A brief guidance on consolidation of financial statements


Consolidation of financial statements

In the language of accounting, the information and the revenue received by the parent company and its subsidiary is treated as receiving by the single entity though it is received by distinct entities in terms of legality. Some basic principles are indulged in consolidation of financial statements. Now, let us have a fair look on consolidation of financial statements i.e. Balance sheet and P&L. 

(i) Consolidate every item on line by line basis

(ii) Eliminating the items of prevalent transactions between the parent company and its subsidiaries.

Every elimination will arise a double effect parallel with other corresponding elimination. Let us now have a glance on those double effects.

Elimination effects

Name of the item eliminated

Corresponding parallel elimination of item

Share capital Non current / Current investments
Reserves and surplus P&L/ Capital
Long term / Short term borrowings Long term / Short term loans and advances
Trade payables Trade receivables
Trade receivables Trade payable
Incomes Expenses
Expenses Income

Let us discuss the about the above table:

1) The elimination of share capital of your subsidiary leads to parallel elimination in the category of non current / current investments in the other i.e. Whatever the money invested in that subsidiary will be shown in the subsidiary company's capital resulting in duplication of values effecting the true and fair value of financial statements which leads to this elimination of prevalent transactions. As per AS 21 - Consolidation of financial statements. Share capital and investments are eliminated in the following way:

Case (i): First year of resulting in subsidiary i.e. In the year of acquiring

Have a brief look on the following example

Balance sheet of company X

Liabilities Amount Assets Amount
Share capital 100000 Fixed assets 100000
Reserves 50000 Investments 95000
Profit and loss 50000 Cash in hand 5000
Total 200000 Total 200000

Balance sheet of company Y

Liabilities Amount Assets  Amount
Share capital  100000 Fixed assets 50000
Reserves 50000 Loans and advances 50000
    Cash 50000
Total 150000 Total 150000

In the above example X ltd has acquired 95% of Y Ltd shares. Let us have a brief look on the solution

Here, Share capital and the investments to be eliminated because they are the common transactions. In order to eliminate following procedure to be followed as per As-21 consolidation of financial statements.

Compute net worth of Company Y

Share capital  100000
Reserves and surplus 50000
Net worth 150000

Since, Company X holds only 95% of shares.

Net worth (95%) = 142500
Less: Cost of investments = 95000
Capital reserve = 47500
In the prime year of consolidation, 
if net worth > cost of investments = Then capital reserve will be created
if net worth < cost of investments = Then goodwill will be created

So, the ultimate effect is share capital will be eliminated and reserves will be eliminated and corresponding elimination is done to the investments. After eliminating an amount of capital reserve is created to the extent of such amount.

It is shown as

Consolidated balance sheet

Liabilities Amount Assets Amount
Share capital  100000 Fixed assets  150000
Capital reserve  47500 Loans and avances  50000
Minority interest 7500 Cash 55000
Profit and loss 50000    
Reserves  50000    
Total 255000 Total 255000

Case (ii): In the subsequent year of acquiring

In the subsequent year of acquiring, Compare the net worth as on the date of balance sheet and as on the date of acquiring. Any difference in the net worth leads to revenue profit/loss in the consolidation of financial statements.

For suppose from the above example if the net worth of the company is increased to 143000/-(Share of parent company). Difference between the net worth i.e. 143000-142500 = 500 (Irrespective of the amount of increase or decrease) will be treated as revenue profit and will be added to the profit and loss of the company. In the same pattern, if the net worth is decreased then it will be treated as the revenue loss. The capital reserve/Good will created in the year of acquiring will be forwarded to subsequent years.

Since, Ultimately the company holds only 95% of shares of the company. Remaining 5% is treated as the minority interest and will be disclosed in the face of the balance sheet.

Minority interest = 5% of net worth + 5% of profit or loss(In the given example minority interest is 5% since the company holds 95%).

Therefore, If the company faces losses and even the net worth is not sufficient to set off the loss to the minority holders. Such remaining amount will be beared by the parent company.

2) Elimination of long term or short term borrowings:

Suppose, From the above example Company Y has taken a long term loan from Company X equal to an amount of Rs.85000/-. 

In the books of Company X, That amount will be shown under long term loans and advances

In the books of Company Y, that amount will be shown under long term borrowings.

At the time of consolidation, For the purpose of true and fair view of financial statements long term borrowings of company Y will be eliminated resulting in the parallel elimination of long term loans and advances of company X. In practical the case may also be Vice versa.

3) Elimination of trade receivables: 

Suppose, From the above example, Company X has sold some of it goods to company Y for an amount of Rs.65000/-

In the books of company X, The amount will be shown under the head trade receivables

In the books of company Y,  the amount will be shown under the head trade payables.

At the time of consolidation, For the purpose of true and fair view of financial statements trade payables of Company Y will be eliminated resulting in the parallel elimination of trade receivables of company X. In some cases the situation may be Vice Versa.

4) Elimination of prevalent incomes or expenses:

Suppose, From the above example, Company X has given loan to Company Y. And company Y is paying interest to the Company X an amount of Rs.5000/-.

In the books of Company X, The amount will be shown under the head other income

In the books of Company Y, The amount will be shown as an expense in the finance cost.

At the time of consolidation, For the purpose of true and fair view of the financial statements, Company Y will eliminate the interest expense and corresponding effect will be given by eliminating interest income in the books of Company X. Some times the situation may be Vice Versa. 

Note: If the parent company has a foreign subsidiary the share capital and reserves exclusively should be translated at a rate on that day when the share of that company are acquired by the parent company. The resulting difference in will be treated as Foreign currency translation reserve / Fluctuation reserve. For computation of net worth it also forms a part of the reserves.

This article is just a brief of the consolidation of financial statements.

Disclaimer: Readers are advised to cross check if you want to rely on the contents of this article.

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eswarachandra bommisetty 
on 06 December 2017
Published in Audit
Views : 2234






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