Consolidated financial

statements
Anders Svensson, 2008-09-22

Limitations
This compendium is a summary of the principles for
establishing consolidated financial statements. It makes no
claims to being exhaustive. Its aim is to introduce the subject for
persons who are not familiar with accounting.

Synonyms
Consolidated financial statements (AmE) are also known under
as consolidated accounts and group accounts (BrE).

Background
History
Modern accounting was developed in Italy in the late 15th
century. It was only at the beginning of the 20th century that
consolidated financial statements arose in USA. Corporations in
Europe followed during the 1920s and 1930s. It wasn't until the
1940s, however, that legislation began to handle the subject.
One of the main reasons why legislation was introduced in
Sweden was the Kreuger Crash of the early 1930s. The empire
of Ivar Kreuger was composed of companies all over the world.
The companies often had different financial years. Due to
possibilities to transfer gains and losses between the companies,
all companies were able to show profits. Assets were sold
between the companies with profit close to the year-end closing
for the selling company. When the bubble burst the fact came
out that the companies were overvaluing their assets. These
transactions would not have resulted in these horrid
consequences if there had been demands for consolidated
financial statements with elimination of internal
income/expense, profits/losses, assets and liabilities.

Consolidated financial statements

What is a group
A group consists of one parent company with one or more
subsidiaries. A parent company is a company that directly or
indirectly owns more than 50% of the votes in another company.
The company owned is called a subsidiary. A group also exists
if a company has determining influence over another company
without owning more than 50% of the votes. Such influence
may refer to the contractual right to appoint more than half of
the members of the board of directors or the management, the
right to decide on strategies, etc.

Parent Company

100%

100%

Subsidiary 1

100%
Subsidiary 4

Subsidiary 2

75%

90%
Subsidiary 3

25%

Subsidiary 5

Figure 1 Example of a group

Why establish consolidated financial statements

A primary motive for establishing consolidated financial
statements is that the group's result and position should be
judged by how much dividend the parent company can pay to its
shareholders. A single company can pay dividends to the
shareholders only if the company has distributable earnings. If
the same rules were not applied to the group, it would be
possible to pay dividends even if the group lacked distributable
earnings.
Another motive is that the consolidated balance sheet should
show the group's profit/loss for the year minus dividends within
the group and minus internal profits/losses during the financial
year. The group's unrealized internal profits may not be included
in distributable earnings.
For public companies, the consolidated financial statements are
the primary reporting to the shareholders, creditors, employees
and other stakeholders. The reporting of the parent company is
of secondary importance.

Consolidated financial statements

What are consolidated financial statements

Consolidated financial statements are fiction. It shows the result
and position that would have occurred if the parent company
had directly bought the assets and liabilities of the subsidiary
instead of the shares.
Consolidated financial statements are made using a crossindexed summary of similar assets, liabilities, income and costs
for the different group companies. Everything should be
valuated according to the same principles, recalculated to the
same currency and closed at the same date. Since the objective
is to show the group as if they were one company, all internal
balances and earnings must be eliminated and only show
profits/losses that are earned by the parent company or by the
subsidiaries after they joined the group.
The income statements and the balance sheets that the
consolidated financial statements are based on should subscribe
to the same principles regarding valuation and classification.
The all-inclusive income concept should be applied by groups.
This means all changes to equity of the group, excepting
dividends and capital contributions in the parent company,
should be accounted for by the income statement.
The acquisition in the parent company of a subsidiary is
regarded as an acquisition of the assets and liabilities of the
subsidiary in consolidated financial statements. The shares in the
subsidiary are substituted for the assets and liabilities of the
subsidiary. The assets and liabilities are revaluated to the
acquisition cost of the parent company.

Laws and recommendations

National legislation
Every country has their own legislation regarding different kinds
of legal entities and their businesses. The legislation is often
affected by international influence. Even if legislation is specific
on many subjects it generally refers to the Generally Accepted
Accounting Principles (GAAP) when it comes to consolidated
financial statements. GAAP can be both national and
international.

