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Various corporations consist of many separate companies which necessitate them to prepare consolidated financial statements (Jeter & Chaney, 2010). Consolidated financial statements refer to the combined statements of a parent firm and its subsidiaries. Consolidation is necessary when a company possesses most of the outstanding common stock of another company. This paper discusses the objective and limitations of consolidated financial statements.
The Underlying Objective of Consolidated Financial Statements
The primary objective of consolidated financial statements is to present the financial position and the operating results of the parent company (the controlling company) and its subsidiaries (the controlled entities) together for the general purpose of financial reporting (Jeter & Chaney, 2010). Consolidated financial statements, therefore, enable people to gauge the general health of a whole group of companies rather than the position of the individual entities.
Limitations of Consolidated Financial Statements
It is important to mention that while consolidated financial statements are valuable, they have a number of limitations. For instance, multiple and different accounting methods are used during the consolidation process, and this may have an effect on the figures presented in the financial statements (Jeter & Chaney, 2010). In addition, some information is likely to be lost during the aggregation process, especially when the companies involved have significantly dissimilar operating characteristics. Because the details of individual entities are not presented in consolidated financial statements, information on the unprofitable entities tend to be hidden in case the entire group of companies is doing well, thus failing to paint the real picture as it is (Jeter & Chaney, 2010).
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Another important point to note is the fact that subsidiary companies are legally detached from the controlling (parent) company, thus the stockholders and creditors of the subsidiaries have no share in the profits made by the parent company. Therefore, consolidated financial statements are of little use to the people interested in acquiring information regarding the income, assets, or capital of the individual subsidiaries (Jeter & Chaney, 2010). Finally, when extremely diversified corporations operate across many industries, aggregating different information makes data analysis difficult (Jeter & Chaney, 2010).