Who is exempt from preparing consolidated financial statements?

By Sigma Conso

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What we’re going to talk about:

  • The IFRS 10 Consolidated Financial Statements Standard outlines which parent entities must prepare consolidated financial statements
  • The principle of ‘control’ is key in defining an entity that controls one or more other entities must prepare consolidated financial statements
  • Group accounts consolidation adds together all the assets, liabilities, and results of each subsidiary and adjusts them for goodwill, internal transactions and balances, and non-controlling interests
  • Parent companies which meet certain conditions and criteria are exempt from preparing consolidated financial statements
  • The right consolidation software is key to simplifying the increasingly complex process of consolidating financial statements and financial information

In 1970, there were just 7,000 transnational corporations. Half a century later, there are roughly 77,000 parent companies with around 770,000 subsidiaries operating almost everywhere in the world.

But as the number of parent companies with numerous subsidiaries grows, so does the challenge of financial consolidation and reporting. CFOs therefore need to take reasonable steps to check if the parent company is exempt from preparing these statements – and, if not, that the process of preparing the consolidated accounts runs smoothly towards the end of the financial year.

Are you interested in discovering more about financial consolidation and reporting software? We have a team of experts who will be happy to discuss your specific needs.

IFRS 10

The IFRS 10 Consolidated Financial Statements Standard was issued in May 2011 and is applicable to annual periods beginning on or after January 1, 2013. It provides practical guidance and outlines the general requirements for the preparation and presentation of consolidated financial statements, requiring parent entities to consolidate the entities it controls.

Consolidated financial statements are defined as the financial statements of a group in which the assets, liabilities, equity, income, expenses, and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.

The Standard:

  • Requires a parent entity (an entity that controls one or more other entities) to present consolidated financial statements
  • Defines the principle of control, and establishes control as the basis for consolidation
  • Sets out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee
  • Sets out the accounting requirements for the preparation of consolidated financial statements
  • Defines an investment entity and sets out an exception to consolidating particular subsidiaries of an investment entity.

The principle of control is key here. The parent company must clarify what ‘control’ means in terms of its obligations under international accounting standards. Control is defined as three elements:

  • Power over the investee. The investor has existing rights that give it the ability to direct the relevant activities (the activities that significantly affect the investee's returns)
  • Exposure, or rights, to variable returns from its involvement with the investee
  • The ability to use its power over the investee to affect the amount of the investor's returns.

If these three elements are present, the parent company is then considered to control the subsidiary and must prepare consolidated financial statements unless it is exempt.

Group accounts consolidation

Consolidated group accounting is relevant when an entity consists of a group of companies. A big company may be a single company, or it could be made up of many companies, all ultimately controlled by the parent company.

Each individual company must prepare accounts and separate financial statements which show its profit, loss, inventory, etc. at the end of each financial year and for certain periods over the year.

However, under international financial reporting standards, the group’s consolidation manager must prepare a financial statement which demonstrates how the parent company is performing as a whole. The consolidated group accounts show the assets and liabilities and the results of the entire entity.

For group accounts consolidation to take place, the assets, liabilities, and results of the parent company and all its subsidiaries are added together. The parent company’s investment in each subsidiary is not shown, but is replaced with the assets and liabilities of each subsidiary.

The finance team must then adjust in three key areas to follow consolidation procedures:

Goodwill

This is the amount paid for a company over and above the actual value of its assets. For example, if Company A’s assets are worth €1m and the parent Company Z pays €1.5m to acquire the company, the goodwill is €0.5m. Of course, goodwill can be zero if Company A’s purchase price only covers its actual assets.

Goodwill is a long-term intangible asset: it could cover, for example, customer base, the reputation of a company, or the skill of its employees. It must be calculated and recorded in the consolidated group accounts, but this is done separately from other tangible assets.

Internal transactions and balances

Internal transactions are not relevant for group accounts as they record details of money flowing from one member of a group to another. These transactions must be identified and matched before the consolidated accounts are finalised.

For example, if Company Z sells shares, goods, or services to Company A for €500, Company A’s purchase of €500 must be matched by Company Z’s sale of €500 record. The two transactions cancel each other out and the balance is reduced to zero.

All intercompany transactions must be removed from group accounts to ensure that they give an accurate picture of the company’s activities.

Non-controlling interests

In some cases, a parent company might not own all the subsidiary company. While the group accounts include the assets from the subsidiary, regardless of the ownership percentage, the value owned by different shareholders must still be recorded.

The non-controlling interest portion of the value must be factored into the group accounts by multiplying income by the NCI percentage. Consider Company Z: it owns 90% of Company A, which has a net income of €1m. Company X owns the other 10%. Therefore, the non-controlling interest is €1m x 10% = €100,000.

Exemption from preparing consolidated financial statements

Different countries have very different statutory requirements and criteria around the consolidation of group financial statements. In some countries, it is mandatory; in others, discretionary. Not all countries have adopted IFRS as the standard. Directors and CFOs must therefore ensure that they are familiar with the group consolidation statutory requirement under the laws of the country in which it operates.

However, under IFRS standards, not all parent companies need to prepare consolidated financial statements. According to Paragraph 4 of IFRS 10, parent companies which meet certain conditions are exempt from preparing consolidated financial statements.

These exemption criteria are:

  • If the parent company is a wholly owned subsidiary or is a partially owned subsidiary of another entity and its other owners, including those not entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements
  • If the parent company’s debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets
  • If the parent company did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market

The ultimate parent or any intermediate parent of the parent company produces financial statements available for public use that comply with IFRSs, in which subsidiaries are consolidated or are measured at fair value through profit and loss in accordance with IFRS 10.

Long-term employment benefit plans are also exempt, as are entities which are defined as ‘investment entities’. This could apply to certain mutual or investment funds.

Simplifying your group accounts consolidation

Group accounts consolidation is a complex, time-consuming, and expensive process, involving a vast amount of data from different subsidiaries across different sites, countries, and time zones.

The global nature of the group and its associates also means that subsidiaries will prepare accounts and the balance sheet according to their own country’s reporting standards – such as the Companies Act in the UK – and in different currencies.

Subsidiaries may also use varying, outdated consolidation platforms and error-prone software such as Excel to collect their data. They might share sensitive information via email without adequate password protection, which anyone can access and view, violating a company's privacy policy.

However, unless your parent company is exempt, group accounts consolidation is a necessary process to meet international financial accounting standards. Therefore, CFOs should consider how much time, effort, and error they could save by investing in efficient financial consolidation software.

Are you interested in discovering more about financial consolidation and reporting software? We have a team of experts who will be happy to discuss your specific needs.