In the accounting world, financial consolidation is the process of combining financial data from several subsidiaries or business entities within an organization, and rolling it up to a parent company for reporting purposes.
Financial Consolidation in the Accounting World
By itself, the term “consolidation” simply means to put things together. But in the accounting world, “financial consolidation” is a well-defined process that includes several complexities.
Here are the key steps in the financial consolidation process:
- Collecting trial balance data (e.g., Assets, Liabilities, Equity, Revenue, and Expense accounts) from multiple general ledger systems, and mapping it to a centralized chart of accounts
- Consolidating the data following specific accounting rules and guidelines, such as US GAAP or International Financial Reporting Standards (IFRS)
- Reporting results to internal and external stakeholders
Key financial reports generated from consolidated financial results include the income statement, balance sheet, and statement of cash flows.
It’s More Than Just Adding Up Numbers
To those who aren’t familiar, financial consolidation might sound like simply adding up numbers. But it’s more than this. In financial consolidation, there are specific calculations and adjustments made as the numbers are consolidated from the subsidiary level to the parent company level. This includes the following:
- Foreign currency translation
- Elimination of intercompany transactions and balances
- Adjusting journal entries
- Accounting for partial ownership
There are also different methods of consolidation. These can vary depending on the controlling stake a parent organization has in a subsidiary. For instance, if the parent has a controlling interest in the subsidiary (more than 50%), then consolidation accounting is used. In this case, all the subsidiary company’s assets, liabilities, revenues, and expenses are combined into the parent company’s financial statements.
When a company owns a stake that is less than controlling but still allows it to exert significant influence over the business, it must use the equity method of accounting. Accounting rules generally define a controlling stake as between 20% and 50% of a company.
Under the equity method of consolidation, the parent company reports the investment in the subsidiary on the balance sheet as an asset that is equal to the purchase price. Then when the subsidiary company reports its net income, the parent company reports revenue equal to its share of the subsidiary’s profits. So if a subsidiary has $100,000 in profit and the parent owns 30% of the subsidiary, the parent company would increase the value of the investment asset by $30,000 and record the $30,000 in revenue as an increase to retained earnings.
Using the Right Tool for the Job
In a large enterprise, the financial consolidation process is typically handled by the Accounting department, which is under the supervision of the Controller or VP of Accounting/Reporting, and ultimately overseen by the Chief Financial Officer (CFO).
While financial consolidation was done manually for many years, in today’s world there are several types of software tools used to support financial consolidation and reporting.
- General Ledger System – works well if an organization has a single ERP system, but becomes cumbersome if there is a need to collect and consolidate financial results from multiple systems used by different locations or subsidiaries.
- Spreadsheets – while these are widely used by Finance and Accounting professionals, they weren’t designed to support a complex process, such as financial consolidation. Loading data from different systems is a manual process. With multiple tabs in a workbook, the spreadsheet can become unwieldy. Undetected errors can occur. And spreadsheets don’t provide adequate audit trails regarding changes to financial results.
- Purpose-Built Financial Application – purpose-built financial consolidation applications are designed to integrate data from multiple sources, have specific functionality built in to handle the complexities of financial consolidation, and typically have all the required security and audit trails. While these systems have historically been deployed in on-premises data centers, they are now available as cloud or software as a service (SaaS) offerings.