Unveiling Consolidated Financial Statements

When a company has control over one or more entities, we use the terms parent company and subsidiaries, or simply a group.

A consolidated statement combine the financial records of the parent company and its subsidiaries. That leads to a comprehensive display of all the group’s assets, liabilities, equity, income, expenses and cash flows as one economic entity.

Consolidated financial statements give a true and fair view if one of the group’s companies has a controlling financial interest directly or indirectly in the other companies.

In addition, it results in better organization of the company’s financial documents and prepares a valuable financial summary to the business owners, shareholders and creditors.

But what about the consolidated statement report being handled in Hong Kong? What are the standards for it? You have to keep on reading to find out about it!

Are consolidated financial statements required?

Under Section 379 of the Companies Ordinance (CO), a company that controls one or more entities at the end of the financial year is obliged to prepare a consolidated financial report.

Certain exceptions to the requirement of preparing consolidated financial statements are outlined in section 379(3) of the Companies Ordinance (CO):

• In cases where the company operates as a wholly owned subsidiary of another corporate entity during the financial year; or
• if:
  • the company is a subsidiary partially owned by another body corporate during the financial year;
  • not less than 6 months before the end of the financial year, the directors inform the members in writing of the directors’ decision not to prepare consolidated statements for the financial year and the notification does not pertain to any other financial year; and.
  • at a date, being 3 months before the end of the financial year, no member has responded to the notification by providing the directors with a written request for the preparation of the consolidated statements for the financial year.

Nonetheless, even if you are not required to present statements, it is a good summary for yourself, the shareholders and directors.

The consolidated accounts will provide one view of the finances of your company, and this is very crucial if you are operating in several countries that have different accounting and tax laws.

What are the typical financial reporting obligations?

The accounting standards in Hong Kong are regulated by the Companies Ordinance and Financial Reporting Standards, which comply with the International Financial Reporting Standards (IFRS) starting from 2005. Although IFRS is the global standard for for-profit entities, entities in Hong Kong are allowed to use different reporting standards as long as they comply with the Hong Kong Financial Reporting Standards (HKFRS).

Under section 379 of the Companies Ordinance, directors of companies are required to prepare financial statements that comply with certain requirements and these statements are then audited by external auditors to produce annual statutory audit reports.

Consolidated financial statements are the combination of the financials of the parent company and its subsidiaries, adjusting for currency differences and eliminating intercompany transactions. Such statements should be in line with the relevant sections of the Companies Ordinance and HKFRS.

There is no particular time frame for the preparation of consolidated financial statements, yet, they may need to be submitted within the other statutory deadlines, e.g. tax filing or annual general meetings.

What constitutes a consolidated financial report?

In Hong Kong, a company that has control over one or more entities at the end of the fiscal year has to prepare a consolidated financial report that is compliant with sections 380, 381, and 383 of the CO.

The financial report should present detailed content that all the assets, liabilities, equity, income, expenses, and cash flows of both the parent and the subsidiary companies. This means that within this context these all become a single economic entity.

It is essential for an individual owning a company in Hong Kong to prepare a consolidated financial statement.

On the other hand, if a company belongs to a company body, some exemptions may also exist.

As per section 379(3) of the CO, companies may qualify for exemption from preparing consolidated financial reports if they fulfill any of the specified conditions:

• If a company is wholly owned as a subsidiary of another corporate entity during the financial year, it may qualify for exemption.
• When a company with a partial ownership in the other body corporate is incorporated in the financial year and the director gets approval from all the stakeholders to the notice, then the exemption can be applied.

Companies failing to prepare a consolidated financial statement (and not qualifying for exemption) can anticipate an auditor’s qualified opinion in the audit report, highlighting the company’s non-compliance with CO.

What is the objective of consolidated financial statements?

In the capacity of a financial position statement, a consolidated statement is used to show the operations results and financial position of a parent company and its subsidiaries as if the group were a single entity with one or more branches. These disclosures are mainly for the benefit of the shareholders and creditors of the parent entity.

Consolidated financial reports are more useful than separate statements and they are required for a fair presentation when one of the group companies has a controlling financial interest, directly or indirectly, in the other companies.

Thus, as an example, assume that you want to develop your company. You can achieve this by growing through acquisition of smaller companies. These subsidiaries tend to remain as independent units. However, they are controlled by the parent company.

On the other hand, each company has its own consolidation accounting records. These separate accounting records are later consolidated with the parent company’s accounting records to get the consolidated finances.

The outcome is a consolidated financial report that makes the finance records of the business more efficient and life of the business owner easier to a great extent.

How do combined financial statements differ from consolidated financial statements?

Combined statements can be used by an entity that has subsidiary branches. The consolidated financial statement consolidates the activities of a group of related companies into one statement. Despite their consolidation, the financial statements of each entity are still separate. Each subsidiary company is presented as an independent company.

The most apparent advantage of a consolidated financial statement is that investors can evaluate the corporation as a whole and then analyze the performance of each of the individual subsidiary companies separately.

Unlike that, a consolidated financial statement combines the financial status of both the parent company and its subsidiaries into one report. A combination like this one enables an investor to assess how the entire company is doing as a single unit rather than looking at financial statements of each segment of the business separately.

Additionally, in consolidated statements there are no increases in items for example stock value and retained earnings. But in a consolidated statement, the stockholders’ equity is summed across the accounts.