Consolidated financial statements

International legislation
The 7th EU directive establishes the minimum requirements for
consolidated financial statements within the European Union.
The legislation of the individual EU countries are based on this
legislation.

National recommendations
As legislation refers to GAAP there is ongoing development of
accounting regarding market demands for accounting and
insight into companies. The GAAP are put together as a joint
effort of the authorities and the trade and industry organisations.
National recommendations are modified to adhere to national
and international developments in accounting.

International recommendations
On the international level, GAAP development is made in
conjunction with the International Accounting Standards Board.
IASB publish recommendations called IFRS (International
Financial Reporting Standards). There is also the IASC
(International Accounting Standards Committee) organisation. It
publishes the IAS recommendations (International Accounting
Standards).
The role of the IASB as international provider of GAAP has
grown during the past few years since the EU determined that
IAS/IFRS are mandatory as of January 1, 2005 for all companies
traded on a stock exchange. For all other companies adoption of
these recommendations is voluntary.

Methods for consolidated financial

statements
There are four methods for establishing consolidated financial
statements

The purchase method

The pooling method
The equity method
The proportional method

Consolidated financial statements

The choice of method depends on how the acquisition of the

subsidiary has been made. The methods may occur together in
the same consolidated financial statements.
Because the three later methods are rather seldom (and not
permissible in new acquisitions) the following section of this
presentation will deal with the purchase method only.

The Purchase Method

When applying the purchase method the acquisition by the
parent company of a subsidiary is regarded as an acquisition of
the assets and liabilities of the subsidiary in the consolidated
financial statements. The shares in the subsidiary are substituted
for the assets and liabilities of the subsidiary. The assets and
liabilities are then revaluated to the acquisition cost of the parent
company. The valuation of the subsidiary is based on an
acquisition analysis.
In reality it is not the assets and liabilities that form the basis of
the valuation of the subsidiary. Instead it is the equity of the
subsidiary that is the point of departure of the analysis. The
equity may consist of both taxed and untaxed equity. The latter
is transformed to taxed equity when the consolidated financial
statements are made. The amount of deferred tax is then
subtracted from it.
Equity

Assets

Debit

Credit

Assets

Equity

Liabilities

Net assets

Liabilities
Figure 2 Balance sheet

Financial statements of the possession

When an acquisition of a subsidiary is made the purchase price
of the share is often based on a financial statement on the
takeover date. In this statement the assets and liabilities of the
purchased company are market valued.

Consolidated financial statements

In the example below the properties of a company are valued at

10 000. Other assets and liabilities are market valued at their
booked value. In the agreement, the buyer and seller has agreed
that a deduction for deferred tax should be done with 10% on
the surplus value of the properties.

Balance
sheet
Properties
Receivables
Cash and
Bank

Equity
Deferred tax
Liabilities

Booked Adjustment Adjustment

value
Assets Liabilities
2 500

7 500

Market
value
10 000

500

500

100

100

3 100

7 500

10 600

1 500

7 500

-750

8 250

750

1 250

500
1 100
3 100

1 100
7 500

10 600

Figure 3 Example of a financial statement for a takeover

Based on the values above the company is valued at 8 250.

If the deferred tax had been calculated at a higher percentage,
the valuation would have declined. Conversely it would have
increased at a lower percentage.

