Consolidated Financial Statements

Meaning
Consolidated financial statements (or usually abbreviated as CFSs) are defined as the financial statements in which the company’s financial statements, as well as financial statements for all of its subsidiaries, divisions, or sub-organizations, are combined and presented as being those of a sole business entity.

What is the purpose of consolidated financial statements?
Consolidated financial statements play an integral part in the accounting process and help in reviewing the overall financial position of the entire group altogether. It is of utmost significance from the viewpoint of creditors and shareholders of the parent company. It is always presumed that consolidated statements represent the result of operations and the financial position in a much meaningful manner as compared to separate individual statements. It is also obligatory for a fair representation when one of the business entities in the group has a pecuniary interest in the other business entities.

Example
Coca-Cola is a company having its operations globally and thus operates with many subsidiaries. Its worldwide subsidiaries help it to support its global presence in numerous ways. Each of its subsidiaries helps in contributing towards its food retail chain goals with subsidiaries in the areas of packaging, beverages, products, and more.

How do Consolidated Financial Statements work?
Let’s consider an example; Company ABC is a holding company that owns three other companies: Company X, Company Y, and Company Z. Each of the three companies pays a certain amount of royalties and other fees to Company ABC.

At the end of the financial year, the income statement of Company ABC is reflecting a large amount of royalties and fees with hardly any expenses — mainly because of the fact that they are being recorded on the income statements of subsidiary companies. In this case, an investor who is looking solely at financial statements of the holding company (Company ABC) possibly will easily get a misleading interpretation of the performance of the business entity.

However, if Company ABC goes with consolidating its financial statements — “adding” the financial statements of the group ( that is holding companies and its subsidiaries all together) mainly involving income statements, balance sheets, and cash flow statements — the outcomes would give a more comprehensive representation of the whole Company ABC enterprise.

In Figure 1 below, the assets of Company ABC are only $2 million, but the consolidated number shows that the entity as a whole controls $422 million in assets.

Figure 1

Company ABCCompany ACompany BCompany CConsolidatedRevenue$20,000,000$200,000$10,000,000$100,000$30,300,000Assets$2,000,000$10,000,000$400,000,000$10,000,000$422,000,000

Who should prepare consolidated financial statements?
When an investing company acquires less than 20 percent outstanding common stock of another company, then the fair value method is used by that company to show its investment while the company would use equity method if ownership interest in another company is in the range of 20–50%.

The investing company will be mandatorily required to prepare consolidated financial statements if ownership interest in another company is 50 percent or more. When a company is having more than 50 percent ownership interested, then that company enjoys the privilege of controlling the business and does take part in the company’s financial decisions. CFSs are generally prepared as per the Single economic entity concept which suggests that companies having an association with each other through the virtue of common control should operate as a single economic unit and represent their financial statements accordingly in the form of consolidated financial statements.

The accounting procedures that should be adopted for preparing the consolidated financial statements depend upon several factors. These factors are:

The extent of ownership: whether the subsidiary is wholly owned or not. Here, a wholly-owned subsidiary is one where the parent owns 100 percent of the subsidiary’s voting rights;

The amount of purchase consideration paid i.e. the amount transferred to subsidiary against the stock acquired. In other words, whether any goodwill arises or not;

The structure of the group: the number of subsidiaries and whether the subsidiary has further a sub-subsidiary or not;

How do you prepare a consolidated financial statement?
There are certain steps that must be followed for preparing a consolidated financial statement. These steps are as follows:

• Record intercompany loans
  The foremost step in preparing consolidated financial statements should be recording intercompany loans from the subsidiaries to the parent company while consolidating the cash balances of its subsidiaries into an investment account by the parent company. Additionally, interest income apportionment for the interest earned on consolidated investments should also be recorded from the parent company down to its various subsidiaries.
• Charge corporate overhead
  The overhead costs to subsidiaries should also be allocated to various subsidiaries and in this regard, computation should also be made so as to charge it to the various subsidiaries.
• Charge payables
  It should be verified that all accounts payable recorded in the course of the business are suitably charged to the various subsidiaries by the parent company if the parent company runs a consolidated payables operation.
• Charge payroll expenses
  There should be proper allocation of payroll expenses to its various subsidiaries by the parent company if the company is using a common paymaster system to make payments to all of its employees throughout the company.
• Complete adjusting entries
  The adjusting entries should also be made wherever required to suitably record business transactions in the correct financial year. This should be made to subsidiary as well as corporate levels.
• Investigate asset, liability, and equity account balances
  There should be proper verification on the matter that the contents concerning asset, liability, and equity accounts for the subsidiaries as well as the corporate parent are correct, and do make adjustments wherever required.
• Review subsidiary financial statements
  The financial statements for each subsidiary should be thoroughly reviewed and an investigation may be carried out to identify any item that may seem to be unusual or incorrect. All the rectifications or adjustments should be made in this regard.
• Eliminate intercompany transactions
  There should be an elimination of the intercompany transaction. If there are any intercompany transactions, these should be reversed on the part of the company to eliminate their effects from CFSs.
• Review parent financial statements
  The financial statements for the parent company should also be thoroughly reviewed and an investigation may be carried out so as to identify any item that may seem to be unusual or incorrect. All the rectifications or adjustments should be made in this regard.
• Record income tax liability
  The income tax liability should also be recorded if the company has made a profit. The same should be done at each of the subsidiaries’ level as well.
• Close subsidiary books
  In order to prevent the recording of additional transactions in the financial year being closed, it may be required to access each subsidiary’s financial records and mark them as closed with the help of accounting software in use.
• Close parent company books
  Once the subsidiary’s financial records have been marked as closed, the accounting period of the parent company should also be marked as closed so that no additional transactions may be recorded further in the accounting period being closed.
• Issue financial statements
  The last but not the least step is supposed to be printing and distributing the financial statements of the parent company.
  

