Abstract
This article analyzes consolidated financial statements and separately prepared financial statements. It brings out the major differences between the two types of financial statements. In the whole article, the holding company is considered to be situated in the U.S while the subsidiaries are located in foreign countries. The article explains why separately prepared financial statements are better than consolidated financial statements.
Do you agree with the author’s conclusion? Explain. Support your response with a rationale, well-reasoned explanation
I do not agree with the conclusion made by the author of the article. The financial statements of the holding company in the U.S and those of its subsidiaries in foreign countries should be prepared separately. This should be done using international financial reporting standards for easy interpretation and comparison. There are various reasons as to why I disagree with the author’s conclusion and they are as discussed in the following paragraphs (Holt, 2004, p.161).
The use of different currencies by the holding company and the subsidiaries is a major problem. Translation of financial statements of the subsidiaries from foreign currencies to the U.S dollar causes a lot of distortion to the financial information that is presented. Material information is lost in the process of changing the financial statements from foreign currency to U.S currency. This may occur as a result of rounding off the calculated values or even making major calculation errors while translating the statements (Holt, 2004, p.160).
The exchange rates may change from time to time. Thus the rates to use in translating the subsidiaries’ financial statements are hard to decide on. On most occasions, the financial statements are translated using average exchange rates which may not be a true reflection of the accurate exchange rates that are in operation. The process of translating financial statements is a tiresome exercise when the parent company has many foreign subsidiaries. This may lead to major errors and delays in the presentation of financial statements. The errors may give a misleading impression to the public on the performance of the holding company and its subsidiaries. The delays in presenting these financial statements may affect or delay the making of important decisions by the public (Hsu, Duh & Cheng, 2012, p.221).
The different environments of operation of the holding company and the subsidiaries also cause a major problem when consolidating the financial statements. The subsidiaries and the holding companies operate in different countries. The countries have different economic levels which greatly impact the performance of these subsidiaries. Taking an example of subsidiaries in third world countries and consolidating their financial statements with those of their mother company in the U.S can clearly show the significance of the environment of operation. The subsidiaries do not seem to cause a major change to the financial statements of the holding company.
The strengths of the economies of the different countries where the subsidiaries are situated determine their performance. The U.S has a strong economy and the holding company is likely to have the best performance. When the financial statements are consolidated the values from foreign subsidiaries become insignificant. However, if the financial statements are prepared separately then the significance of these subsidiaries can be noticed as the information they provide is read and interpreted separately. Thus there is no loss of material information and decision-making cannot be negatively affected.
The different methods of translating the financial statements used may also confuse. There are various methods of translating the foreign subsidiaries’ financial statements to the currency of the holding company. Different companies may adopt different translating methods. The rates of translating particular items of financial statements differ from one method to another. Comparison of these financial statements is not possible when different methods are used in preparing them. This will negatively affect the investment decisions made by the public. To avoid this, the subsidiaries should prepare their financial statements separately. Alternatively, a single method of translating the financial statements can be adapted to deal with the confusion (Duh & Hsu, 2012, p 233).
The holding company and the subsidiaries could be carrying out different business activities. This creates a major problem when trying to consolidate the financial statements of the parent company and that of the holding company. It is difficult to merge sales of one commodity with those of another as a result of the difference in prices and other considerable qualities. As a result of engaging in different economic activities, the financial statements of foreign subsidiaries may contain some items that are not reflected in the financial statements of the holding company or even in those of other foreign subsidiaries.
This poses a major challenge when merging the financial statements. To curb this problem and give relevance to the financial performance of the subsidiaries and the holding company the financial statements should be prepared separately (Muller, 2011, p.332).
The difference in management is also another reason why the financial statements should be presented separately. The foreign subsidiaries are managed by different managers from those of the holding company in the U.S. These managers employ different policies in their day-to-day management activities. These policies have different impacts on the performance of both the subsidiaries and the holding company.
The financial statements are used to show how relevant the managerial techniques employed are. Based on this the managers can consider using different policies. When the financial statements are consolidated the managers have no means of evaluating the impact of their policies. Poor managers in foreign subsidiaries also make use of the consolidation by hiding behind the good performance of the mother company and other foreign subsidiaries.
The holding company and the foreign subsidiaries may have adopted different accounting policies. The methods of recognizing transactions may be different in the subsidiaries and the holding company. The methods of accounting for depreciation could also differ from one subsidiary to another. Merging this information when preparing consolidated financial statements becomes a challenge. The subsidiaries should therefore be given chance to prepare their financial statements separately if uniform policies cannot be adopted. This will solve the problem of conflicting accounting policies used by the different subsidiaries and the parent company.