Alternative method for calculating the purchase price

Market value of the assets
Booked value of the assets
Market value of the liabilities
Booked value of the liabilities
Book value of the equity

+
+
+

10 600
3 100
2 350
1 600
1 500

Purchase price for the shares

8 250

Consolidated financial statements

Acquisition analysis
At the date of acquisition an analysis must be preformed in order
to determine:

the acquisition value of the shares

the market value of the assets and liabilities of the
purchased company

If the acquisition value of the shares is higher than the market

value of the net assets, this constitutes goodwill.
The acquired equity equals the equity of the purchased company
at the date of acquisition. This amount equals the booked value
of the assets and liabilities in the purchased company at the date
of acquisition (fig. 2, page 5).
A surplus value of an asset exists if the market value of the asset
is higher than the booked value. Is the market value of a liability
is lower than the booked value, a surplus value also exists.
An undervaluation exists if the situation is reversed. This is
where the market value of an asset is lower than the booked
value of the asset or if the market value of a liability is higher
than the booked value of the liability.
The significance of the acquisition analysis is to establish the
group-relevant acquisition value for the assets and the liabilities
of the purchased company. This is based on the acquisition
value of the shares. The analysis is based on the income
statement and the balance sheet of the subsidiary upon the date
of acquisition. The acquired assets and liabilities are market
valued and the accounting principles regarding classification are
adjusted to the principles of the parent company.
The acquisition analysis below is based on the financial
statement for the takeover above (fig. 3, page 6). The analysis
affects both the income statement and the balance sheet. The
analysis is meant to establish how the purchased assets and
liabilities of the subsidiary would affect the consolidated
balance sheet. As a result of this the amount of equity acquired
before purchase is established along with any surplus values or
undervaluations.
In the example below, the market values of the assets and
liabilities and the deferred tax correspond to the financial
statement of the takeover. This is quite rare. Normally there is a
difference of some kind regarding the valuation or the
percentage for the deferred tax. This affects the surplus value of
the shares.

Consolidated financial statements

Acquired Equity
Purchase price for the shares
Share capital
Restricted reserves
Non-restricted reserves
Profit for the period
Properties
Deferred tax

8 250
1 000
200
250
50
7 500
9 000

Market value of the

properties
Booked value
Surplus value for group
Deferred tax
Booked value
Undervaluation for group

Acquired Income
Income
Operating expense
Depreciation
Interest
Tax
Profit

750
9 000

10 000
-2 500
7 500
1 250
-500
- 750

1 000

1 000

500
50
379
21
50
1 000

Figure 4 Example of an acquisition analysis

The acquired equity affects both the immediate and future

consolidated balance sheet. The acquired income affects only
the immediate consolidated income statement. The net profit
(income reduced with expenses etc.) earned by the subsidiary
before the date of acquisition is not included in the net profit for
the group. The elimination/reduction is made row by row in the
income statement.
When the acquisition analysis is done there is a foundation for
how the assets and liabilities of the subsidiary should be handled
in the consolidated balance sheet. The fundamental is that the
equity which the subsidiary owns at the acquisition date is never
considered a part of the consolidated equity.

Consolidated financial statements

Deferred tax
You encountered the term deferred tax above. This term refers
to a tax consequence which is not accounted for in the income
statement. Instead, this consequence is deferred to the future. A
deferred tax may both refer to assets and liabilities.
The most common deferred tax asset is losses that the company
has not been able to use during the accounting period. These
losses do not result in reduced tax until they are used in the
income tax statement of the company.
On the other side of the balance sheet, the most common
deferred tax liability is the consequence of different treatment of
assets and liabilities in the accounting records compared with
the income tax statement. This is allowed in some countries but
not in others. A company might also have untaxed reserves,
which will not result in any tax until they are reversed in the
income statement. Finally, consolidated surplus values result in
a deferred tax liability. This liability is reversed in proportion to
the reversal of the surplus value. The opposite situation occurs
with consolidated undervaluations.

Minority
When the parent company owns less than 100% of the
subsidiary this constitutes a minority. The minority has a right to
a share both in the net profit/loss of the year and in the net
assets.

Elimination of shares
The acquisition analysis forms the basis for eliminating the
shares in the subsidiary. The analysis refers to the situation at
the date of acquisition. It must be adjusted in future consolidated
financial statements with regard to development within the
group. Since depreciations reduce the surplus value there is a
corresponding change reduction of the deferred tax related to the
surplus value. The net effect of these transactions is accounted
for in the income statement.