At last, while consolidating the statements, income and expenses of the subsidiary, add to the income statement of the parent company. Likewise, when consolidating financial statements, income and expenses are summed across the entities to give a group figure. This inclusion leads to an increase in the group’s income as opposed to the numbers that would be shown if the companies were reported separately.

What are the steps involved in preparing consolidated financial statements?

In the preparation of consolidated financial statements, there are a few considerations.

• To begin with, the balance sheets like assets, liabilities, equity, income, and cash flow should be consolidated between the parent company and its subsidiaries. In addition, transform various currencies into a similar presentation currency (in case of foreign operations).
• After that, eliminate the carrying value of the parent company’s investment in the subsidiaries and the parent equity share in each subsidiary.
• Finally, eliminate intercompany assets, liabilities, and equity in the balance sheet as well as expenses and transactional flows between entities of a group (the parent company and its subsidiaries).

The process output with combined figures is accounted for in the Consolidated Management Accounts. Those are typically exported as Excel files. The concluding numbers in consolidated management accounts will be shown in the unaudited or audited financial statements.

The directors are duty-bound to provide the statements and present them to the company at the annual general meeting. 

The financial statements must adhere to Accounting Standards mandated by the Accounting Standards Council.

How is the company subjected to auditing?

Annually, the financial statements of Hong Kong incorporated companies are required to be audited by a registered Certified Public Accountant (CPA).

The auditor should be an independent CPA rather than the regular accountant or bookkeeper maintaining the company’s financial accounts.

Because the CPA is independent and separate, an unbiased review can be conducted free from internal bias and false reviews.

The criteria for “Reporting Exemption” under the CO are provided below. They are not exempt from audit. “Reporting Exemption” applies to private or guarantee companies (some exceptions apply) that are qualified to prepare simpler accounts and director reports.

• A small holding company that meets at least two of the following conditions in a financial year:A small holding company that meets at least two of the following conditions in a financial year:
• The total revenue (or total aggregate revenue) shall not exceed HK$100 million.
  • The aggregate total assets must not be more than HK$ 100 million.
  • The number of employees (or aggregate number of employees) shall not exceed 100.
  • A private company or companies that is not a member of a corporate group should have a written unanimous agreement between the members.
• Small guarantee company (or holding of a group of small guarantee companies) with a maximum of HK$ 25 million in a financial year.
• An eligible private company (or a holding of a group of eligible private companies) that satisfy the higher-size criterion and with 75% approval from members of the holding.company. Furthermore, no member shall vote for the resolution.
• A holding company of a group of companies which includes one or more small private companies (or eligible private companies and one or more small guarantee companies provided that the holding company and its subsidiaries meets the prescribed size criteria) that receives a 75% approval from members of the holding company and no member votes against the resolution.

The group of companies may have non-Hong Kong body corporates.

If a company meets the exemption criteria, the exemption will be effective from the company’s financial year and every following financial year until the company is disqualified.

How can you ensure compliance?

It is necessary for company to learn the basics of the accounting standards of Hong Kong as described in both HK CO and HKFRS so as to be compliant to the provisions stated therein.

In case a company has the consolidation audit report from the previous year and wishes to change to a non-consolidation audit report in the current year, they will need professional help of getting the consistency in the different audit accounts as Hong Kong Inland Revenue Department will question the reasons for the change.

Moreover, realize that running a current accounting software system can reduce a large amount of work by automating some COA mapping and GAAP conversion tasks.

Therefore, the multinationals which would like to consolidate financial statements across a number of jurisdictions should upgrade the necessary modules of their ERP system, and properly configure their accounting systems.

Can a company exempted from audit?

The following aspects determine if you will benefit from an exemption report under CO:

• A small private company (or a holding company) of a group of small private companies has to meet two of the following conditions in a financial year:A small private company (or a holding company) of a group of small private companies has to meet two of the following conditions in a financial year:

1. Total revenue of the acquired company (or aggregate total revenue) shall not exceed $100 million.
2. The total value of (the aggregated value of) assets shall not exceed $100 million.
3. Employees’ numbers (or aggregate number of employees) shall not exceed 100.

• The other (or one of the) private companies (or companies) which is (or are) affiliated with a corporate group should be written down in the unanimous memorandum included in the agreement of members.
• No small guarantee company (or a collection of guarantee companies) shall have more than $25 million during a financial year.
• To qualify, an eligible private company ( or a holding company of group of eligible private companies) with larger size and having 75% approval from members of the holding company. The resolution shall not be put to vote if no member opposes it.
• A holding company group consisting of one or more small private companies (or an eligible private company and one or more small guarantee companies, provided both the holding company and its subsidiaries meet the criteria) require 75% approval from members of the holding company, provided that no member of the holding company shall vote against the resolution.

The group of enterprise could include those which are non-Hong Kong owned.

If a company qualifies the criteria that have been listed out as the reporting exemption, the exemption shall apply to the company in the first financial that has commenced on or after the commencement of the new Company or the Companies (Amendment) (No. 2) Batches 2018 and every year after that until the company gets disqualified.

How FastLane Group Can Help?

The process of consolidating financial statements is vital for showing correct financial performance to shareholders and other stakeholders. One of the crucial steps of an accomplished business owner is to prepare accurate financial statements of all related entities, including the parent company and its assets. Knowledge of consolidation accounting is crucial for keeping a high level of financial reporting. If you need help, FastLane is at your service. Our specialists ensure smooth financial statements and compliance with legal requirements. Contact us now.