How does consolidation accounting work?
Consolidation accounting is the process of combining the financial results of several subsidiary companies into the combined financial results of the parent company. This method is typically used when a parent entity owns more than 50% of the shares of another entity.
The following steps document the consolidation accounting process flow:
- Record intercompany loans. If the parent company has been consolidating the cash balances of its subsidiaries into an investment account, record intercompany loans from the subsidiaries to the parent company. Also record an interest income allocation for the interest earned on consolidated investments from the parent company down to the subsidiaries.
- Charge corporate overhead. If the parent company allocates its overhead costs to subsidiaries, calculate the amount of the allocation and charge it to the various subsidiaries.
- Charge payables. If the parent company runs a consolidated payables operation, verify that all accounts payable recorded during the period have been appropriately charged to the various subsidiaries.
- Charge payroll expenses. If the parent company been using a common paymaster system to pay all employees throughout the company, ensure that the proper allocation of payroll expenses has been made to all subsidiaries.
- Complete adjusting entries. At the subsidiary and corporate levels, record any adjusting entries needed to properly record revenue and expense transactions in the correct period.
- Investigate asset, liability, and equity account balances. Verify that the contents of all asset, liability, and equity accounts for both the subsidiaries and the corporate parent are correct, and adjust as necessary.
- Review subsidiary financial statements. Print and review the financial statements for each subsidiary, and investigate any items that appear to be unusual or incorrect. Make adjustments as necessary.
- Eliminate intercompany
transactions. If there have been any intercompany transactions, reverse them at the parent company level to eliminate their effects from the consolidated financial statements.
- Review parent financial statements. Print and review the financial statements for the parent company, and investigate any items that appear to be unusual or incorrect. Make adjustments as necessary.
- Record income tax liability. If the company earned a profit, record an income tax liability. It may be necessary to do so at the subsidiary level, as well.
- Close subsidiary books. Depending upon the accounting software in use, it may be necessary to access the financial records of each subsidiary and flag them as closed. This prevents any additional transactions from being recorded in the accounting period being closed.
- Close parent company books. Flag the parent company accounting period as closed, so that no additional transactions can be reported in the accounting period being closed.
- Issue financial statements. Print and distribute the financial statements of the parent company.
If a subsidiary uses a different currency as its operating currency, an additional consolidation accounting step is to convert its financial statements into the operating currency of the parent company.
Given the considerable number of steps, it is useful to convert them into a detailed procedure, which the accounting department should follow religiously as part of its closing process. Otherwise, a key step could be missed, which would throw off the financial statement results.
Some of the tasks noted here can be automated, or at least made simpler, in order to produce financial statements more quickly. However, to some degree, the higher level of precision required to produce more accurate financial statements requires additional consolidation effort, and therefore more time.