Consolidated financial statements

Balance item

Opening
elimination

Reallo- Elimination
Closing
cation of the year elimination

Properties

7 500

Shares in
subsidiary

-8 250

-8 250

1 000

1 000

200

200

Share capital
Restricted
reserves
Non-restricted
reserves
Net profit/loss
Deferred tax

250
50

-56

50
-50

-750
0

7 444

51

300
51

-745

Figure 5 Example of share elimination

In the income statement the reduction of the surplus value of the

properties is accounted for as depreciation. The reduction of the
deferred tax is accounted for as a reduction of tax expense.
The closing elimination of this year forms the opening
elimination for the next year.

Adjustments
Aside from elimination of acquired equity and changes in share
elimination, the consolidated financial statements must be
adjusted in some way to provide a fair view of the group as if it
were one company. The most common adjustments are:

Internal income, expenses and profits/losses

Internal receivables and liabilities
Untaxed reserves converted to equity and deferred tax
Group contributions are converted to tax expense and
equity
Other adjustments which are needed to adjust the
accounts of the subsidiaries to the accounting principles
of the parent company

Consolidated financial statements

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Consolidated financial statements

Joint accounts for the companies in the groups, the elimination
of shares, the adjustments etc. form the consolidated financial
statements. Enclosure 1 shows a group consisting of a parent
company with two subsidiaries. The first subsidiary has been
part of the group for a number of years. The second subsidiary
was acquired by the parent company during the past year. Based
on these conditions the acquired equity is eliminated together
with the acquired income statement of subsidiary 2.
Depreciations are made on the acquired surplus values. The
depreciations reduce deferred tax. Internal income, expenses and
the result are adjusted along with internal receivables and
liabilities. Finally, untaxed reserves are converted to nonrestricted equity and deferred tax.

Summary
A company that owns more than 50% of the votes in another
company is a parent company to the subsidiary owned. Together
they form a group which is obligated to submit consolidated
financial statements. It is also mandatory to issue consolidated
financial statements when a company has determining influence
over another company. Consolidated financial statements are
prepared in order to show all the companies in the group as if
they were one. All companies in the group must apply the same
accounting principles and accounting year as the parent company.
Internal income, expenses and profits/losses must be eliminated
from the income statement. The same goes for internal
receivables and liabilities in the balance sheet. The consolidated
financial statements are guided by both national and international
laws and recommendations. The most common method to apply
consolidated financial statements is the purchase method. This
method is based on an acquisition analysis which determines the
acquired equity of the subsidiary. The acquired equity is never
included in the equity of the group. It is only the equity of the
parent company and profits/losses in the subsidiaries after the
acquisition that should be included in the equity of the group. The
acquisition analysis changes constantly as acquired surplus values
and deferred tax are reduced as depreciations and tax expenses.

__________

Consolidated financial statements

11

Questions
1. What is a group (in accordance with a consolidated
financial statement)?
2. What is a parent company?
3. What is a subsidiary?
4. Why is there a need to establish consolidated financial
statements?
5. Which method is most common for establishing
consolidated financial statements?
6. What do the net assets of a company consist of?
7. Which equity should be included in the equity of the
group?
8. What should be excluded when consolidated financial
statements are established?
9. Why should these items be excluded?
10. What is the meaning of determining influence

References

FARs Samlingsvolym 2008, FAR Frlag 2008

Ernshagen, Ingrid & Larsson, Marie;
Koncernredovisning 4:e upplagan, KPMG 2001
Eriksson, Lennart: Koncernredovisning, 10:e
upplagan, Studentlitteratur 2002
Ljungberg, Roland & Phillips, Dan;
Koncernredovisning i praktiken, Bonniers 2001
Heinestam, Bengt; Koncerner, 2:a upplagan, Bjrn
Lundn Information 1999

Consolidated financial statements

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Enclosure 1

Consolidated financial statements

Consolidated financial statements

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