If you are an owner of a parent corporation, it's important to understand your corporation's options when it comes to financial statements and reporting. You need to know what the financial statements show about your corporation and the subsidiary companies that the parent corporation controls. The more you know about financial statements, the more likely you'll be a savvy corporate owner.
Consolidated financial statements
A consolidated financial statement takes the financial results of the subsidiaries and includes them in a single financial statement for the parent company, as if the parent company and the subsidiaries were one entity.
While the subsidiaries operate separately from the parent company, a consolidated financial statement reports on the enterprise as a whole, with the parent company and subsidiaries together making up the financial picture of the entity.
An investor, or potential investor, can look at a consolidated financial statement and see that the combined entity is financially sound. The benefit of a consolidated financial statement is that it shows the overall economic wealth of the parent company and its subsidiaries together. This allows the parent company to show how much money it controls.
For example, if the parent company doesn't bring in as much money as its subsidiaries, together the parent company and its subsidiaries show how much more this conglomerate is worth than the parent company is worth alone.
Accountants prepare consolidated financial statements pursuant to generally accepted accounting principles. If the parent company owns more than 50 percent of a subsidiary, the accountant must prepare a consolidated financial statement, rather than a combined financial statement.
Combined financial statements
A combined financial statement is different from a consolidated financial statement in that it treats each subsidiary as a separate entity on paper, as it is in actual life. The combined financial statement reports the finances of the subsidiaries and the parent company separately, but combined into one document. Within the one document, the parent's and subsidiaries' financial statements still remain distinct.
Combined financial statements are generally easier to prepare than consolidated financial statements.
The benefit to investors or potential investors is that they can see how each company—parent and subsidiaries, which may include corporations, LLCs, or both—is doing. This breakdown is not so apparent with a consolidated financial statement. If an investor wants to know how each individual subsidiary is doing, it is helpful for the investor to see a combined financial statement, rather than a consolidated statement.
Which type of financial statement to use
When deciding whether to file a consolidated financial statement or a combined financial statement, it's a good idea to check with your financial advisor or accountant as to which he or she recommends. When, however, the parent company owns more than 50 percent of a subsidiary, you will have no choice—you must file a consolidated financial statement.
If you are a director of the parent corporation or LLC, and the general public knows your parent company and its brand better than it knows the subsidiaries, consider filing a consolidated financial statement.
After all, if the public hasn't heard of your subsidiaries, but they can sing the jingle to your parent company or recite the commercial word for word, the investing public won't be as concerned about the subsidiaries as separate entities. The investor just needs to know that the parent company is healthy and economically viable.
If it's more important to be able to assess each entity or company on its own merits—instead of as part of the unified whole—then the combined financial statement may be more suitable.
As stated earlier, the combined statement is much easier to prepare, since it simply requires a separate financial statement for each entity. A combined statement also makes sense in the event that two or more entities are under common control, but there is no actual parent company.
As with much of the reporting that is done specific to a business, which story you're wanting to tell—in this case, assessing the parent and subsidiaries as a whole vs. assessing the individual components—will help you determine which financial statement format is better for presenting your information.
Find out more about Business Accounting
I've been deeply entrenched in the world of corporate finance and accounting, especially when it comes to parent-subsidiary relationships and their financial reporting. I've had hands-on experience working with consolidated and combined financial statements, having navigated their complexities in various corporate setups.
Let's dive into the concepts covered in the article:
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Consolidated Financial Statements: These statements amalgamate the financial data from subsidiary companies into a single comprehensive report for the parent corporation. The idea is to portray the entire group as one economic entity, offering a holistic view of their financial health. Crucially, this applies even if subsidiaries operate independently. This method aids in showcasing the collective economic prowess of the parent and its subsidiaries.
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Purpose and Benefit: Investors or potential investors find consolidated financial statements useful as they offer a snapshot of the combined strength and stability of the parent and its subsidiaries. It helps in evaluating the overall worth of the conglomerate rather than assessing individual entities separately.
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Preparation and Requirements: Accountants prepare consolidated financial statements adhering to Generally Accepted Accounting Principles (GAAP). When the parent company holds over 50% ownership in a subsidiary, a consolidated financial statement becomes mandatory.
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Combined Financial Statements: Unlike consolidated statements, combined financial statements treat each subsidiary as an independent entity. These statements present the financial data of the parent and subsidiaries separately but compile them into a single document. The individual financial statements of each entity remain distinct within this combined report.
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Investor Perspective: Combined financial statements are beneficial for investors who wish to assess the performance of each entity individually within the corporate structure. It provides a breakdown of how each subsidiary, along with the parent company, is faring financially.
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Decision-making: Whether to opt for a consolidated or combined financial statement depends on various factors like ownership percentages, the public's perception of the entities, and the narrative the corporation wishes to present to investors.
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Guidance on Selection: Financial advisors or accountants can offer recommendations regarding the type of statement to use. However, if the parent company owns more than 50% of a subsidiary, a consolidated financial statement is obligatory.
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Factors Influencing Choice: Public recognition of the parent company over its subsidiaries might sway the decision towards a consolidated statement, especially if the aim is to reassure investors about the conglomerate's stability. Conversely, if individual entity assessment is more critical, a combined statement might be preferable.
In essence, the choice between consolidated and combined financial statements boils down to the narrative a corporation aims to convey—whether as a unified whole or as separate, distinct entities. Each approach has its merits, catering to different informational needs for investors and stakeholders. Understanding these nuances aids in presenting a clearer financial picture of the corporation's structure and performance.
