How to Consolidate Under GAAP

Consult a professional accountant before finalizing a consolidation.
Consult a professional accountant before finalizing a consolidation. (Image: John Foxx/Stockbyte/Getty Images)

The accounting profession and the business world in general use Generally Accepted Accounting Principles, or GAAP, to perform certain accounting operations or procedures. This is the case when it comes to consolidation of companies, which results in the merging of financial data across multiple business entities. Consolidating business or group of businesses using GAAP can help to streamline the process. Counterparty Risk Management Policy Group indicates that there are rules under the GAAP that make consolidation possible, but others that simply complicate the process.

Determine whether or not your company has a controlling interest in the subsidiary company. By law, you must consolidate your subsidiary's financial information if you determine that you have a controlling interest. By GAAP standards, there are two basic models for determining if you have a controlling interest or not. The first of those is if your company owns more than 50 percent of the voting interests in the other company. The second is if your company has a majority of the economic impact on the company and its decisions, even if you may only control a minority interest in terms of voting.

Perform the variable interest entity, or VIE, test to determine if you can consolidate. The GAAP define VIEs as those businesses entities that have too little investment equity to be at risk. Also, if the equity holders have no decision-making power or voting rights, this also indicates a potential VIE. In addition, if the organization lacks any obligation to absorb expected losses or does not have the right to receive its normal residual returns on its equity interests, it fits the profile of a VIE.

Ascertain who the primary beneficiary is. GAAP principles define the beneficiary as anyone or any entity that will absorb 50 percent or more the the VIEs losses or receive more than half of its residual income. Only one primary beneficiary can exist. In the event that there are two individuals or entities that may be considered the primary beneficiaries, the one that absorbs the majority of the losses, as opposed to receiving the majority of residual income, is the one that should be designated as the beneficiary.

Consult a CPA to complete the necessary paperwork and disclosures needed to consolidate the VIE. Counterparty Risk Management Policy Group points out that no uniform standards exist within GAAP to determine exactly how this is done. Instead, there are multiple ways this can be carried out and a financial professional like a CPA will be able to put together the best road map for doing so. Because each business situation differs from another, all variables between the controlling entity and the subsidiary should be professionally evaluated.

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