Consolidated Financial Statements

Consolidated financial statements are the combined financial statements of a parent company and its subsidiaries. Consolidated financial statements present an aggregated look at the financial position of a parent company and its subsidiaries, and they provide a picture of the overall health of an entire group of companies as opposed to one company's standalone position.

Consolidated financial statements report the aggregate of separate legal entities. A parent company can operate separately from its subsidiaries; when operating separately, each reports their own financial statements. However, because the subsidiaries form one economic entity, investors, regulators, and customers find consolidated financial statements more beneficial to gauge the overall position of the entity.

The consolidated financial statements only report income and expense activity from outside of the economic entity. Any revenue earned by the parent company that is an expense of a subsidiary is omitted from the financial statements. This is because the net change in the financial statements is $0. The revenue generated from one legal entity is offset by the expenses in another legal entity. To avoid overinflating revenues, all internal revenues are omitted.

Certain account receivable balances and account payable balances are eliminated from the consolidated balance sheet. These eliminated amounts relate to the amounts owed to or from parent or subsidiary entities. Like the income statement, this is to reduce the balances reported as the net effect is $0. All cash, receivables, and other assets are reported on the consolidated statements, as well as all liabilities owed to external parties.

Consolidated financial statements must be prepared using the same accounting methods across the parent and subsidiary entities. If relevant, the parent and subsidiaries must all be accounted for using generally accepted accounting principles (GAAP) if the consolidated financial statements are to be in accordance with GAAP. All subsidiary equity accounts, such as common stock or retained earnings, must be eliminated. A non-controlling interest account may be used if the subsidiary is not wholly owned. When preparing the consolidated financial statements, the subsidiary’s balance sheet accounts are readjusted to the current fair market value of the financial assets.

There are three ways to calculate the ownership interest between companies. Only companies that are owned are included in the consolidated financial statements. Ownership is based upon the total amount of stock owned. If a company owns less than 20% of another company's stock, it may use the cost method of financial reporting. If a company owns more than 20% but less than 50%, the company uses the equity method. Under both methods, consolidated financial statements are not permitted.