help.. i dun understand..?

Question

One company may hold shares in another company. If one company wishes to obtain control of another company, it can do so by obtaining more than 50% of the equity shares in that company. When such a group exists the Companies Acts required a set of financial statements prepared in respect of the group as a whole.

In the light of the above statement, what benefits accrue to the investor in a parent undertaking by the use of consolidated financial statements?

Answer 1

The objective of consolidated financial statements is to show the financial performance and position of the group as if it was a single economic entity. There is a view that, as the entity financial statements of the parent company contain the investments in subsidiaries as fixed assets, they reflect the assets of the group as a whole. The more traditional view is that entity financial statements do not provide users with sufficient information about subsidiaries for them to make a reliable assessment of the performance of the group as a whole. The following illustrates benefits of consolidated financial statements:
– they identify the nature and classification of the subsidiary’s assets. For example, the investment in a subsidiary may be almost entirely in intangible assets or conversely they may be substantially land and buildings. Such a distinction is of obvious importance to users.
– the amount of the subsidiary’s debt could not be assessed from the parent’s entity financial statements. In effect the subsidiary’s assets and liabilities are netted off when it is shown as an investment. This means group liquidity and gearing cannot be properly assessed.
– the cost of the investment does not reflect the size of a company. For example a parent company may show an investment in a subsidiary at a cost of £10 million. This may represent the purchase of a subsidiary that has £10 million of assets and no liabilities. Alternatively this could be a subsidiary that has £100 million in assets and £90 million of liabilities. Clearly the latter subsidiary would be a much larger company than the former.
– the cost of the investment may be a fair representation of its value at the date of purchase, but with the passage of time (assuming the subsidiary is profitable), its value will increase. This increase would not be reflected in the original cost, but it would be reflected in the consolidated net assets of the subsidiary (and the increase in group reserves).
– the cost of the investment might represent all of the ownership of the subsidiary or only just over half of it i.e. there would be no indication of the minority interest.
To summarise, in the absence of a consolidated balance sheet, users would have no information on the current value of a subsidiary, its size, the composition of its net assets and how much of it was owned by the group.