Consolidated Financial Statements: Preparation Process and Accounting Obligations
What is the purpose of consolidated financial statements ? How to construct and then analyse them for sound accounting management of your company?
All companies are required to keep proper accounts, but not everyone is an accountant. You need to draw up a consolidated balance sheet, but do not know where to start? Have you heard of consolidation methods and subsidiaries , but do not know how to apply them? And which companies are obliged to prepare consolidated financial statements?
This article guides you through the process of preparing this accounting document. Will you no longer have any doubts about the structure and preparation of consolidated financial statements?
Consolidated Financial Statements: Definition
Consolidated financial statements are financial statements that group together the financial statements of a number of companies that are linked by a co-partnership relationship. The structure remains the same as that of normal annual financial statements, with the presence of a balance sheet , income statement and notes to the financial statements .
Being to all intents and purposes a financial statement, it fulfils the role of an indicator of the financial health of the group of companies. However, it has no legal value: this means that any redistribution of profits between the companies forming the group will not be possible.
What are the elements that make up a consolidated financial statement?
Accounting standard OIC 17 is the accounting document that regulates and establishes the elements that make up a consolidated financial statement. In order for the consolidated financial statements to be validated, the group of companies must present:
- the balance sheet and the income statement , correlated with the data of all the companies that are part of the group
- the management report of the controlling bodies (auditor and board of auditors)
- the cash flow statement
- a statement showing the changes and movements in shareholders' equity items between the beginning and end of the year
- a statement reconciling shareholders' equity and the result for the year of the parent company and the group
Which companies draw up consolidated financial statements?
Article 25 of Legislative Decree No. 127 of 9 April 1991 stipulates that consolidated financial statements must be prepared by companies that are considered 'subsidiaries and associated companies'. Thus, the article in question refers to companies that control others within a group formed by the interconnection of these companies.
What are the obligations?
Article 27 specifies in detail the companies that are obliged to draw up consolidated annual accounts. These companies must meet the following size criteria:
- A balance sheet asset of at least EUR 20 million;
- A turnover of at least 40 million;
- An average annual number of employees of at least 250.
In addition, it is important to note that:
- At least two of the three conditions are met;
- The two financial years are consecutive.
- these requirements are maintained for two consecutive years
Thus, for example, local authorities such as the region, the province and the municipality are among the groups of corporations that are obliged to draw up consolidated financial statements in order to monitor the financial situation and results of all controlled bodies.
Who is exempt?
Article 27 of the Civil Code also lists the cases of exclusion from the obligation to prepare consolidated financial statements. The focus is mainly on those companies that are considered small groups .
To fall into this category, the company, for two consecutive years, must meet the following criteria
- assets of less than EUR 17.5 million
- revenues of less than EUR 35 million
- employees of up to 250.
In addition, the other group exempt from the consolidated financial statements are sub-holdings , i.e. those companies that control other companies, but are themselves controlled by another company for a percentage of more than 95 per cent.
The Preparation of Consolidated Financial Statements
Once we have checked the cases of exemption and our company is among those for which consolidated financial statements are required, we must move on to its preparation.
The first step in the process of preparing the consolidated financial statements is to identify the consolidation area .
The consolidation area corresponds to all the companies that are part of the consolidation , i.e. the group of companies.
Preparatory Phase: Consolidation Phase
The companies that are part of the consolidation must be identified. This means that all subsidiary companies must be included in the consolidation.
Excluded from this selection are those companies that prevent the preparation of the consolidated financial statements in a true and fair manner and thus provide a distorted view of the company's financial health and economic performance.
A group company that has been in liquidation for years and is in the process of being dissolved falls under this exception. In fact, it will not be calculated in the consolidation.
Once the proportional consolidation has been performed, one can move on to the actual stage of preparing the consolidated financial statements.
It is therefore up to the directors of the parent company to prepare the consolidated financial statements, an action that consists of several stages.
Stages in the Preparation of Consolidated Financial Statements
Standardisation of items and valuation criteria
This step is of vital importance as it makes the balance sheet items and valuation criteria of the different companies that are part of the consolidation comparable.
It is necessary to equalise and homogenise all the figures in the companies' financial statements in order to have clear and truthful consolidated financial statements.
Aggregation of balance sheet and income statement items
Having comparable data available, one can proceed to aggregation . The operation really consists of aggregating the financial and economic values line by line.
The result is still not a consolidated, but an aggregated balance sheet , as it is the aggregation of all the data from the financial statements.
Elimination and arrangement of intra-group items
This is the most complex operation in the preparation process. In fact, it consists of the elimination in the accounts of the equity and financial effects created due to asset and liability transactions during the course of the financial year. These transactions must have taken place with the subsidiaries that make up the consolidation.
These transactions must be eliminated, as they create value between the companies forming the consolidation, although they do not at the same time cause an increase in the group's assets or profits.
In most cases, the various intra-group receivable and payable items must be eliminated, bearing in mind that there is no distinction between financial and trade receivables.
Derecognition of Investments in Subsidiaries
The last step in the preparation of consolidated financial statements is the derecognition of participations in consolidated enterprises.
The item to be entered instead of the reversal is the full value of the assets and liabilities of the subsidiaries.
This step is important in order to understand whether there are any differences between the value at which the company's shareholding in the consolidated financial statements is recorded and the value of its assets and liabilities.
These differences may be
- positive, in the case where the value of the investment is higher than the value of the subsidiary's net assets
- negative, if the value of the shareholding is lower than the net asset value of the subsidiary.
What is the importance of consolidated financial statements?
The preparation of consolidated financial statements is of fundamental importance for several reasons:
- the analysis of the economic and financial situation within the group.
- the possibility for shareholders, investors and stakeholders to have access to information on the overall performance of the company as a whole. The companies within the group are, in fact, evaluated with respect to the situation of the group. This evaluation, therefore, can influence their listing for the better or for the worse.
- The possibility for companies within the group to apply for loans and bonds with lower rates, if the group's soundness is verified.
Do you still have doubts about the consolidated financial statements? Did we manage to answer your questions? Write to us in the comments.
And if you are interested in finding out about other types of financial statements, do not hesitate to read the other articles in the accounting section.
Article translated from Italian