Consolidated financial statements consist of the income statement, balance sheet and cash flow statements of a parent company and the subsidiaries under its ownership or administrative control. When preparing consolidated financial statements, you must eliminate some entries to avoid duplicating or overstating financial data. Such entries include inter-unit purchases, sales, financing and equity transactions.
Basics of Consolidated Financial Reports
A business that holds controlling shareholding stakes or majority board positions in subsidiary entities must prepare consolidated financial statements. The consolidation process involves combining the financial statements of the parent company with those of the subsidiaries. Prepare separate financial reports for the parent and the subsidiaries before summarizing them into a single set of financial information. You can then proceed to eliminate some of the entries in the unit-specific financial statements that cannot be included in consolidated financial reports.
Inter-Unit Sales Transactions
Cancel sales transactions that occur within the group, because they do not count towards profit generation. Treat such sales as transfer of inventory between stores owned by the same entity. You should actually acknowledge that the transferred items merely switched premises and not ownership. Recognition of such inter-company movement of goods under sales would inflate your consolidated inventory and effectively understate your cost of sales. Understated cost of sales overstates profits. Cost of sales is the difference between closing stock and the sum of opening stock and purchases.
Intra-Group Assets and Liabilities
Strike out payable and receivable invoices attributable to intra-group transactions. This is because a pending payable of one unit is essentially a receivable of another unit owned by the same umbrella organization. To eliminate the entries for account payables and receivables, debit and credit the amount in the consolidated accounts payable and consolidated accounts receivable, respectively. Maintaining such accounts payable and receivable in the consolidated financial statement would be as good as saying that the group owes itself money, a situation that is practically unrealistic.
Eliminate inter-company investments -- that is, is the parent’s shareholding stakes in the subsidiaries. The shareholding structure of the parent and the subsidiaries is reported in the owner’s equity section of each entity’s separate balance sheet. This means the parent’s balance sheet has already stated its interests in the subsidiaries, and consolidating the interests reported in the subsidiaries’ balance sheets would be tantamount to duplication. In other words, the parent’s owner’s equity is representative of the entire group’s owner’s equity.