Convergence to international financial standards should not be used to justify the conclusion of the author. This is because as much as the international financial standards are strong and important they have their weaknesses. It is our role as the stakeholders of the world’s economy to identify these faults and find ways of correcting them. The author should not base his conclusion on a weak international financial standard. The fact that the standard exists does not make it right. These international financial standards were put in place by human beings and they are prone to errors. The standards were created a long time ago and as we know the economy and the economic decisions we make change with time. As time goes by we need to make complex decisions as the economy becomes complicated too.
The best the author could suggest is the amendment of the standard that calls for consolidation of the financial statements of foreign subsidiaries with those of the parent company. The act of using the wrong procedure just because the standards dictate so does not make the procedure right. I suggest that the international financial standards be looked into as a whole and amended in totality if they are found to create more harm than good to the public. This is major because they are meant to protect the public from incurring unwarranted losses (Muller, 2011, p.330).
At some points, the international financial standards contradict each other. For example in this case the international financial statement that requires materiality of information presented to be taken care of is contradicted by the standard that advocates for consolidation. The superior of the two financial standards override the other according to the provisions of the standards. In this case, the materiality standard is superior thus it overrides the consolidation standard. Major facts should not be lost by upholding minor standards. The author should thus not use the international financial standards as a scapegoat for making wrong conclusions.
The U.S and the international community should reconsider the role of financial statements. The financial statements are prepared in the consolidated form majorly to ensure uniformity that can facilitate comparison. Uniformity can still be attained if all holding companies prepare their financial statements separate from those of their subsidiaries. Comparison can be done in a better way as the financial statements of the different subsidiaries will be used in the comparison.
The financial statements are also prepared in a consolidated form to treat the group as one entity. In the process of doing this a lot is lost and the financial statements become too complex. This prevents the majority of the public from understanding the financial statements. Financial statements are supposed to guide the public in making economic decisions. It does not beat logic when the financial statements fail to aid this important process.
The consolidated financial statements tend to hide material information that could aid in decision-making. For instance, much of the information is lost during translation. We cannot ignore the major reason for preparing the financial statements and struggle to ensure they play minor roles. The financial statements are expected to measure the financial performance of the companies and shade light on the financial position of the company. Consolidated financial statements fail to play these major roles as most of the relevant information is lost in the consolidation process.
The financial statements are supposed to be used as a tool for checking the effectiveness of management policies put in place. This determines the strength of the managers of a given company. The poor managers of either the foreign subsidiaries or the parent company hide behind the consolidated financial statements. This could not be happening if the financial statements were prepared separately. The foreign subsidiaries are situated in countries other than the US and their financial statements should be availed to the citizens of those countries as they are directly affected by the performance and financial position of these subsidiaries.
Preparing consolidated financial statements and presenting them in the U.S media denies the citizens of those other countries a chance to access this information. The U.S and the international community should look into the roles and re-evaluate them if they are found to be irrelevant then they should be done away with. New roles that are relevant to the economy should be put in place.
I suggest that both the consolidated financial statements and separate financial statements be prepared and presented. This will achieve both the roles played by the consolidated financial statements and those played by the separately prepared financial statements. The consolidated financial statements can be used for comparison purposes and ensuring uniformity. When the consolidated financial statements are presented it becomes easy and faster to analyze the financial statements of the parent company and the subsidiaries. This will enhance faster decision-making when one does not have a lot of time to make a decision.
However, this may lead to the making of poor decisions as to the details of the subsidiaries and the holding company is not considered. To avoid this, a copy of separate financial statements should be presented together with the consolidated financial statements. These separately prepared financial statements will enhance quality decision-making as they will provide detailed information. The citizens of the foreign countries will have access to this economic information and use it in decision making as the foreign subsidiaries will be required to present their financial statements in the media of their respective countries (Hsu, Duh & Cheng, 2012, p.221).
The governments under which the foreign subsidiaries operate to require separately prepared financial statements to aid in taxation. Preparing the financial statements separately can help address this concern. The managers of the foreign subsidiaries and the holding company will be responsible for their managerial policies as they will no longer hide behind the consolidated financial statements. The impact of the changing translation rates can be dealt with using the financial statements prepared separately. The material information lost during translation can be traced when necessary as this can be done using the separately prepared financial statements.
References
Hsu, W. A., Duh, R, & Kang, C. (2012). Does the Control-based Approach to Consolidated Statements Better Reflect Market Value than the Ownership-based Approach? The International Journal of Accounting, 47(2), 198-225.
Holt, P. E. (2004). A case against the consolidation of foreign subsidiaries’ and a United States parent’s financial statements. Accounting Forum, 28(2), 159-165.
Muller, V. (2011). Value relevance of consolidated versus parent company financial Statements: Evidence from the largest three European capital markets. Accounting and Management Information Systems, 10(3), 326-350.
Duh, R, & Hsu, W. A. (2012). Response to Discussant of “Does the Control Based Approach to Consolidated Statements Better Reflect Market Value than the Ownership-based Approach?” The International Journal of Accounting, 47(2), 232-234.