What is Consolidation?

Consolidation is the combining of all the assets, liabilities, revenues and expenses of a parent and all its subsidiaries under one group set of accounts as if it were a single entity.

Consolidated financial statements are produced when control has been achieved by a holding company. When control is achieved, a parent-subsidiary relationship is created. The parent is then required to produce consolidated accounts. This means that the parent and all subsidiaries are reported in one set of financial statements as if it were a single trading entity.

Key Learning Points

  • Full consolidation is used for subsidiaries which are controlled by the parent
  • The process of consolidation involves adding the investor amount to the investee amount and adjusting for the incremental impacts of the transaction
  • Goodwill is shown on the balance sheet following the acquisition of a subsidiary
  • The income statement of subsidiaries is consolidated from the date of completion which means a partial consolidation for the period in which the transaction is done

Accounting for M&As

The diagram below highlights how a holding company accounts for M&As.

Accounting for Full Consolidation

When 100% is purchased the parent becomes the sole shareholder in each subsidiary and no other shareholders are involved. In substance, the shareholders of the parent are the shareholders of a family of corporations, via subsidiary relationships. These subsidiaries are always included in full, in the consolidated financial statements.

Balance Sheet Consolidation

The parent must include all subsidiaries in consolidated financial statements. The process can be summarized as follows:

  • Add the assets and liabilities of the target to those of the parent on a line by line basis
  • Account for the transaction specific deal effects

This process can be better understood by applying the following formula:

Investor + Investee +/- Transaction effects = Consolidated

The investor represents the holding company and the investee the subsidiary. Each line item in the balance sheet is summed including any additional transaction effects. There are three key transaction effects to consider:

The shareholders of the investee (equity) have been bought out, therefore, you must zero out the investee’s shareholders’ equity on consolidation. The shares no longer exist and in simple terms have been “ripped up”.

A transaction must be financed, and this often involves raising additional capital. These are summarized in a sources and uses of funds table before being included in the calculation.

The final consideration is the “premium paid above book”. The book value of the investee’s equity does not represent its market value and its identifiable assets and liabilities are restated to fair value. This may involve step ups and step downs, and these must be included. These are summarized into one line item as goodwill.


A Inc. buys all of the equity of B Inc. from the shareholders of B Inc. for 35 in an all cash deal.

Produce the consolidated balance sheet of A Inc.

A Inc. financed the deal using 35 of balance sheet cash, so we must decrease the cash balance to reflect this.

The equity of B Inc. no longer exists and must be zeroed out. A value of minus 30 is inputted into the cell. This effect can be inputted as -D25 (30.0) to reference B Inc’s shareholders’ equity.

Finally, we need to calculate the goodwill which represents the premium paid above the target’s equity book value. The company has paid 35.0 for 30.0 of B’s equity. This difference of 5.0 is the premium paid and is reflected as a new line item call goodwill. For this example, we have kept it simple and it is included under “Long term assets”.

Sources and Uses of Funds

M&As are expensive processes and companies likely need to raise additional capital to finance the deal. The deal financing is summarized in a sources and uses of funds table. These items represent the most common found in a deal but in reality, there may be many more.

Uses of Funds Sources of Funds
Purchase of equity Balance sheet cash
Retirement of target debt Equity issuance
Fees Debt issuance

Income Statement Consolidation

To consolidate the income statement, we use the same methodology as we use to consolidate the balance sheet. Each line item must be summed plus any transaction effects.

What sort of transaction effects are we likely to see in an income statement? Often, they are effects of timing. If the holding company makes its investment partway through the year, it only includes the income statement of the subsidiary from the moment of purchase and does not include the full year’s revenues and expenses.

Another effect may come from the financing used to purchase the company. The company may issue additional debt, in which case it may have to pay extra interest on that deal debt. The company may also decrease interest expense on retired debt or lose interest income on any balance sheet cash used to finance the deal.

Any expected synergies due to the transaction will have to be included in the forecast Income Statement and will need to be captured in the appropriate line item, most commonly SG&A expenses.

The PPE or Intangibles of the acquired company may have increased in value as a result of the deal (asset step-ups/downs), in which case the company may also experience an increase or decrease in depreciation or amortization.

Lastly, the tax impact of all of the above transaction effects must be included.