Financial Consolidation and Close Explained

Consolidated financial statements may seem to be a concern only for big, well-known corporate conglomerates. But even the owner of two restaurants may need to do a financial consolidation and close. And though consolidations are more complicated for the big companies that make news with merger-and-acquisition scenarios that extend their business strategies, the basic methods and guidelines apply equally to businesses of all sizes. Anytime a common owner, or parent, has one or more separate subsidiaries, financial consolidation is the way “headquarters” can see the combined results of all its businesses.

This article discusses what financial consolidation and closing are and how they are done.

What Is Financial Consolidation?

Financial consolidation is the combination of financial and accounting information from multiple subsidiaries into a single set of financial statements for a parent company to study. That’s a mouthful, so let’s parse out the key pieces. A parent company is one that owns and controls another, called a subsidiary. A subsidiary business is a separate legal entity from the parent, so this discussion excludes divisions and branch offices. For example, PepsiCo is the parent company for many subsidiaries, including Quaker Foods and Frito-Lay. Accounting rules require the parent company to have a majority ownership and control over the subsidiary in order to be eligible to consolidate. In practice, control and majority ownership are generally defined as having greater than 50% of voting stock, although there are some legal exceptions.

A parent company must combine the results of all of its subsidiary businesses into a single set of financial statements, meaning an income statement, a balance sheet and a cash flow statement. There are several reasons for this, one of which is to satisfy external stakeholders including regulators, investors and lenders. At the same time, parent companies use consolidated financial statements to evaluate their entire business in a single view, regularly toggling between the subsidiary level and the consolidated level when analyzing business results.

Key Takeaways

• Financial consolidation combines the accounting and financial data of the parent company and its subsidiaries into a single set of financial statements.
• It requires precise integration of data from multiple legal entities.
• Consolidating adjustments are required to eliminate double-counting of intercompany transactions and to record any activity at the parent level.
• Several best practices can help minimize delays in financial closings arising from the six-step consolidation process.
• Specialized consolidation software can automatically handle several of the consolidation steps.

Financial Consolidation and Close Explained

Financial consolidation isn’t as easy as simply adding one subsidiary’s account to another’s. Complexities arise when the different subsidiaries do business with each other or with the parent company, which happens frequently — it’s often part of the underlying business reasons for owning multiple subsidiaries. That’s why consolidation requires two stages: first, aggregating all the subsidiary information and, second, adjusting the combined data to include parent-level transactions and eliminate inaccurate information. An example of a parent-level transaction may simply consist of amounts owed to minority owners, if the parent doesn’t own 100% of a subsidiary. Inaccurate information that would make the consolidated financial statements inconsistent or misleading includes double-counting revenue, which can occur when one subsidiary pays another for goods or services. Only sales from external customers should end up in consolidated financial statements.

There are several accounting guidelines for the consolidation process that provide advice on various related-party situations. In the U.S., these are published by the Financial Accounting Standards Board, which also is the source of Generally Accepted Accounting Principles, and by the Securities and Exchange Commission. Outside the U.S., guidance comes from the International Accounting Standards Board, which also publishes International Financial Reporting Standards.

When Do Financial Consolidation and Close Happen?

Consolidation is one of the last steps in a financial close process, because it relies on final, or closed, information from the subsidiaries. The financial close is a multistep process of finalizing the accounting books for one fiscal period and setting up for the next. During the close, accountants verify that all the transactions for the period have been recorded correctly in order to prepare accurate financial statements. After a subsidiary closes its books for a month, quarter or year, that information flows to the parent so it can begin the consolidation process.

Financial Consolidation and Close Process

The financial consolidation and close process is a six-step procedure that can begin, in theory, only after each subsidiary has gone through its financial closing process. In practice, to move the process along so that the consolidated financial statements remain timely, some post-closing work at the subsidiary level — account reconciliations, for example — may take place concurrently with the consolidation process. However, any material discoveries must be addressed before the consolidation process is completed. Let’s dive deeper into the six consolidation steps.

1. Data Collection

The first step in the financial consolidation process is to collect the necessary information from the subsidiaries. Each subsidiary provides an adjusted trial balance, which is a list of the final balances for the period in each of the subsidiary’s general ledger (GL) accounts, and its three primary financial statements. It is common for parent companies to request a standard reporting package with supplemental information, as well. To avoid confusion, “adjusted trial balance” is an accounting term of art that actually refers to the final balances for the period, because during the subsidiary’s closing process there will be “unadjusted” balances and then adjustments that finalize them.

