What it means
A large company is rarely one legal entity. It is a parent with dozens or hundreds of subsidiaries, each keeping its own books.
Reading the parent's individual accounts tells you almost nothing, because the parent may do little except hold shares in its subsidiaries. Consolidation combines all of them line by line, adding the subsidiaries' revenue, costs, assets and liabilities to the parent's, so that the reader sees the whole business.
Simple addition would overstate everything, because group companies trade with each other. A manufacturing subsidiary sells to a distribution subsidiary, which sells to customers; adding both sales counts the same goods twice.
The parent lends to a subsidiary; adding both balance sheets shows a loan asset and a loan liability that cancel out from the group's point of view. Consolidation eliminates all intercompany sales, purchases, balances, dividends and unrealised profit on goods still held within the group, leaving only what the group as a whole earned from and owes to outsiders.
Two further adjustments arise when the parent does not own 100% of a subsidiary. The group still consolidates all of the subsidiary's assets, liabilities and results, because it controls them, but the share belonging to outside shareholders is shown separately as non-controlling interest (formerly minority interest) in equity and in profit.
And when a subsidiary was acquired, the difference between the price paid and the fair value of the net assets acquired is recorded as goodwill, which then sits on the consolidated balance sheet and is tested annually for impairment. Control, not ownership percentage, decides what is consolidated.
A company usually controls another when it holds more than half the voting rights, but it can also control through contractual arrangements or by being the dominant party in a structured entity. Entities the group influences but does not control, typically 20% to 50% holdings, are not consolidated but accounted for using the equity method, which shows the group's share of their profit as a single line.
In practice
Real-world examples.
Example
A hotel group with 40 hotel-owning subsidiaries publishes consolidated accounts showing total room revenue and total property, with the management fees each hotel pays to the parent eliminated.
Example
A company that owns 60% of a joint venture consolidates it in full and shows the partner's 40% as non-controlling interest, while a 30% holding in another venture is equity accounted.
Example
A group that acquires a competitor for $50 million records $18 million of goodwill in its consolidated balance sheet, being the excess over the fair value of the competitor's identifiable net assets.
Think of it
“Consolidated financial statements are like a family portrait that includes all generations. Instead of individual photos, you see the whole family together as one unit.
Formula
Calculation
Consolidated figure = Parent + 100% of each Subsidiary minus Intercompany eliminations
Non-Controlling Interest in profit = Subsidiary profit x Percentage not owned by the parent
Goodwill at acquisition = Purchase price minus Fair value of net assets acquired (for the parent's share)
Worked example. Parent P owns 80% of Subsidiary S, bought two years ago for $2,000,000 when S's net assets had a fair value of $2,000,000 (so goodwill on P's 80% share was $2,000,000 minus 80% x $2,000,000 = $400,000). This year:
- P: revenue $10,000,000, profit $1,200,000
- S: revenue $4,000,000, profit $500,000
- S sold $600,000 of goods to P during the year at a 25% margin on cost; P has sold all of them to outside customers
- P has lent S $300,000, outstanding at year end
Consolidated revenue = $10,000,000 + $4,000,000 minus $600,000 (intercompany sales) = $13,400,000
Consolidated profit = $1,200,000 + $500,000 = $1,700,000 (no unrealised profit adjustment, because P has sold the goods on)
Of which attributable to non-controlling interest = 20% x $500,000 = $100,000
Attributable to P's shareholders = $1,600,000
The $300,000 intercompany loan is eliminated: it does not appear as an asset or a liability in the consolidated balance sheet.
Goodwill of $400,000 remains on the consolidated balance sheet unless impaired.
If, instead, $200,000 of the goods S sold to P were still in P's inventory at year end, the unrealised profit of $40,000 ($200,000 x 25/125) would be eliminated, reducing consolidated profit and inventory by $40,000 until the goods are sold outside the group.Case study
Seen in the real world.
A private group with eleven trading subsidiaries had never prepared consolidated accounts; the owner reviewed each company separately and believed the group made about $3 million a year. When the group sought a bank facility secured across all entities, the bank required consolidated statements. The consolidation revealed that $1.1 million of the apparent profit was intercompany: the property company charged the trading companies above-market rent, the holding company charged management fees, and two subsidiaries had sold slow-moving stock to each other at a mark-up before year end.
After elimination, group profit was $1.9 million. The consolidation also exposed $4 million of intercompany loans that had been used to move cash to the weakest subsidiary for years, hiding its losses. The bank lent on the consolidated figures, at a smaller amount than requested, and the owner used the exercise to close the loss-making subsidiary he had not known was one.
Watch out
Common mistakes.
- Adding subsidiaries together without eliminating intercompany transactions, which overstates revenue, assets and often profit.
- Consolidating based on ownership percentage rather than control, or consolidating only the parent's share of a subsidiary. Control means 100% consolidation with non-controlling interest shown separately.
- Forgetting to eliminate unrealised profit on intercompany stock still held at year end.
Questions
People also ask.
What is the difference between consolidated and combined statements?
Consolidated statements have a parent that controls the other entities. Combined statements aggregate entities under common ownership without a parent, for example several companies owned by the same individual.
Do all groups have to consolidate?
Most jurisdictions exempt small groups below size thresholds and intermediate parents whose own parent consolidates them. Listed companies always consolidate.
Where does goodwill come from in consolidated accounts?
From acquisitions: it is the amount paid above the fair value of the identifiable net assets bought, and it appears only in the consolidated balance sheet.
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