Question

Discussion: Consolidated Financial Statements

Briefly discuss the entity theory and the parent company theory of consolidations and identify one drawback of each method. Suggest to management a strategy to overcome each drawback. Provide a rationale for your suggestion.

Answer 1

The drawbacks of the consolidation process of the parent with the subsidiary company are:

1)The products of both the companies are different with different clients and product policies.

2) The purchase terms of all the assets are different from each other in both the company.

3) The Accounts receivables and Accounts payable credit periods are different.

4) The fund rate of interest is different for each company.

5) The both companies shareholders are different and having varied objectives of investment in the company.

6) Consolidation of the accounts of the companies will unfold some assets of subsidiary company which give rise to unnecessary goodwill.

The suggestions to the management to overcome these drawbacks are: a) prepare each company's balance sheet separately. b) The income of the subsidiary company can be amalgamated with the parents income figure to come up with gross income of the group.

This will not disturb the whole balance sheet but only the income figures are got merged with each other to provide combined group income.

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