FINANCIAL ANALYSIS : Getting to grips with consolidated accounts
Consolidation aims at presenting the financial position of a group of companies as if they formed one single entity. It is an obligation for companies that exclusively control other companies or exercise significant influence over them. The scope of consolidation encompasses the parent company and the companies in which the parent company holds at least 20% of the voting rights. The basic principle of consolidation is to replace the book value of investments on the parent company's balance sheet with the assets, liabilities and equity of the consolidated subsidiaries.
Full consolidation, which is generally applied when the parent company holds more than 50% of voting rights in its subsidiary, consists of replacing the investments on the parent company's balance sheet with all the subsidiary's assets, liabilities and equity, as well as adding all the revenues and charges from its income statement. This method gives rise to minority interests in the subsidiary's net income and shareholders' equity.
Where the parent company exercises significant influence (usually by holding over 20% of the voting rights) over another company (hence called an associate), the equity method of accounting is used. The book value of investments is replaced by the parent company's share in the associate's equity (including net income). This method is actually equivalent to an annual revaluation of these investments.
From a financial standpoint, the ownership level, which represents the percentage of the capital held directly or indirectly by the parent company, is not equal to the level of control, which reflects the proportion of voting rights held. The level of control is used to determine which consolidation method is applied. The ownership level is used to separate the group's interests from minorities' interests in equity and net income.
A group often acquires a company by paying more than the book value of the company's equity. The difference is recorded as goodwill under intangible assets, minus any unrealised capital gains or losses on the acquired company's assets and liabilities. This goodwill arising on consolidation is compared each year with its estimated value and written down to fair market value, where appropriate.
When analysing a group, it is essential to ensure that the basic accounting data are consistent from one company to another. Likewise, intra-group transactions, especially those affecting consolidated net income (intra-group profits, dividends received from subsidiaries, etc.), must be eliminated upon consolidation.
Two methods are used to translate the accounts of foreign subsidiaries: the closing rate and the temporal method for currency exchange rate translations. In addition, specific currency translation methods are used for companies in hyperinflationary countries.