According to the FASB accounting standards codification, consolidated financial statements are "the financial statements of a consolidated group of entities that include a parent and its subsidiaries presented as those of a single economic entity.1 The purpose of consolidated financial statements is to present the operations of a parent company and its subsidiaries as if they were that of one company with several branches or divisions.
When to Consolidate
The financial statements of a parent and its subsidiary should be consolidated when the parent company directly or indirectly owns a controlling interest in the subsidiary. This usually occurs when the parent company owns more than 50% of the voting shares of a subsidiary.2
Eliminating Intercompany Balances and Transactions
When the financial statements of the companies are consolidated, intercompany balances and transactions should be eliminated (2). For example, companies often loan money to one another, purchase on account from one another, pay interest to one another, and pay dividends to one another. For example, a parent company has loaned a subsidiary $100,000 at 10% interest. The $100,000 asset should be removed from the assets of the parent company and the $100,000 liability should be removed as a corresponding liability of the subsidiary. Similarly, the $10,000 interest revenue should be removed as revenue from the parent company and an expense from the subsidiary. If a profit or loss is realized on the sale of an asset that remains within the group, the profit should be eliminated as well (although if taxes are paid on the profit, the amount that is eliminated should be reduced accordingly).
In some cases a subsidiary may capitalize its earnings by issuing stock dividends. This should be reversed and retained earnings should be retained when the stock dividends are received by the parent company.
Non-controlling Interests
The consolidated financial statements should clearly separate out the amount of income or equity attributable to any non-controlling interests of the subsidiary.3
References:
1. FASB, "Consolidated Financial Statements," FASB ASC Master Glossary.
2. ARB 51: Consolidated Financial Statements. Retrieved from: http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820901468&blobheader=application%2Fpdf.
3. FASB, “Statement No. 160.” Retrieved from: http://www.fasb.org/pdf/fas160.pdf.
Consolidated Financial Statements
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