Question

Discuss the pros and cons of each type of consolidation statement.

Answer 1

CONSOLIDATED FINANCIAL STATEMENTS

What Are Consolidated Financial Statements?

Consolidated financial statements combine the balance sheets, income statements and cash flow statements of two or more companies or business units. They are often presented for companies that have one or more subsidiaries to show an overview of the entire operation. During the consolidation process under generally accepted accounting principles, activity between the companies disappears.

Although Consolidated financial statements can give readers a misguided sense of profitability and financial stability in the absence of non-consolidated information.

Some of the Cons are ;-

Masks Poor Performance

When income statements are brought together and reported on a consolidated basis, the revenues, expenses and net profit are presented as combined figures. This can hide any profitability issues with one or more of the companies.

Skews Financial Ratios

One way that investors assess the viability of a company is by its ratios. Ratios are comparisons between financial statement lines. For example, the current ratio is current assets divided by current liabilities. This ratio tells investors how well the company will be able to pay its near-term obligations. If one of the companies has a high level of debt compared to the equity of the owners, that leverage would be hidden in a consolidated statement

Hides Inter-company Sales

All inter-company transactions are removed in a consolidation. On one hand, this presents a truer view of the companies by showing only financial activity with non-related parties. However, it also hides the level of inter-company transactions. If related companies spend most of their time and resources selling products or services in the group, an outside investor will not be able to assess transfer prices or profit-shifting in the group. Both of these things can be manipulated by companies and can affect income taxes.

Pros of consolidation

1. Economies of Scale: Combination of two or more organizations results in a single large organization. The large organization enjoys economies of scale in buying (quantity discounts because of bulk purchases), marketing (advertisement time in media is bought in bulk and therefore costs less) etc.

2. Unity of interest: There is unity of interest and less scope for manipulation of affairs of constituent companies.

3. Stability: When compared to other forms of combinations, complete consolidation has more stability and enjoys longer life.

4. Simple structure: The organization structure is simple. Therefore it is easy to manage and control.