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A consolidated balance sheet is a compilation of a company’s balance sheet information and all its subsidiaries. Generally Accepted Accounting Principles (GAAP) requires companies with multiple business divisions, special purpose entities, or partially owned subsidiary businesses to be included in the parent company’s balance sheet information. This consolidated statement allows banks, lenders or private investors to have a clear picture of the company’s financial health. The format also presents a snapshot of the company’s current asset and liability balances.
The balance sheet includes all the assets, liabilities, and retained earnings or owner’s equity of the company. This information usually represents the wealth created by the company, rather than its net income for the current accounting period. Banks and investors use this information to determine the value of the company’s assets and how much debt the company has incurred to purchase these assets or run its daily operations. While the parent company’s consolidated balance sheet is most important to external users of financial information, they may also be interested in the individual subsidiary’s balance sheet.
Most large or publicly held companies usually prepare individual financial statements for each subsidiary along with the consolidated financial statements. These individual financial statements may be included in the company’s quarterly or annual reports for review by public investors. Individual financial statements also help managers determine how well each subsidiary business is operating and the value each subsidiary creates for the company. Managers may also measure individual balance sheets against the company’s consolidated one to see the amount of assets and liabilities each subsidiary contributes to overall business wealth.
When comparing subsidiary balance sheets to the parent company’s consolidated balance sheet, managers must strip out all inter-company transactions from these financial statements. Inter-company transactions do not represent wealth creating transactions; they are merely shifts of economic inputs or resources from one company division to another. Allowing these transactions to remain can create a misrepresentation of the company’s overall economic wealth. Publicly held companies are usually held to higher standards regarding this financial information.
During the accounting scandals of 2001, Enron was shifting liabilities and other negative accounting information from its consolidated balance sheet to a special-purpose entity balance sheet. This allowed the company to present a stronger financial statement to investors and increase the amount of public investment. Once the public auditors discovered this accounting trick, they forced Enron to restate its balance sheet, leading to the eventual downfall and bankruptcy of the company from falsified accounting information.