By Thomas A. Ratcliffe, Ph.D., CPA
Certain business arrangements lead financial statement preparers to question whether consolidated financial statements are required, combined financial statements are needed, or separate financial statements of affiliated entities should be prepared.
The authoritative accounting technical literature guidance that is applicable in preparing consolidated or combined financial statements is in the FASB Accounting Standards Codification (FASB ASC) Topic 810, Consolidation. The focus of discussions in these materials is on some of the more frequently asked questions associated with using the FASB ASC 810 technical literature requirements and guidance.
Would combined financial statements be useful?
Using the guidance in FASB ASC 810-10-55-1B, there are circumstances under which combined financial statements, as distinguished from consolidated statements, of commonly controlled entities are likely to be more meaningful than these entities’ separate financial statements. As an example, combined financial statements might be useful if one individual owns a controlling financial interest in multiple entities that are related in their operations. Combined financial statements also might be used to present the financial position and results of operations of entities under common management.
Assume that an individual owns the entirety of stock in both Company A and Company B, and those two companies operate to complement each other in work in a particular industry. Given the common control relationship that exists with Company A and Company B through having one individual owning the entirety of the stock in both entities, issuing combined financial statements would be appropriate. Those statements most likely would be more useful to end-users of the statements when compared to having separate financial statements prepared for the two entities. If combined financial statements are prepared, there would be no need to present the separate statements of the two commonly controlled entities.
Another possible approach to consider in these types of situations is to have combining financial statements prepared. Just as it is appropriate to have consolidating, rather than consolidated, financial statements prepared as general-purpose financial statements of a reporting entity, it also is appropriate to have combining, rather than combined, financial statements prepared when it is determined that financial statements of commonly controlled entities should be prepared with both entities reflected in the statements.
What about the issuance of parent-only financial statements?
In certain circumstances, parent-only financial statements may be needed in addition to consolidated financial statements to indicate adequately the position of bondholders and other creditors or preferred shareholders of the parent. As a reminder, using the requirements in FASB ASC 810-10-45-11, consolidated financial statements are the general-purpose statements of a parent company having one or more subsidiaries. As such, parent-only financial statements are not a valid substitute for having consolidated financial statements prepared for general use.
In these types of situations, when parent-only financial statements are needed – and given that parent-only statements cannot constitute the general-purpose financial statements when a parent and subsidiary relationship exists, a practical approach to address the issue would be to have consolidating, when contrasted with consolidated, financial statements prepared in which one column is used for the parent company and other columns are used for subsidiaries or groups of subsidiaries.
May primary beneficiaries of variable interest entities prepare combined statements?
A reporting entity is required to consolidate a variable interest entity (VIE) if that reporting entity has a variable interest or a combination of variable interests that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both, according to the provisions of FASB ASC 810-10-25-38. In circumstances in which one reporting entity will absorb a majority of a VIE’s expected losses and another reporting entity will receive the majority of that VIE’s expected residual returns, the reporting entity absorbing a majority of the losses is required to consolidate the VIE.
Notice in the requirements spelled out above that nothing indicates that primary beneficiaries of VIEs would be allowed to issue combined financial statements in lieu of consolidated financial statements in efforts to comply with FASB ASC 810 consolidation requirements. Given this fact, it would not be appropriate for primary beneficiaries to prepare combined financial statements including the VIEs because the preparation of combined financial statements is allowed only in certain situations in which consolidated financial statements are not required.
As a reminder, using the combined financial statements requirements and guidance in FASB ASC 810, the starting point for the preparation of combined financial statements is having two or more sets of financial statements that are prepared using U.S. generally accepted accounting principles (U.S. GAAP). In circumstances in which a reporting entity is the primary beneficiary of a VIE, the U.S. GAAP-based financial statements of the primary beneficiary would be the consolidated financial statements so that there would be no entity left to combine.