Consolidation is mandatory to group together companies with multiple subsidiaries. Usually, if a parent company has more than 50% of ownership over another firm, it will need to be included in the consolidated reports. If they have less ownership, their voting shares will be considered to calculate their level of influence over the subsidiary. Even when consolidation is necessary, each subsidiary can still produce its own financial statements for internal use, but for a company-wide financial report, consolidation is required.
The GAAP sets out principles that include key themes to clarify company details, complexities and legalities. They have numerous rules that are followed by the majority of organisations. These regulations ensure that accounting reports are accurate and impartial. Some of the rules outlined by the GAAP include:
During financial consolidation, transactions between two entities within a group that are being consolidated need to be eliminated – to present a final economic figure for accurate results. These intercompany transactions will initially appear twice in the reports – once for each entity – and will both need to be cancelled out so the final figure equals zero. Transactions with unrelated companies can remain in the reports. These removals are made to eliminate any profit or loss that arises from intercompany transactions. These transactions include receivables, payables, investments, capital, revenue and cost of sales.
Equity accounting is used when a business or investor holds a high level of influence over another entity but doesn’t exercise control over it. They won’t be referred to as a parent or subsidiary, but may be known as associate companies. This occurs when a business holds between 20-50% of equity or shares in another company. This type of accounting tracks the interest and records any investment in associated companies. An example of this is if a large number of transactions between two associate companies occur or if they share employees.