‘The suggestion that we were pursuing consolidation as a replacement for reaching our financial targets by 2018 is fundamentally a bunch of hogwash’
Sergio Marchionne, former CEO of Fiat Chrysler Automobiles
In a nutshell
Group accounts show the financial results of a group of companies. A group comprises a parent company and at least one subsidiary. A subsidiary is a company controlled by another company (i.e. parent).
Company law (and accounting standards) requires a parent company to combine its own financial results with those of its subsidiaries to present group accounts, as if it were a single entity.
The process of combining results is known as group accounting or consolidation. Adding together (consolidating) each income and expense line from the profit and loss account for each company in a group creates a group profit and loss account. Similarly, all the assets and liabilities from each balance sheet are added together to produce a group balance sheet. These accounts, when presented (together with other required disclosures) in a single set of financial statements, are known as group accounts or consolidated accounts.
Companies can only be consolidated when they are ‘controlled’ by the parent. Control typically arises when a parent owns a majority of shares in a subsidiary, although it is the ability to direct decisions made by a subsidiary that ultimately determines control.
Need to know
Why is this important?
Every company is required to prepare financial statements annually to report its performance (profit and loss) and position (balance sheet). Financial statements should reflect how the business has performed during the year as a result of trading on what is known as an ‘arm’s-length basis’, i.e. with the business trading independently or without influence from any other party.
Group companies are related parties because they are under the control of a common parent. It is typical for related parties to trade with one another on more favourable terms than would be the case if the companies were not part of the same group. Where a group company trades with another on a non-arm’s length basis (for example, obtaining supplies at a lower cost than would otherwise be available) then its reported performance will be impacted because of the related party relationship. This can give a misleading impression to the outside world of the true (i.e. arm’s length) performance, success or otherwise, of a business.
The group accounts and individual accounts of companies in the group should therefore disclose or adjust for the effect of any transactions within the group.
In the group accounts, the financial impact of any transactions between group companies is eliminated, to show only the trading and performance of the group ‘with the outside world’.
In the individual accounts, every company in the group should disclose the financial effect of any transactions undertaken with other group companies. This ensures that the underlying ‘arm’s length’ performance of each company with the outside world can be understood.
Example
Parent company A acquired 100% of subsidiary company B during the year.
Company A is a well-established and profitable company whereas company B is a company that has reported losses for a number of years. Following acquisition, company A is able to control the activities of company B (by virtue of its shareholding) and can directly affect the performance of company B, for example, by setting uncommercial prices for trade between the companies.
During the year company B is instructed to sell goods to company A at an uncommercially high price. As a result, company B reports profits and positive growth in net assets, because of this favourable trading relationship within the group.
The accounts of company B, when looked at in isolation, would show a significant turnaround in year-on-year performance, from a loss-making business to a profitable business. In the absence of any disclosure of the existence of transactions between the group companies, a lender (bank) or creditor might be misled and form an unduly positive impression of company B based on the latest reported performance.
To ensure transparency, accounting standards require company B to disclose the financial impact of any group transactions on reported performance. Company B must also disclose the identity of its parent company. A fuller understanding of the business may be gained from reviewing the group accounts that incorporate the results of the subsidiary. The group accounts will also disclose separately information about parent company A.
When is this important? 
Suppliers and lenders typically review financial statements as part of due diligence before extending credit to a company. Looking at any company in isolation, without understanding the influence exerted by a parent for example, can provide a misleading view of its performance.
Having knowledge of group activities can result in creditors/banks seeking additional parent company guarantees before advancing credit/monies to a subsidiary that is dependent on intra-group trading for its success.
In practice 
Companies are separate legal entities. A company therefore has no legal obligation to settle the debts of any other company in a group unless legally enforceable guarantees exist. In addition to legal guarantees sought from the parent company for monies lent to subsidiaries, lenders may seek to register legal charges over assets held within the group as further security for lending to a subsidiary company (see Chapter 30 Debt finance).
Nice to know 
Ownership versus control
While 51% (or more) ownership demonstrates majority ownership and therefore might also suggest control, it does not necessarily always result in control. Similarly, 49% (or less) does not imply that a controlling relationship does not exist. What matters in deciding if control exists is the actual degree of power that one party has to direct another party’s operations.
Example
Company A owns 60% of the shares of company B. The remaining 40% is held by company C. However, by virtue of a legal agreement between the parties company A has the right to appoint only two of five directors onto the board while company C appoints the remaining three directors. Despite holding the majority of shares, company A’s directors do not hold majority voting rights on the board. Rather, it is company C that controls board decisions and therefore the company.
Significant influence (associate relationships)
A company that owns between 20% and 50% of another business is unlikely to have control of the business. It may nevertheless have significant influence. This gives the minority investing company a degree of influence over decisions, but not the right to force through those decisions. These investments are known as associate relationships.
Because there is no ability to control, associate relationships are not consolidated, i.e. the results are not added together (line by line) in the manner described for subsidiaries. Rather, it is only the relevant % share of profits (or losses) and relevant % share of net assets owned that are included in the consolidated accounts of the investing company. This form of accounting is known as equity accounting. Equity accounting is applied only where a parent company has existing subsidiaries and prepares consolidated accounts.
Optional detail 
Consolidation accounting
The accounting involved in consolidation can be quite complex. However, the basic steps in every consolidation involve a standard set of adjustments, as explained below.
