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Issues related to consolidation of financial statements of MNCs

What is consolidation of Financial statement
  • Many corporations are composed of numerous separate companies and, in turn, prepare consolidated financial statements.
  • Consolidated financial statements present the financial position and results of operations for a parent (controlling entity) and one or more subsidiaries (controlled entities) as if the individual entities actually were a single company or entity.
  • Consolidation is required when a corporation owns a majority of another corporation’s outstanding common stock. 
  • The accounting principles applied in the preparation of the consolidated financial statements are the same accounting principles applied in preparing separate-company financial statements.
  • Two companies are considered to be related companies when one controls the other company. • 
  • Consolidated financial statements are generally considered to be more useful than the separate financial statements of the individual companies when the companies are related. 
  • Whether the subsidiary is acquired or created, each individual company maintains its own accounting records, but consolidated financial statements are needed to present the companies together as a single economic entity for general-purpose financial reporting. 
Issue Related To consolidation of Finacial Statements of MNC

1. Subsidiary Financial Statements  
  • Because subsidiaries are legally separate from their parents, the creditors and stockholders of a subsidiary generally have no claim on the parent, nor do the stockholders of the subsidiary share in the profits of the parent. 
  • Therefore, consolidated financial statements usually are of little use to those interested in obtaining information about the assets, capital, or income of individual subsidiaries.
2. The Tradition View of Control 

  • The professional guidance regarding consolidated financial statements is provided in ARB 51 and FASB 94. 
  • Under current standards, consolidated financial statements must be prepared if one corporation owns a majority of another corporation’s outstanding common stock
3.Less Than Majority Ownership 
  • Although majority ownership is the most common means of acquiring control, a company may be able to direct the operating and financing policies of another with less than majority ownership, such as when the remainder of the stock is widely held. 
  • FASB 94 does not preclude consolidation with less than majority ownership, but such consolidations have seldom been found in practice.
4. Indirect Control  
  • The traditional view of control includes both direct and indirect control. • Direct control typically occurs when one company owns a majority of another company’s common stock. 
  • Indirect control (or pyramiding) occurs when a company’s common stock is owned by one or more other companies that are all under common control.
5.Ability to Exercise Control 
  • Under certain circumstances, the majority stockholders of a subsidiary may not be able to exercise control even though they hold more than 50 percent of its outstanding voting stock. Examples: 
  • Subsidiary is in legal reorganization or bankruptcy 
  • Foreign country restricts remittance of subsidiary profits to domestic parent company 
  •  Parent is unable to control important aspects of the subsidiary’s operations
  • • When consolidation is not appropriate, the unconsolidated subsidiary is reported as an inter corporate investment. 
6. Differences in Fiscal Periods 

  • A difference in the fiscal periods of a parent and subsidiary should not preclude consolidation of that subsidiary.  
  • Often the fiscal period of the subsidiary, if different from the parent’s, is changed to coincide with that of the parent. 
  •  Another alternative is to adjust the financial statement data of the subsidiary each period to place the data on a basis consistent with the fiscal period of the parent.

7. Differences in Accounting Methods 

  • A difference in accounting methods between a parent and its subsidiary generally should have no effect on the decision to consolidate that subsidiary. 
  • In any event, adequate disclosure of the various accounting methods used must be given in the notes to the financial statements.

8.Reporting Entity-A Changing Concept  

  • The FASB is currently considering some of the difficult issues relating to control. Ultimately, the FASB is expected to move beyond the traditional concept of legal control based on majority ownership and also require consolidation of entities under the effective control of another entity, even though the other entity may not hold majority ownership. •
  •  This broader view would contribute to the harmonization of accounting standards in the global economy

9.Inadequate Standards • 
  • Consolidation standards relating to partnerships or other types of entities (such as trusts) have been virtually nonexistent. •
  •  Even corporate consolidation standards have not been adequate in situations where other relationships such as guarantees and operating agreements overshadow the lack of a significant ownership element.
  •  Although many companies have used special entities for legitimate purposes, companies such as Enron took advantage of the lack of standards to avoid reporting debt or losses by hiding them in special entities that were not consolidated. 
  •  Only in the past few years have consolidation standards for these special entities started to provide some uniformity in the financial reporting for corporations having relationships with such entities.
10.Inter corporate Stock holdings • 
  • The common stock of the parent is held by those outside the consolidated entity and is properly viewed as the common stock of the entire entity. 
  • In contrast, the common stock of the subsidiary is held entirely within the consolidated entity and is not stock outstanding from a consolidated viewpoint.
11Difference between Cost and Book Value • 
  • Typical Situation: Generally speaking, if the parent paid more for the subsidiary than book value of the shares acquired (a net debit differential), the excess would be allocated (during the consolidation process) to specific assets and liabilities of the subsidiary, or to goodwill. • 
  • Allocation of differentials is extensively.
12. Mechanics of the Consolidation Process • 
  • A worksheet is used to facilitate the process of combining and adjusting the account balances involved in a consolidation.
  •  While the parent company and the subsidiary each maintain their own books, there are no books for the consolidated entity. •
  • Instead, the balances of the accounts are taken at the end of each period from the books of the parent and the subsidiary and entered in the consolidation work paper.
  • Where the simple adding of the amounts from the two companies leads to a consolidated figure different from the amount that would appear if the two companies were actually one, the combined amount must be adjusted to the desired figure. • 
  • This is done through the preparation of eliminating entries. • Consolidation work papers and eliminating 
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