Consolidation concepts and applications

Subsidiary Consolidation

The Necessity and Effects of revisions Concerning the Circumstances in which Subsidiaries are Excluded from Consolidated Reporting

Of the many changes to financial reporting methods enacted over the past decade, one of the seemingly most unnecessary is the change that has been made to the exclusion of subsidiaries from consolidated financial reporting. The legislation on this point has seemingly taken steps in both directions, mandating consolidated reporting in some instances that previously excluded subsidiaries from such reporting, and the IASB has proposed additional changes that would complicate which portions of a subsidiary's value -- whether presumed or actual -- can and should be included on a consolidated financial report form a controlling entity (Shortridge & Smith 2007). There is a great deal of disagreement as to how much this truly affects the accuracy of financial reporting from consolidated entities, and there is also understandable disagreement regarding the direction and degree of distortion that the changes to consolidated reporting rules may have created.

This distortion is understandable due both to the complexity and the seeming bi-directionality of the changes made. Certain circumstances that previously prevented consolidated reporting or allowed companies not to include subsidiaries in their consolidated financial reporting have been changes so that corporations are now required to report consolidated earnings under a broader range of circumstances (CPA Class 2009). At the same time, proposals for certain other exclusions based on percentages of ownership and the actual amount of control exerted on a subsidiary by a controlling company would affect which portions of a subsidiary's assets are listed on consolidated reports (Shortridge & Smith 2007).

First, an examination of the changes that have already been made to consolidation practices in financial reporting concerning subsidiaries is necessary in order to come to an understanding of the current situation. Previously, subsidiary companies -- those in which a controlling entity owned more than fifty-percent of the outstanding voting shares of stock or a majority voting interest by some other means -- were to be included in consolidated financial reports unless they were a foreign operation, if there was a large minority interest in the subsidiary company, if the operations of the controlling company and the subsidiary company were considered on-homogenous (e.g. A manufacturing subsidiary owned by a financial services company), or if significant doubts existed about a controlling interest's actual ability to exert control over the subsidiary (CPA Class 2009).

The modifications made to financial reporting policy generally eliminate most circumstances under which subsidiaries would not be included in consolidated financial reports. The remaining exception is when there is significant doubt as to the controlling interest's actual control over the subsidiary (CPA Class 2009). This also ties in with other notable exceptions that have been recently modified, namely that a subsidiary is specifically not to be included in a consolidated financial report when the controlling interest's holding of the majority voting value/shares in the subsidiary is intended to be temporary, and a sale is expected or desired in the near future (Shortridge & Smith 2007). The vague definitions in both of these exclusionary circumstances are the main cause for concern as to the real effects that the financial reporting consolidation changes have had on accuracy.