2. Data Processing

Sometimes, the information sent to the parent by the subsidiaries needs extra processing before it can be used. For example, if the accounting systems aren’t integrated, the subsidiary data may need to be manually uploaded into the parent’s systems. Similarly, if the subsidiary’s and parent’s charts of accounts don’t match up, the accounts will need to be manually mapped.

3. Consolidation

The actual consolidation step is done in two stages. First, accountants make adjusting journal entries to the combined financial data to reflect parent-level considerations. These adjustments are made after the subsidiaries have closed and are necessary for a variety of reasons, such as to account for foreign currency fluctuations, reflect minority interests and eliminate intercompany transactions. For example, a U.S. parent company with subsidiaries in Mexico and Canada would have to translate all of the subsidiaries’ transactions from their native currencies into USD to present unified results for the overall business. What makes this example particularly challenging is that each transaction must be converted at the currency exchange rate in place at the time of the transaction, not at the rate prevailing at the time of the consolidation. This usually produces an adjustment for a foreign currency gain or loss. Once all such adjustments are made, the second step is to generate the consolidated trial balance and financial statements, which combine all the subsidiary information and the consolidation adjustments, from the parent’s accounting system.

4. Review and Approval

Before the consolidated financial statements are finalized, they should be put through a rigorous review to check for errors and anomalies. It’s a best practice for these reviews to be done by someone other than the team that prepared the consolidated financial statements. An example is when staff in the financial planning and analysis team reviews the financials as part of a variance analysis. Finally, the responsible executive — typically the CFO — should approve the draft financial statements.

5. Reporting

Once the consolidated financial statements have been prepared, the rest of the reporting process can be completed. This includes writing all the footnotes to the financial statements, a process that provides supplemental details and explanations about the balances in the financial statements. Additionally, specialized reporting is prepared for external parties, such as lenders, shareholders and partners.

6. Close

The final step in the consolidation process is to close the books. In this step, all account balances are locked for the period and the income statement accounts are reset to zero for the next period. In addition, the equity accounts on the balance sheet are updated to reflect any losses or undistributed income for the just-closed period.

Data Required for Financial Consolidation and Close

When working through the six steps, it’s necessary to have access to data at both the subsidiary level and the consolidated level. This facilitates the discovery of any items that need to be addressed in order for the consolidated financial statements to represent only transactions with third parties, using consistent policies and approaches. The following data is required for the financial consolidation and close process.

General Ledger Data

The GL is the record of all activity for the period for each subsidiary. Every transaction is recorded with an equal number of debits and credits and posted in the appropriate GL accounts. The GL is a long ledger showing the beginning balance, all the activity for the period and the ending balance for every account in the chart of accounts. This level of detail is helpful during consolidation to identify any items that might need to be addressed by adjusting journal entries. The trial balance, mentioned previously, is a summary of the GL, listing only the ending balance of each account.

Subledger Data

Accounting systems use subledgers to capture detailed activity for various accounts, such as accounts payable and customer billing/accounts receivable. A summary of each subledger is “closed,” or posted, to the GL accounts. Using subledgers helps keep the GL uncluttered, since the details of every transaction are recorded in the subledger, from dates and descriptions to GL account codes. The subledgers may be used during consolidation to track down the original entry for transactions that need to be adjusted during consolidation.

Adjustment Entries

There are several layers of adjusting journal entries in the consolidation and financial close process. As each subsidiary closes its books, it adjusts for any unrecognized transactions in the period, such as accruals, deferrals and estimates. These adjustments are reflected in the subsidiary’s adjusted trial balance that gets rolled up to the parent. In addition, the parent makes several consolidating adjustments so that the consolidated financial statements will be accurate. The most common adjustments — such as for intercompany transactions and fluctuations in the foreign exchange rate — are described in the following sections. Other typical consolidating adjustments include entries that account for inconsistent accounting policies from subsidiary to subsidiary; accounting for contingencies; such as groupwide legal issues; and any impairment of intangible assets, such as goodwill derived from a subsidiary that was acquired.

Intercompany Transactions

Intercompany transactions — that is, any activity between the parent company and its subsidiaries — must be identified and eliminated, to avoid double-counting in the consolidated financial statements. Examples include sales and purchases between subsidiaries or loans from parent to subsidiary.

