What it means
The trigger for consolidation is control, not simply ownership. If a parent controls another entity, usually by holding more than half the voting rights, it must consolidate that entity in full even where it owns less than 100% of it.
Full consolidation means adding every line of the subsidiary's revenue, costs, assets and liabilities to the parent's, not just the parent's share. The portion of the subsidiary that outside shareholders own is then shown separately as a non-controlling interest.
Eliminations are the heart of the exercise. Sales from one group company to another, intercompany loans and unrealised profit on stock still sitting inside the group are all removed, because a group cannot make a profit by selling to itself.
Where a parent has influence but not control, typically a stake of 20% to 50%, the investment is equity accounted instead. Only the parent's share of the profit appears, on a single line, rather than the whole of the other company's revenue and costs.
The nuance that catches people out is the difference between control and economics. A group that owns 51% of a subsidiary reports 100% of its revenue, which can make the top line look far larger than the group's real economic interest in it.
In practice
Real-world examples.
Example
A hotel group buys 100% of a laundry business that previously invoiced it $2,000,000 a year. After consolidation that $2,000,000 vanishes from group revenue, because the group is now simply washing its own linen.
Example
A brewer owns 60% of a bottling plant. Group accounts show all of the plant's $18,000,000 revenue, and a non-controlling interest line accounts for the 40% of its profit that belongs to the minority partner.
Example
A technology group holds 30% of a joint venture and equity accounts it. None of the venture's revenue appears in group revenue, and only the group's share of its profit shows on one line below operating profit.
Formula
Calculation
Consolidated revenue = parent revenue + subsidiary revenue - intercompany sales
Non-controlling interest = subsidiary net income x (1 - parent ownership %)
A manufacturing parent reports revenue of $80,000,000 and owns 80% of a components subsidiary that reports revenue of $30,000,000. During the year the subsidiary sold $5,000,000 of components to the parent.
Consolidated revenue is $80,000,000 + $30,000,000 - $5,000,000 = $105,000,000. Note that all $30,000,000 of the subsidiary's revenue is brought in even though the parent owns only 80% of it, and the $5,000,000 internal sale disappears entirely.
On profit, suppose the parent earns $9,000,000 from its own operations and the subsidiary earns $4,000,000. Total consolidated net income is $9,000,000 + $4,000,000 = $13,000,000. The non-controlling interest takes $4,000,000 x 20% = $800,000, leaving $13,000,000 - $800,000 = $12,200,000 attributable to the parent's shareholders, which is the figure used to calculate the group's earnings per share.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Braxton Rail Holdings, an invented rolling stock group, grew through acquisition and by its fourth year owned five subsidiaries, three of them supplying components to the others. Management circulated a group revenue figure of $340,000,000, arrived at by adding the five companies' individual revenues together.
The audited consolidation told a different story. Intercompany sales between the subsidiaries came to $47,000,000, so consolidated revenue was $340,000,000 - $47,000,000 = $293,000,000, and a further $2,300,000 of profit sitting in unsold intercompany stock had to be eliminated as well. Two of the fictional group's divisional bonus schemes had been built on the pre-elimination numbers.
Braxton's response was to change what it measured internally. Divisional targets were restated on external revenue only, intercompany transfers were priced at cost rather than at a margin, and the group's reported revenue and its internal reporting finally described the same business.
Watch out
Common mistakes.
- Adding subsidiary revenues together without eliminating intercompany sales, which inflates group revenue and can distort bonus schemes built on it.
- Consolidating only the parent's percentage share of a controlled subsidiary, when full consolidation brings in 100% and shows the outside share as a non-controlling interest.
- Confusing control with ownership, so a 51% holding is reported as though the group owns just over half of every line rather than all of them.
Questions
People also ask.
When must a company consolidate another entity?
When it controls it, which usually means holding more than 50% of the voting rights, though control can also arise through contractual rights without a majority stake.
What is a non-controlling interest?
It is the portion of a consolidated subsidiary's equity and profit that belongs to shareholders other than the parent, shown separately within group equity and below group profit.
Does consolidation change how much tax a group pays?
Not directly, since tax is normally assessed on individual legal entities, though many jurisdictions allow group relief or tax grouping that lets losses in one company offset profits in another.
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