Consolidation adjustments – examples of preparing consolidated financial statements in practice
How to prepare financial statements in the context of consolidation? Which consolidation adjustments to apply? Reporting teams face this challenge as their company evolves into a Group. FlexiSolutions blog regularly addresses key financial consolidation issues.
The expert, Agnieszka Dziedziela, analyses typical consolidation adjustments that arise in the consolidation process, regardless of the specific nature and structure of the Group.
A key aspect of making consolidation adjustments to the financial statements is adhering to the principle of double‑entry accounting.
Consolidation adjustments must be balanced, regardless of their type or accounting pattern. Otherwise, inconsistencies in the consolidated financial statements can lead to problems with the balance sheet. For this reason, it is recommended that double‑entry accounting patterns (Debit-Credit) be planned for the various consolidation adjustment scenarios. This process organisation ensures transparency of elimination and prevents problems with data reconciliation in the future.
Consolidation adjustments – what are they used for?
The preparation of the consolidated financial statements of the Group requires the combining of the separate financial statements of the consolidated companies and the making of appropriate consolidation adjustments.
Consolidation adjustments eliminate economic events occurring between the Group entities from the values presented in the consolidated reports.
Thus, the consolidated financial statements reflect the financial results and asset situation of the entire Group, as if all the activities were carried out by a single commercial entity.
Capital adjustments
Capital adjustments, often referred to as historical adjustments, are determined at the time control of a subsidiary is acquired and are repeated in each subsequent reporting period.
Capital adjustments are updated when:
- additional shares are acquired,
- share capital is increased,
- some shares are sold.
Capital adjustments are repeated in subsequent reporting periods until the subsidiary to which they relate is sold or liquidated.
Elimination of capitals and shares
The manner in which capital adjustments are recognised depends on the consolidation method to be used for the acquired company and the relation of the price paid for the shares to the net value of the assets measured at fair value at the date the control is obtained.
If the parent company acquires 100% of the shares of the subsidiary, the consolidation adjustment consists in excluding from the consolidated balance sheet the value of the shares recognised by the parent company in its balance sheet and the value of the capital (at the time of acquiring control) of the acquired company.
Goodwill adjustment
Capital is otherwise known as net assets. At the time of taking control, they are measured at fair value. Goodwill arises when the price paid in the acquisition of a company exceeds its net asset value, measured at fair value at the date of acquisition. Goodwill is recognised by means of an appropriate consolidation adjustment in the assets of the consolidated balance sheet.
There may also be cases where the transaction price is lower than the net asset value of the acquired company. In such cases, negative goodwill should be recognised in the equity and liabilities of the balance sheet.
Goodwill amortisation
Goodwill amortisation should be included in the consolidated financial statements in subsequent reporting periods. As a general rule, goodwill should be amortised over 5 years; the regulations provide for an extension of amortisation to 20 years in justified cases.
This means that the consolidation adjustment related to the goodwill amortisation should be repeated in subsequent years in accordance with the amortisation period adopted.
Exclusion of intercompany transactions and settlements
In most Groups, transactions involving the sale of products, goods or services between companies are common practice. These transactions can be seen in the companies’ separate financial statements – revenues and expenses in the Income Statement, receivables, payables and current assets or fixed assets in the Balance Sheet.
Since the consolidated financial statements are supposed to show the Group as ‘one entity’, consolidation adjustments are necessary to eliminate these transactions.
Elimination of receivables and payables
The adjustment eliminating mutual settlements (trade receivables and trade payables) is the most common example of consolidation adjustments and occurs in probably all Groups. If affiliated entities engage in any operational transactions (intra-group sales of products, goods or services), this results in trade receivables for the seller and trade payables for the buyer. The elimination of receivables and payables therefore consists of excluding these balances from the Group’s consolidated balance sheet.
The adjustment itself is straightforward and does not need to be repeated in subsequent periods, at each balance sheet date, the Group excludes the current balance of mutual receivables and payables.
