- Difference Between Income Statement vs. Balance Sheet vs. Cash Flow
- What Are the Differences Between IFRS and U.S. GAAP for Revenue Recognition?
- Accounting Rules for Payable & Receivable
- Financial Statement Functions
- Realized vs. Recognized Income
- Does Earnings Before Interest & Tax Include Interest Income & Interest Expense?
When one company holds a controlling interest in another company, the arrangement can complicate the task of preparing financial statements. Even though one "owns" the other, the two enterprises frequently remain separate legal entities, with each responsible for its own bookkeeping. When it comes time to report results, consolidated financial statements and stand-alone statements provide two ways of looking at the companies' performance.
A consolidated financial statement covers the activities of the parent company and its subsidiaries in a single report, as if they were all a single company operating under one roof. Stand-alone financial statements, by contrast, treat each entity as if it were entirely separate -- the parent unrelated to the subsidiaries, and the subsidiaries unrelated to one another. If a subsidiary earned $1 in income, for example, that $1 would show up on the parent's consolidated statement and the subsidiary's stand-alone statement -- but not the parent's stand-alone statement.
It's common for companies to do business with their subsidiaries -- and subsidiaries to do business with each other -- as if they were unrelated. An automaker, for example, might own the company that makes its transmissions, but it still pays that company for the transmissions it provides. Or if a subsidiary is struggling financially, its parent company may loan it money, with the expectation that it will be paid back with money from the subsidiary's operations. Transactions like these will appear on stand-alone financial statements because they affect the profitability of the individual units, which is important for internal bookkeeping and evaluation. But such transactions would not show up on consolidated statements because they don't affect the overall state of the larger company.
Types of Transactions
Typical transactions that appear on stand-alone statements but not on consolidated statements include equity investments, sales and loans. When a parent owns stock in a subsidiary, the stock appears as an asset on the parent's stand-alone balance sheet but as equity on the subsidiary's sheet. When the parent buys something from the subsidiary, or vice versa, each accounts for the transaction separately on its cash flow or income statements. If one lends money to the other, the loan is an asset on the lender's balance sheet and a liability on the borrower's. During consolidation, a company's accountants will eliminate these and other intracompany transactions. If they didn't, the transactions would in effect be recorded twice.
The Financial Accounting Standards Board, which sets rules for U.S. companies' financial statements, and the International Accounting Standards Board, which does the same worldwide, requires companies to prepare consolidated financial statements when they hold a controlling interest -- more than 50 percent ownership -- in other businesses. When a subsidiary is wholly owned, meaning that the parent owns 100 percent of the subsidiary, its finances are fully incorporated into the consolidated statement. In other words, from looking at the consolidated statement, you wouldn't even know the subsidiary exists. If the subsidiary is not wholly owned -- that is, if another investor or company holds a minority stake -- then that "non-controlling interest" must be accounted for on the consolidated balance sheet. Non-controlling interest appears on the balance sheet as a separate category under stockholders' equity. Finally, wholly owned subsidiaries don't have to produce stand-alone financial statements, although they frequently do for internal purposes; non-wholly-owned subsidiaries generally have to produce stand-alone statements for the sake of their minority owners.
- "Financial Accounting for MBAs," Fourth Edition; Peter Easton et al; 2010
- McGraw-Hill Online Learning Center; Modern Advanced Accounting - Consolidated Financial Statements Highlights; E. John Larsen; 2006
- Dummies.com: Reading Consolidated Financial Statements