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Section 141 of the Companies Act, 2013- Eligibility, qualifications, and disqualifications of auditors

Introduction

A company is defined as a business entity formed for performing certain lawful purposes and is incorporated under the Companies Act, 2013. It is somewhat imperative on the part of the company to work transparently in the best interests of the public in general and its stakeholders. In this regard, an auditor is generally appointed by the company who is entrusted with monitoring the company’s affairs and inspecting the company’s books of accounts and further validating the accuracy of the transactions.

An audit is an impartial or unprejudiced analysis and assessment of the financial statements of a business entity. It is carried out to ensure that the books of accounts are a fair and accurate representation of the affairs or transactions that business entity claims to represent.

The term “Auditor” refers to an individual who is entrusted with all the audit works of the business entity. In other words, the Auditor’s primary role is to critically and prudently inspect the books of accounts of the business entity.

Appointment of Auditors
It is mandatory on the part of the company to appoint an auditor in its very first Annual General Meeting (AGM). The written consent from the appointed auditor should also be produced before finally appointing him as the company’s auditor. In this regard, a certificate may also be taken from him concerning his appointment in compliance with prescribed rules and regulations. The auditor so appointed shall fulfill the criteria provided in Section 141 which mentions the qualifications and disqualifications of auditors. The Registrar of Companies (ROC) should also be notified about such an appointment and a notice must be issued within 15 days of the AGM in this regard.

Qualifications of an auditor [Section 141(1) & (2)]:There are certain conditions that must be fulfilled with a view to successfully qualify to be appointed as an Auditor in a company. The conditions are:

an individual shall be considered eligible to be appointed as company’s auditor if he mandatorily fulfills certain conditions prescribed under the Chartered Accountants Act (or CA Act), 1949 and further possesses a valid certificate of practice as-

• An individual, or
• In a partnership firm (a business entity of which majority of partners practicing in India are considered qualified for such appointment), or
• In a limited liability partnership (where an LLP is being appointed as a company’s auditor, then only the partners who are qualified chartered accountants (or abbreviated as CAs) shall be accredited with acting and signing on firm’s behalf).

Disqualifications of auditors [Section 141(3)]
The following individuals shall not be considered qualified for appointment as a company’s auditor.

• Body corporate-A body corporate except LLP registered under LLP Act, 2008 shall not be considered eligible for appointment as auditor.
• Officer or employee- An officer or company’s employee shall also not be considered eligible for an appointment as an auditor.
• Relative or partner- an individual who is a partner in business or who is rendering services as an employee, of an officer or company’s employee shall also not be considered eligible or qualified for appointment as auditor.
• Business relationship-An individual or a firm that is either directly or indirectly having an association with the company or its affiliates shall not be considered eligible for an appointment as an auditor.
• Director or Key managerial personnel (or abbreviated as KMP) — an individual whose relative is a director or rendering services as an employee in the position of company’s director or KMP shall not be considered eligible for appointment as auditor.
• Full-time employment and audit limit- An individual who is in employment at a different place or an individual or a firm’s partner holding appointment as its auditor, if such individuals or partner is at that particular time duration of such appointment or reappointment holding appointment as auditor over more than 20 companies should also not be considered eligible for appointment as auditor.
• Convicted by a court-an individual who was held guilty of some sort of conviction by a court of an offense involving fraud and a period of 10 years has not elapsed from the date of such conviction.
• Consulting and specialized services (or abbreviated as C&S services)- any company or business entity whose subsidiary or affiliates, is engaged as on the appointment date in C&S services as specified in section 144.
• Where an individual appointed as a company’s auditor sustains any of the disqualifications as specified in sub-section (3) after his appointment, he then will have to vacate his office as such auditor and such vacation would be considered as a casual vacancy in the auditor’s office.

At AJSH & Co, we do assist our clients in complying with the regulatory requirement by auditing their financial statements. To know more about our services and offerings, you can write to us info@ajsh.in or click here.