance.

Consolidated income statement

A consolidated income statement reflects the sales revenue and expenses of the combined entity over a period of time.

Consolidated balance sheet

A consolidated balance sheet presents the financial situation of the parent and subsidiaries as if it were a single entity.

Consolidated statement of cash flow

A consolidated statement of cash flow aggregates the combined operating, investing, and financing activity of the parent and subsidiaries, again, as if it were a single entity.

What is the best way to consolidate financial statements?

As with any accounting activity, they can be done manually, but that leads to inefficiency and the risk of human error. Accounting software provides the tools and automation needed to complete these consolidated accounting activities with both speed and precision.

How to consolidate

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 von das 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 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

Consolidating journal entries plays a crucial role in the consolidation process. Without it, the overall story of consolidation might get obscured in the records. Journal entries record details of individual transactions in the order they occur. For these entries to be accurately included in a consolidated statement, they need to follow a specific process: eliminate intercompany transactions. This ensures that the consolidated entries only reflect transactions with external entities, providing a clear picture of the group's financial activities.

A high-level consolidation process

Let's take a closer look at this process in more detail. The following is an example of when a parent 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.
  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.

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

How to consolidate

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 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, 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 to determine the profitability of their products, vendors, and business segments.

Read the full case study here.

What are the best consolidation accounting tools?

1. Prophix One

Prophix is a complete Financial Performance Platform for the Office of the CFO.

Best for: Agile companies that need a Financial Performance Platform that can grow with them.

Features: Comprehensive suite of tools focused on budgeting and planning, reporting and analytics, financial consolidation, and intercompany management.

Pros: Excellent suite of industry-specific tools, value for cost, ease of use, and customer service.

Cons: There can be a bit of a learning curve for junior members of the Office of the CFO.

Integrations: Power BI and MS365 add-in. You can also use Data Integration to connect to any other data sources.

Pricing: See Prophix in action

2. Fluence Technologies

Fluence is a modern close-to-disclose platform for finance teams with complex companies.

Best for: Accelerating financial close, consolidation, and reporting.

Features: Financial consolidation, close management, finance-led reporting, reconciliation, and disclosure management

Pros: Pre-built calculations for numerous requirements. No code and finance-owned approach alleviates IT stresses.

Cons: Less specialized than other offerings.

Integrations: Use Datablend to aggregate your data sources.

Pricing: Contact their sales team to get a quote.

Fluence vs. Prophix

Fluence has a lower bar to entry, meaning it gets up and running faster, but that comes at the cost of depth and detail. Out-of-the-box functionality only works if your use case fits in the box. Prophix’s slower learning curve means more power in your hands at the end of the day.

3. NetSuite

NetSuite from Oracle is a full business management platform with worldwide reach. The most expensive toolset on this list.

Best for: Enterprise-level solutions across all aspects of financial and business needs, all in a single integrated suite.

Features: Numerous accounting tools, permissions controls, activity tracking, reporting, alerts, and audit management.

Pros: Has a tool for most use cases.

Cons: Over-featured for small and midmarket businesses.

Integrations: NetSuite Connector lets you connect your own data sources.

Pricing: Quotes available through their website.

NetSuite vs. Prophix

All these features come with a price tag. As nice as a fully unified business management suite might sound, it’s likely more than most companies need. A specialized tool like Prophix is going to provide much better detail for its purpose than general-use software.

Conclusion: Faster consolidation accounting with Prophix

With the right platform for the job, even complex and time-consuming tasks can be a breeze. You need a platform that meets your consolidation accounting needs every quarter and every year – one that is more agile and accurate than you are.

This is where Prophix comes in - get started today and start accelerating tomorrow.

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