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Accounting rules for consolidation: what is required from a business?

Consolidation is incredibly important for a business's financial management: with it you can see the financial performance of an organisation. Most preparation will be done in accordance with the generally accepted accounting principles (GAAP).
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When is consolidation accounting required for businesses?

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.

What rules must be followed when consolidating financial statements?

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: 

  • Economic entity assumption: businesses must include the differences between transactions carried out within a group of companies.
  • Monetary unit assumption: companies will record all statements in a financial currency, despite whether conversions are needed across global organisations or not. 
  • Time period assumption: all reports made by subsidiaries should be based on a specific time period before consolidation to ensure consistency and accuracy across smaller subsidiaries' financial statements. 
  • Cost principle: all assets need to be initially recorded to their actual cost. 
  • Full disclosure: these reports should highlight all financial data that is significant to the performance of the business. Anything that is overlooked will make the reports less fair and unreliable.

What accounts are eliminated in consolidation?

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.

When must a business report its financial statements using the equity method?

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.

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