A consolidate financial statement portrays the financial situation of a group of companies as one whole. To find out more, you can read an interview with Alice Šrámková.  The user of the financial statement thus obtains information of far greater quality for deciding about a group of companies than was the case in case of drawing up only an individual financial statement of the parent company. Since 2016, an amendment of the accounting act took effect, which has lowered the limits for Czech companies that establish the duty of drawing up a consolidated financial statement. The parent company now has this duty in case of exceeding two out of the three following criteria.  The first criterion are consolidated assets of CZK 100m in total, the second criterion is a consolidated net turnover of CZK 200m and the last is a consolidated average number of employees reaching 50. It also needs to be mentioned that the duty of drawing up a consolidated financial statement does not arise in case the company itself is part of a consolidated financial statement of another company. Let us now take a look at the entire procedure.

Evaluation of the duty of consolidation

The evaluation of the duty is somewhat controversial itself. The above-mentioned limits are set on consolidated basis. This means, that the parent company actually needs to “consolidate” first, in order to find out, if the duty of consolidation relates to it. At the same time, it is necessary to distinguish between subsidiary and affiliated companies, which do not enter into the evaluation of the criteria. In practice, the management of a company is, of course, able to evaluate gross estimates as to whether or not the criteria have been fulfilled. However, especially in marginal cases and in case of a greater number of mutual transactions, companies are de facto forced to consolidate for the purpose of assessing the duty of consolidation itself.

The consolidating whole

The process of drawing up the consolidation begins with defining the consolidating whole. A process of evaluation takes place, as to which subject has the duty to draw up a consolidate financial statement in the position of a parent company, and which subject has been freed from this duty, because it part of another (superordinated) consolidating whole.

Reporting framework

After defining the consolidating whole, it is necessary to decide, based on what accounting standard the consolidated financial statement will be drawn up. According to the accounting act, in case of a consolidated financial statement, parent companies can choose between Czech accounting standards and the International Financial Reporting Standards (IFRS). In practice, this decision-making is often influenced by the fact of whether the drawn up consolidated financial statement subsequently enters into consolidation of a foreign parent company, which may itself be reporting according to the IFRS, or whether it only serves for local purposes on the territory of the Czech Republic. It is necessary to mention that the drawing up of a consolidated financial statement according to IFRS places relatively high information demands on the individual entities participating in the consolidation, because in this case, IFRS reporting must be ensured primarily on the level of the individual financial statements already.

Control

After defining the consolidating whole and setting up the reporting framework, the decision-making then takes place, as to which companies have the duty to be subject to consolidation and in what way they will be included and portrayed in the consolidated financial statement. They key in this is the assessment of the scope of influence and control, which the parent company exerts over its companies. A distinction is made between the parent company controlling the participating companies or only participating in their management, or co-controlling them with another entity. The actual state of control is being evaluated, which may be treated by a contract for example, regardless of ownership interests. In most cases, though, ownership interests are the key criterion.

Consolidation methods

In connection to the above-mentioned evaluation, companies are then included in a consolidated financial statement, using one of the following consolidation methods: the full method, the proportional method or the equivalence method (this differs from the equivalence method used in portrayal of ownership interests in individual financial statements). When applying the above-mentioned procedure of inclusion and selection of consolidation method, minor differences may exist already in connection to the chosen reporting framework. It is therefore always necessary to carry out this procedure in the context of the selected reporting framework.

In case of the full method, all assets and liabilities of the parent company and the subsidiaries are in fact included. The part, which does not belong to the parent company but to minority shareholders is reported as a minority stake in equity. In case of the proportional method, the inclusion is carried out in proportion to the share in assets and liabilities. The equivalence method, which is usually used for affiliated companies, which the parent company does not control, re-valuates the ownership interest in the affiliated company with regard to the percentage of the stake in the equity of the affiliated company.

Consolidation rules

In order for the consolidated financial statement to make sense, it is necessary to ensure the same reporting and a unified accounting policy (valuation, depreciation, etc.) in all participating companies. For this purpose, the parent company sets consolidating rules, within which it unifies the accounting policy and form of reporting. It is suitable to make this move before the beginning of the accounting period, for which the consolidated financial statement is drawn up, because its subsequent application is more laborious in practice. If companies do not report individually in a unified way, entries need to be re-sorted in keeping with the set consolidation rules. The consolidation rules also contain a specification of the consolidating whole, so that companies could ensure sufficient records of mutual transactions, which we will discuss further.

Consolidation adjustments

Ownership interests and equity, which corresponds to them, exclude one another in the process of consolidation. This is so, in order for the value of consolidated companies not to be included twice in the financial statement – once in the form of ownership interest and a second time by means of the included assets and liabilities of the subsidiary companies. Similarly in the case of affiliated companies as well. In practice, the acquisition price almost never corresponds to the acquired stake in equity (as of the date of acquisition), and therefore a consolidation difference is posted, which reflects this incongruity. The way of its calculation depends again on the chosen reporting framework. When proceeding according to the Czech accounting standards or according to the IFRS, different methods are being applied in this case. When calculating the consolidating difference, the real values of acquired assets and liabilities are being considered. “New” entries may be posted (especially intangible assets), which were not posted on the basis of an individual financial statement.

In the following steps, mutual balance positions and supplies within the group are then eliminated. For this move, the companies need to ensure their sufficient records and their inventory-taking and mutual approval are recommended. The procedure of elimination itself then depends on whether or not these were so-called consumed supplies (for example services) or unconsumed (supplies of fixed assets, for example inventory, which was not sold further outside the consolidating whole) and further also on the method of inclusion of the company that participates in mutual transactions into the consolidating whole.

Further consolidating adjustments will be carried out at the end, depending on the specific situation in the group – for example reporting of minority stakes in equity or de-consolidation of a company in case of its sale and others. A number of consolidating adjustments has tax effects and leads to posting deferred tax.

Comparative period

When drawing up the consolidated financial statement, it is also necessary to remember to ensure information about a comparative period. It is necessary to reflect consolidating adjustments in the previous period in the consolidation of the current year. In case the parent company is consolidating for the first time, it usually also needs to carry out consolidation of the previous period, in order to ensure comparative information for the user of the financial statement. Another requirement is then the duty of ensuring sufficient information for drawing up the notes to the financial statement. The scope and structure of this information again depends on the selected reporting framework and the size of the group.

Conclusion

The result of the entire consolidation process is the consolidated financial statement itself in the form of accounting reports and the notes. Their scope, structure and form depend significantly on the selected reporting framework. For example the report on full economic result drawn up according to the IFRS is not treated in Czech accounting rules at all. From next year, reports on equity and cash-flow, which are not required now, will probably also be an obligatory part of the consolidated financial statement according to Czech accounting standards. The drawn up financial statement is then subject to control by an auditor and upon completion of the audit, it is approved and published.

I believe I have shed some light on the world of consolidation and work and consolidation will be easier for you now!
If you would like advice on anything, please do not hesitate to turn to our team of experts at Fučík & partneři.