Consolidation Accounting

Consolidation accounting is the set of rules and procedures by which a parent company presents the assets, liabilities, equity, income, expenses and cash flows of itself and its subsidiaries as if they were one entity. The result is a set of consolidated financial statements. Investors and lenders rely on these, since the legal boundaries between companies in a group say little about the resources and obligations of the business as a whole.

Under International Financial Reporting Standards, the main requirements are in IFRS 10, issued by the International Accounting Standards Board (IASB), with related standards on business combinations, joint arrangements, associates and disclosure. In the United States, the equivalent guidance comes from the Financial Accounting Standards Board (FASB). Both frameworks rest on the idea of control, though they define it differently in places.

A parent consolidates every entity it controls. Under IFRS 10, an investor controls an investee when three conditions are all met: it has power over the investee, meaning existing rights to direct the activities that most affect returns; it is exposed, or has rights, to variable returns from its involvement; and it can use its power to affect the amount of those returns.

Control usually follows from owning a majority of voting rights, but not always. An investor with less than half the votes may have control if other shareholdings are widely dispersed, or through contractual arrangements or potential voting rights. Conversely, a majority holder may lack control if others hold substantive rights to direct key activities. For a special purpose entity in which voting rights are not the deciding factor, the analysis looks at the entity's purpose and design and at who directs the activities that matter. United States standards use a separate model for such variable interest entities, under which the primary beneficiary consolidates.

Preparing consolidated statements involves a series of steps:

• Aligning the inputs. Subsidiaries' figures are adjusted to the group's accounting policies and reporting date.
• Combining. Like items of assets, liabilities, equity, income and expenses are added together line by line.
• Eliminating the investment. The parent's investment in each subsidiary is offset against the parent's share of the subsidiary's equity.
• Eliminating intragroup items. Balances, transactions and unrealised profits between group companies are removed in full; see intercompany elimination.
• Translating. The statements of foreign operations are converted into the group's presentation currency under IAS 21, with the resulting differences taken to equity.
• Presenting non-controlling interests. The share of net assets and profit belonging to other shareholders in subsidiaries is shown separately within equity and in the allocation of profit.

Reliable elimination depends on group companies recording their dealings with each other consistently, the subject of intercompany accounting and intercompany reconciliation. Consolidation is a step in financial close management.

When a parent gains control of a business, it applies the acquisition method. The identifiable assets acquired and liabilities assumed are measured at fair value at the acquisition date. If the consideration paid, plus any non-controlling interest, exceeds the net amount of those assets and liabilities, the difference is recognised as goodwill. Under IFRS, goodwill is not amortised but is tested each year for impairment under IAS 36; a write-down is a goodwill impairment.

The subsidiary's results are included from the date control is obtained and excluded from the date it is lost. A change in the parent's ownership that does not result in loss of control is treated as a transaction between owners and recorded in equity, shown in the statement of changes in equity.

Lesser degrees of influence call for other methods. An associate, over which the investor has significant influence, generally presumed from a holding of 20% or more of the votes, is accounted for using the equity method: the investment is recorded at cost and then adjusted for the investor's share of the associate's profits and losses. Joint ventures, in which parties share control and have rights to the net assets, are also equity accounted. Holdings that give neither control nor significant influence are treated as financial assets and measured under fair value accounting rules.

Judgements about control can be difficult and have large effects. Leaving an entity out removes its debts from the group balance sheet, and the use of unconsolidated vehicles for this purpose featured in the collapse of Enron in 2001 and in banks' exposures to off-balance-sheet conduits during the financial crisis of 2007 to 2009. The current standards on control and on disclosure of interests in other entities were written partly in response.

Consolidated statements also have inherent limits. They do not show which legal entity holds which assets or owes which debts, although creditors' claims are against individual companies and cash may be unable to move freely within a group because of regulation, tax or minority interests. The top entity is commonly a holding company whose own accounts consist mainly of investments in subsidiaries.

• IFRS Foundation
• Financial Accounting Standards Board