To prepare the consolidated balance sheet, the assets and liabilities of the parent and every subsidiary are added together on a line-by-line basis with adjustments made for goodwill (see 1 below) and non-controlling (minority) interest (see 2 below). Intra-group balances are eliminated.
To prepare the consolidated profit and loss account, the income and expenses of parent and each subsidiary are added together on a line-by-line basis. Group income is then reduced by the non-controlling interest in profits (see 3 below). Intra-group trading is eliminated.
1 Identification of goodwill
Compare the ‘cost of investment’ (included in the parent company balance sheet under fixed assets) against ‘share capital and reserves’, i.e. equity in the subsidiary at the time of acquisition (after including any fair value adjustments such as revaluation of assets):
- aWhere the cost of investment is identical to equity, cancel out i.e. there is no goodwill.
- bWhere a company pays more (or less) than the equity in the subsidiary (at the time of acquisition), recognise the difference as positive (or negative) goodwill.
Goodwill on acquisition (purchased goodwill) is an intangible asset and is included within fixed assets in the consolidated balance sheet (see Chapter 10 Goodwill and other intangibles).
2 Non-controlling interest (NCI) – liability
Where a subsidiary is less than 100% owned a non-controlling interest or NCI exists. NCI, known also as minority interest, refers to the financial interests of third-party shareholders.
In situations of less than 100% ownership, while the assets and liabilities may fall under the control of the parent, the parent does not own 100% of those assets and liabilities. NCI reflects the percentage of net assets still owned by third parties and this is reflected as a long-term liability of the business in the consolidated balance sheet. For example, a company that was 60% owned by a parent would show an NCI figure, calculated as 40% of the subsidiary’s balance sheet net assets.
3 Non-controlling interest (NCI) – profit
Where a subsidiary is less than 100% owned, the share of annual profits not owned will belong to non-controlling interests.
NCI profits are deducted from group income, to leave the share of a subsidiary’s income that belongs solely to (the shareholders of) the parent company. For a subsidiary company that is 60% owned by a parent, NCI would be calculated as 40% of the subsidiary’s profit.
Additional considerations
Different accounting policies or year ends will need to be considered and adjusted accordingly. For example, a subsidiary that has a different year end to its parent may need to prepare additional financial information to cover the intervening period.
Group accounting – exemptions
In certain circumstances, a company with subsidiaries is exempt from the requirement to prepare group accounts:
- 1Small groups. A group is small if its combined revenue, total assets and employees are below certain thresholds (see Chapter 21 Information in the public domain).
- 2Where the parent itself forms part of a larger group. In this situation its results would be consolidated into the results of that (larger) group.
Reflect and embed your understanding 
- 1Explain why related party disclosures are important.
- 2A supplier is considering offering credit terms to a new corporate customer. The profit and loss account of the customer (a company) confirms that it is a profitable business. The company is part of a larger group. Explain why related party disclosures may help the supplier gain a more informed understanding of the performance of the customer.
- 3When a company acquires another for more than its balance sheet net worth, an accounting difference known as goodwill is created:
- aHow is this difference accounted for in the group financial statements?
- bWhy is this difference only recognised in the group financial statements?
For the authors’ reflections on these questions, please go to financebook.co.uk
Where to spot in company accounts 
A disclosure note should be included to confirm the existence of a parent company in a subsidiary’s accounts.
Where related party transactions have taken place during the year, a disclosure note should be included to quantify and explain the effect of those transactions, where they have not been undertaken on an arm’s length basis.
Group accounting policies will disclose how intragroup transactions have been accounted for.
Extract from Greggs plc 2020 financial statements Appendix p. 453
(c) Basis of consolidation
The consolidated accounts include the results of Greggs plc and its subsidiary undertakings for the 53 weeks ended 2 January 2021. The comparative period is the 52 weeks ended 28 December 2019.
(i) Subsidiaries
Subsidiaries are entities controlled by the Company. The Company controls an entity when it is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. The accounts of subsidiaries are included in the consolidated accounts from the date on which control commences until the date on which control ceases.
(ii) Associates
Associates are those entities in which the Group has significant influence, but not control, over the financial and operating policies. Significant influence is presumed to exist when the Group holds between 20 and 50 per cent of the voting power of another entity unless it can be clearly demonstrated that this is not the case. At the year end the Group has one associate which has not been consolidated on the grounds of materiality (see Note 13).
(iii) Transactions eliminated on consolidation
Intragroup balances, and any unrealised gains and losses or income and expenses arising from intragroup transactions, are eliminated in preparing the consolidated accounts.
Consolidate and apply
To see how the concepts covered in this chapter have been applied within Greggs plc, review Chapter 36, p. 402.
Watch out for in practice 
- →Goodwill in group accounts (see Chapter 10 Goodwill and other intangibles).
- →Non-controlling interest in group accounts.
- →When reviewing financial statements, check if a company is part of a group and if so, who the ultimate parent is.
- →Interest-free loans to subsidiary companies to fund working capital and/or growth.
- →Significant intra-group trading activity affecting financial performance, e.g. buying/selling stock at uncommercial prices. This can significantly distort the underlying (‘true’) performance and position of a company.
- →Dramatic improvement/deterioration in financial performance of a company following acquisition. The company may have access to new markets or improved/worse commercial terms from group companies.