The Usefulness and Limitations of Consolidated Financial Statements
Whenever information is consolidated there is inherently a sacrifice of datum. Consolidation is necessary because while this information may be pertinent to some users of financial data that information may not, and it is the function of consolidation which segregates this from that. “Consolidated statements often provide the only means of obtaining a clear picture of the total resources of the combined entity that are under the parent`s control and the results of employing those resources…[They summarize] the vast amounts of information relating to the individual companies and how the positions and operations of the individual companies affect the overall consolidated entity (109).” While the consolidated financials provide a general picture of the financial health of an entity and its subsidiaries, the question of whether or not they are important lies in who is asking the question. In a parent/subsidiary relationship the parent’s creditors have an indirect claim on the subsidiaries’ assets; therefore, they are more concerned with the organization’s immediate solvency rather than its long-term profitability. However, “even though they also have an indirect claim on the subsidiaries’ assets, [short-term creditors] are usually more interested in the parent`s immediate solvency rather than its long-term profitability (109).”
The three different theories of consolidation are the proprietary theory, the parent company theory, and the entity theory. Accounting for the proprietary theory involves pro rata consolidation “in which the parent company consolidates only its proportionate share of a less-than-wholly-owned subsidiary`s assets, liabilities, revenues, and expenses (119).” Noncontrolling interest`s share of these accounts is not included in the consolidated financial statements under this approach. All subsidiary assets and liabilities included in the consolidated balance sheet are based on the full fair values at the date of combination, and the full amount of goodwill is included regardless of the percentage of ownership held by the parent.
Under the parent company approach all of the subsidiary`s assets, liabilities, revenues, and expenses are included in the consolidated financial statements but only the parent`s share of any fair value increment and goodwill is included. This theory “recognizes that the parent has the ability to effectively control all of the assets and liabilities of a majority-owned subsidiary, not just a proportionate share, even though the parent does not actually own the subsidiary`s assets or have any obligation for its liabilities (119).” The noncontrolling shareholders` claim on the subsidiary is reported on the consolidated balance sheet based on a proportionate share of the book value of the subsidiary`s net assets and the noncontrolling interest`s share of income is deducted to arrive at consolidated net income.
“As a general ownership theory, the entity theory focuses on the firm as a separate economic entity rather than on the ownership rights of the shareholders (119).” All of the assets, liabilities, revenues and expenses of a less-than-wholly-owned subsidiary are consolidated and no special treatment is awarded to either the controlling or noncontrolling interest. Under this approach, the controlling and noncontrolling shareholders are viewed as two separate groups, each having equity in the consolidated entity as a whole. Subsidiary assets and liabilities are included in the consolidated financials based on the full fair values at the date of combination, and the full amount of any goodwill is included regardless of the percentage of ownership held by the parent (119).
Copyright: Nathan J. Fragala 06/16/14
"Advanced Financial Reporting" (9th edition)
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