Explain Consolidation in Accounting Terms

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Consolidation is the process by which the accounting data for two or more companies is combined to create one set of financial reports (see reference 1). Many corporations have diversified into multiple business lines, with each business line as a separate company. While managers, owners and investors could take the financial statements for every branch of business and add them together, that process might yield mistakes. It is far better to have an accounting system in place that can generate consolidated financial statements for two or more divisions.

Function

  • Consolidated financial statements are used by managers, owners and investors to get a clear picture of the overall financial position of a corporation. A consolidated financial statement can include two of the corporations' operating divisions or more. For example, you might generate a set of consolidated financial statements for all the retail divisions of a corporation and a set for the service divisions of a corporation, then generate one set of consolidated financial statements for every division of the corporation.

Time Frame

  • Consolidated financial statements are produced in monthly, quarterly and yearly format. Consolidated financial statements are the last statements produced because in order to prepare accurate consolidated reports, all of the companies included must have completed the accounting month-end close process.

Considerations

  • A consolidated financial statement provides you with an overall financial picture of every division or company owned by the corporation, but does not provide separate detail for the divisions or companies. Many times there are a few profitable divisions covering the huge operating losses of other divisions. If the unprofitable divisions are the focus of the corporation, and the intent is to pour more assets into those business lines, that position might eventually drain the profitable divisions to nothing. At that point, the entire corporation is poised for failure.

Warning

  • It seems that the larger a corporation becomes, the less upper-management seems to know about operations. Financial statements are easily manipulated, and unless the proper internal and external audit standards are in place, the corporation runs the risk of an Enron-type debacle in one or more of its divisions. With the reported collusion of external auditors in some of the worst cases of fraud, companies should also consider changing auditors every year for a fresh look at the financial data.

Expert Insight

  • Management accounting systems should always be in place for every division within a corporation, especially a corporation that has diversified into many unrelated businesses. A management accounting system provides reports such as trends in income and expenses, comparisons between budgeted income and expense and actual income and expense, and reports that show production costs versus the sales price of a product. Without this key information, managers cannot make informed decisions about the continuing operation of a business.

References

  • Keys to Reading an Annual Report; G. Thomas Friedlob and Ralph E. Welton; 2008
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