Investment and Equity Data

A parent company can consolidate the financial information of any majority-owned subsidiaries, although when a subsidiary is wholly owned — meaning the parent has 100% control over voting shares — the consolidation is simpler. When the parent holds only a majority stake, it can’t lay claim to the entire subsidiary’s results, because there are minority owners who make up the balance. So, the parent must make adjustments to reflect what is owed to the minority owners. There are two accounting methods to calculate a minority interest, called the fair value approach and the proportionate approach. There are several accounting guidelines surrounding which method to use when. Regardless of method, however, these calculations can be performed only during consolidation, after all other adjusting entries have been made.

Foreign Exchange Rates

It’s common for parent companies to use a different currency from their subsidiaries or for there to be multiple currencies among various subsidiaries. Consider a vertical integration strategy, where one or multiple subsidiaries make up a supply chain spread across international locations. The subsidiary financial statements must be converted into the parent’s currency. In addition, specific transactions between parent and subsidiary (or between subsidiaries) may have involved multiple currencies that also need to be translated. And since foreign exchange rates are changing all the time, these translations can be tricky and cause foreign exchange gains and losses. All of this needs to be addressed during the consolidation process.

Tax Data

Parent companies can file consolidated U.S. tax returns using IRS Form 1120, as long as all subsidiaries follow the same tax year as the parent company. There are certain advantages to filing a consolidated return, which may minimize the total amount of taxes owed across the group. In order to do so, each subsidiary needs to provide certain tax data to the parent, such as capital gains and losses, foreign tax credits and operating losses.

Cash Flow Data

Cash flow refers to a company’s inflows and outflows of cash, rather than its profitability. Cash flows are reported on a company’s statement of cash flows, one of three primary financial statements. When creating consolidated cash flow statements, subsidiaries provide their standalone cash flow statement to the parent, as well as bank account information.

Budget and Forecast Data

Budgets are important planning tools that help a company set a financial course toward achieving its goals. Forecasts update the budgets to predict likely results for a period, which may differ from what was originally planned. Budgets and forecasts are key benchmarks to use to compare actual results and to investigate any variances, both components of managing a business. Subsidiaries prepare their own standalone budgets and forecasts, so their business leaders can manage in reference to them. Parent companies also prepare consolidated budgets and forecasts that provide a view for the whole company. Budgets and forecasts undergo the same consolidation process as the actual results, including adjustments for all intercompany activity.

How to Improve Your Financial Consolidation and Close

For many companies, the primary challenge of the financial close process is one of balancing a need for accuracy with a desire for speed. The consolidation process, at the tail end of the close, presents the same challenges, plus compliance reporting issues. In general, a consolidation process adds between four and 10 days to a financial close, with a median of six days, according to a survey of almost 5,000 companies by the APQC (American Productivity & Quality Center). That is a significant stretch of time, when many companies aim to close their books in less than five days. Here are some practices that can improve the financial consolidation and close.

1. Use Modern Technology

The value of integrated accounting systems across a group of companies cannot be overstated. Automated data collection greatly reduces the time needed to get all the relevant information collected in a single place, and it avoids the inevitable errors that arise from manual data entry. Cloud-based solutions have a natural advantage over on-premises software because of the natural dispersion of accounting teams when there are multiple subsidiaries.

2. Implement Robust Data Governance

One of the most important ways to implement data governance for the consolidation process is by using a standardized chart of accounts for all members of the consolidated group. This avoids having to manually remap information during consolidation. It’s also important to establish standard definitions of accounts, to ensure that they are actually being used consistently by every subsidiary.

3. Optimize Process Workflow

Financial consolidation involves a number of people situated in disparate locations, which can slow down the process. A few ways to optimize the workflow among subsidiaries and parents is to minimize the amount of paper involved. Instead, opt for digital data transfer and automated workflows for reviews and approvals. Other tips include choosing software that automates many consolidation tasks, such as intercompany transaction adjustments, foreign currency conversions and generation of consolidated financial statements.

4. Enhance Communication and Collaboration

Depending on the size of the organization, there may be gaps in team communication that slow down the consolidation process. It’s important to get everyone up to speed and on the same page. Training is key, as is providing a set of consolidation policies. These actions should reduce misunderstandings among staff and ensure the consistent application of accounting policies. It is also helpful to explicitly lay out the consolidation schedule and deadlines to keep everyone in sync.

