Generally accepted accounting principles (GAAP) require consolidated financial statements from parent companies that own or control subsidiary companies or have controlling interests in joint ventures and strategic partnerships. To report only the financial information of the parent company tells only part of the story of the entire enterprise: Each subsidiary contributes both income and liabilities to the financial strength of the parent.
What Is the Purpose of Consolidated Financial Statements?
Growing a company often involves buying out the competition to acquire their customers and expanding business through adding new products, services and technology. This usually means purchasing smaller companies that service particular niches through their own product lines or technologies.
The subsidiary companies normally continue to operate as separate companies, only now under the control of the parent company. But according to accounting rules, each must maintain separate accounting records. These separate accounting records are then consolidated with the parent company's accounting records to produce the consolidated finances.
Objectives of Consolidated Financial Statements
It would be difficult for an investor or financial analyst to gather all the accounting reports of a parent company and its many subsidiaries in order to get an idea of the financial health of the total enterprise. Therefore, parent companies are now required to report their finances on a consolidated basis. Occasionally the parent will make a separate report of its own finances, but that cannot stand alone and must be accompanied by the consolidated report.
Risks and Benefits
The ultimate benefit of consolidated financial statements should be ease of understanding and analysis of a company's financial condition for investors, creditors, vendors and anyone else who needs to know how secure the company is.
A more sinister benefit of consolidated finances is that they can be manipulated to hide financial problems. Consolidated financial statements do not always give a more accurate picture of the financial health of an enterprise because the individual accounting reports from the subsidiaries do not show up anywhere but in the notes section of the consolidated finances.
This makes it possible to hide problems in the subsidiary reports, which is how Enron managed to hide the losses and liabilities some of its failed projects generated. The company just buried them in obscure subsidiaries created for the purpose of hiding certain financial problems.
The Financial Accounting Standards Board regularly visits this subject to correct definitions and requirements that might serve as loopholes for companies wishing to hide losses and liabilities. The International Accounting Standards Board is also working to create definitions and rules that will make evaluation easier and more reliable when examining the financial reports of foreign companies and companies with offshore subsidiaries.
Role of the Auditor
Without consolidated financial statements, the process of evaluating a company for investment or financing purposes would be a long, complex affair that might altogether miss important assets or liabilities. In fact, many of the arguments that occur between company management, accounting and auditing at year end involve how the consolidation of reports should be done in order to give the most accurate picture of the company's financial health. It is the auditor's job to make sure this consolidation of accounting reports accurately reflects the true condition of the company.
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