Consolidated financial statements are the financial statements of a group of entities that are presented as being those of a single economic entity. These statements are useful for reviewing the financial position and results of an entire group of commonly-owned businesses. Otherwise, reviewing the results of individual businesses within the group does not give an indication of the financial health of the group as a whole.
The key entities used in the construction of consolidated statements are:
- A group is a parent entity and all of its subsidiaries
- A subsidiary is an entity that is controlled by a parent company
Thus, consolidated financial statements are the combined financials for a parent company and its subsidiaries. It is also possible to have consolidated financial statements for a portion of a group of companies, such as for a subsidiary and those other entities owned by the subsidiary.
These statements require considerable effort to construct, since they must exclude the impact of any transactions between the entities being reported on. Thus, if there is a sale of goods between the subsidiaries of a parent company, this intercompany sale must be eliminated from the consolidated financial statements. Another common intercompany elimination is when the parent company pays interest income to the subsidiaries whose cash it is using to make investments; this interest income must be eliminated from the consolidated financial statements.
As an example of consolidation, ABC International has $5,000,000 of revenues and $3,000,000 of assets appearing in its own financial statements. However, ABC also controls five subsidiaries, which in turn have revenues of $50,000,000 and assets of $82,000,000. Clearly, it would be extremely misleading to show the financial statements of just the parent company, when its consolidated results reveal that it is really a $55 million company that controls $85 million of assets.