Which entities to include in consolidation

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In the complex world of accounting, "consolidation" under the United States Generally Accepted Accounting Principles (US GAAP) or International Financial Reporting Standards (IFRS) can seem daunting. However, it's an essential concept for businesses with multiple entities. This article breaks down the basics of consolidation in plain, everyday language.

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What is Consolidation?

Consolidation in accounting is like creating a family portrait. Imagine a parent company with several children (subsidiaries). The consolidation process is like drawing a single picture that shows the entire family's financial health, instead of individual portraits for each member. For a more detailed overview of the entire consolidation process check out our essential guide here.

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Which entities need to be consolidated?

1. The Parent Company: This is the main entity that has control over other businesses (subsidiaries). Think of it as the head of the family in our portrait analogy.
2. Subsidiaries: These are the companies that the parent company controls. Control usually means owning more than half of the voting stock, but it can also come from other factors like contractual arrangements or the ability to influence the subsidiary's decisions.
3. Variable Interest Entities (VIEs): These are a bit trickier. Sometimes a company doesn't own more than half of another company but still has significant influence or control, often through financial arrangements. These entities also need to be included in the consolidation.

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How Do You Determine Control?

Determining control isn't always about stock percentages. It's about assessing whether the parent company has the power to direct the significant activities of another entity. This can come from voting rights, contracts, or other means.

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Key Points to Remember

• Majority Ownership is a Strong Indicator: Owning more than 50% of another company's voting shares usually means you need to consolidate.
• Control is More Than Just Ownership: Even without majority ownership, if you have the power to influence significant decisions, consolidation might be necessary.
• Look Beyond the Numbers: Sometimes, contractual arrangements or economic dependencies can lead to a consolidation requirement, even without direct ownership.

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Which Special Purpose Entities Must be Consolidated?

Special purpose entities are usually created for a narrow, specific or temporary purpose. Often these companies have complex governance and ownership structures. To determine whether a special purpose entity should be included in the consolidation it is necessary to look at the underlying nature and purpose of the entity. There are extensive rules in both US GAAP and IFRS about whether these entities need to be included in the consolidation.

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Conclusion

Consolidation under US GAAP or IFRS can seem complex, but it's essentially about painting a complete financial picture of a group of related companies. Remember, it's not just about who owns whom; it's about who controls whom. This understanding is crucial for transparent and accurate financial reporting.

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Need More Help?

Accounting rules can get complicated, especially when dealing with multiple entities. If you're unsure about how to apply these rules to your situation, it's a good idea to consult with a professional accountant or auditor who's well-versed in US GAAP or IFRS.

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