5. Adhere to Regulatory Compliance

Adhering to all the various layers of regulatory compliance is fundamental to the financial consolidation process, but it can be a challenge. Compliance includes adhering to a number of rules and laws that multiply with each additional subsidiary. Each jurisdiction faces distinct accounting standards, tax laws and government regulations, in addition to the compliance requirements for other stakeholders, like partners, lenders and investors. Every subsidiary must adhere to the rules governing its location — a European company, for example, cannot avoid paying value-added taxes just because it has a U.S. parent. So, embedded in the adjusted trial balance and financial statements of each subsidiary is the financial impact of all the local laws, which feeds into the consolidated results. The parent, too, must comply with the rules and laws of its jurisdiction, which is often different from its subsidiaries. Adding to the complexity is the reality that all of these rules change over time. Hiring a compliance officer is one way to stay current with all the rules. Another approach is to look for consolidation software that has multiple standards built in (with annual updates) and/or has the flexibility to accept multiple rules and apply them as appropriate.

6. Monitor and Analyze Performance

It’s amazing how much an organization can improve its close and consolidation process simply by monitoring and analyzing it for that purpose. For example, monitoring can help you identify whether tasks were completed on time, and in accordance with the consolidation schedule, or whether specific issues are causing recurring delays. It can also separate approvals that were received quickly and without revision from those that were withheld or required rework, thus pinpointing specific areas in need of improvement.

Streamline the Financial Consolidation and Close Process With NetSuite

The key to accurate and timely financial consolidation rests on centralizing financial data to avoid having to consolidate by means of manual spreadsheets and emails. NetSuite’s cloud-based financial management software automates core accounting processes, from transactional accounting through financial reporting, and has a specialized consolidation feature that can accelerate the close and consolidation process. The NetSuite solution allows parent and subsidiary teams to equally share an integrated system without the need for multiple local, on-premises installations. NetSuite consolidation enables cross-group standardization, like consistent charts of accounts that can be customized for individual subsidiaries but still automatically map properly at the parent level. Furthermore, automatic synchronized posting at the local and parent levels in a shareable database eliminates the need to reconfigure and upload data and provides real-time insight to all levels of business performance, from subsidiary to consolidated. NetSuite is built to handle multiple currencies, automatically net intercompany transactions, and support multiple accounting standards and tax codes for reporting compliance. Whether managing one or many subsidiaries, NetSuite gives parent teams complete oversight of accounting processes and secure access to auditable data.

Consolidated financial statements give a business’s internal and external stakeholders a complete picture of the company as whole. These documents are more complex than a simple combination of information from the parent and subsidiaries, requiring detailed review and adjustments for certain activities. Using integrated accounting software across the group can make the mechanics of consolidation and closing the books easier, allowing more time to investigate, analyze and review the group’s activity, and reduce the time required to issue consolidated financial statements.

Financial Consolidation and Close FAQs

What does consolidation mean in finance?

In finance, consolidation refers to the combination of financial and accounting information from multiple subsidiaries into a single set of financial statements for a parent company.

What is the process of consolidation of financial statements?

There are six steps in the consolidation process. They are: collecting data from each subsidiary, such as an adjusted trial balance and the three primary financial statements; normalizing the data to ensure that it’s consistent and all subsidiary accounts are properly mapped to the corresponding parent accounts; consolidating, which includes making adjusting journal entries and then generating the consolidated trial balance and financial statements; reviewing and approving to check for errors and anomalies; reporting the consolidated financial statements, footnotes to the financial statements and any specialized reporting for external parties, such as lenders, shareholders and partners; and closing — the final step. Closing locks in balances for the period, resets income statement accounts for the next period and updates the equity accounts on the balance sheet to reflect any losses or undistributed income for the period.

What is the 20-consolidation rule?

In order to consolidate a subsidiary, a parent must own greater than 50% of the voting shares. However, there are other, nonconsolidating ways to account for one company’s investment in another, and 20% ownership is a key threshold. If ownership is less than 20%, the cost method is used to value a parent’s equity in a subsidiary. If ownership is greater than 20% but less than 50%, the parent would use another valuation method, called the equity method.

What is the difference between HFM and FCCS?

HFM is an acronym for Hyperion Financial Close Management, which is an on-premises software solution from Oracle that manages all financial close activities. FCCS, or Financial Consolidation and Close Service, is a cloud-based solution from Oracle that can be used to address consolidation and close processes.