However, a frequent challenge is the reconciliation of intra-group balances. This is because the problem with the elimination of receivables and payables arises when the data in the individual companies’ unit packages are not identical. Apart from accounting errors, there may be situations where the balance of receivables in company A differs from the balance of payables in company B.
For the adjustment to balance, it is necessary to reconcile the mutual balances in the consolidation process or to adopt a simplification, such as ‘the seller is always right’.
The screen shows a summary of trade and loan settlements carried out in FlexiEPM.
Other examples of adjustments related to the elimination of intra-group transactions
Items relating to intra-group loans granted/received and adjustments relating to the provision of mutual services are similarly eliminated. Examples of transactions requiring the elimination of intra-group revenues and expenses include:
- space rental services,
- accounting, IT, administrative or corporate services,
- subcontracting or service production in the manufacturing process,
- management or trademark fees,
- financial revenues and expenses related to intra-group financing (loans, cashpooling).
Adjustment of unrealised margin
A common example of business transactions between companies subject to consolidation is the sale of products or goods.
The adjustment presented above eliminating revenues and expenses cannot be applied directly, as the goods purchased (most often products manufactured by one of the Group companies but could equally well be commercial goods purchased for resale) do not always represent a current period expense with the purchaser.
Purchased goods that have not been resold by the purchaser in the same period are recognised at inventory value. The purpose of the consolidation adjustment is to revaluate inventories so as to eliminate the margin realised by the seller. This is necessary in order for the Group financial statements to show the state as if the transaction had not taken place.
In this example, the following items are therefore eliminated: sales revenues, the seller’s cost price (the actual cost of manufacturing products or purchasing goods) and the transaction margin (which reduces the value of inventories disclosed in the Group’s balance sheet).
At the end of each reporting period, the Group determines the current value of the intra-group margin included in the inventories of the consolidated entities and makes the appropriate adjustment on this basis.
At the same time, it is necessary to reverse the elimination from the end of the previous year corresponding to the realisation of the margin as a result of the sale of products or goods to entities outside the Group – this part of the adjustment reduces the cost of sales by the value of the unrealised margin of the previous year.
Adjustments relating to the sale of tangible assets
Another item on the list of examples of consolidation adjustments is elimination related to the sale of fixed assets between Group companies. As in previous transactions, also here the purpose of the adjustment is to ‘withdraw’ the transaction from the consolidated financial statements.
In the case of transactions involving tangible or intangible assets, it is not only the fact of sale itself (gain or loss on the sale of tangible assets) that is eliminated, but also its impact on the carrying values and the depreciation schedule of the asset. Therefore, consolidation adjustments must be repeated for several or even more than ten years. The elimination of gains/losses on the transaction and depreciation adjustments in subsequent years are recognised in gains/losses from previous years, meaning that the adjustment values need to be recalculated each year.
Adjustments relating to the payment of dividends
Dividends paid within the Group do not affect its financial position and should therefore be eliminated from the financial statements. In the individual accounts, the payment of dividend reduces retained earnings at the payer and increases financial revenues at the recipient.
The consolidation adjustment related to the payment of dividend will differ when the group does not have overall control of the subsidiary. In such a situation, the dividend paid should be shared with the minority shareholder
Consolidation adjustments – examples of FlexiEPM capabilities
FlexiEPM comprehensively manages the financial statements consolidation process, including the management of consolidation adjustments. The FlexiSolutions consolidation system offers:
- creation of built-in reports and mechanisms for reconciling intra-group transactions,
- automating consolidation adjustment scenarios using configurable rules and accounting patterns established during implementation,
- possibility to enter consolidation adjustments manually, ensuring accurate eliminations in transactions,
- mechanisms for transferring adjustments between periods, reducing the workload and risk of error when carrying out historical adjustments.
These functionalities significantly simplify the preparation of consolidation adjustments, shorten the process, increase transparency and minimise the risk of errors, which could affect the accuracy of the data in the Group’s consolidated financial statements.
