How to Handle Reconciliation and Consolidation

July 8, 2016

Consolidating a large group of companies today is nearly impossible without a properly set system and confirmation of mutual relationships, or reconciliation. The primary goal of the reconciliation process is to ensure that suppliers and customers have the same view of intergroup transactions, highlight any discrepancies, and then prompt responsible parties to reconcile.

There are several reasons for differing views on intercompany transactions, including issues like one party issuing a document that the other has not yet received or approved. Currency differences in the booking of large transactions can also cause discrepancies, affecting values in the consolidation currency but not in the transaction currency.

Reconciliation typically follows precisely defined account groups or report lines (assets versus liabilities, expense accounts versus income), allowing for detailed analysis down to individual transactions.

The outcome of reconciliation is agreement, with alerts for material discrepancies prompting responsible parties to reach consensus or, in other cases, creating proposals for reconciliation adjustments aimed at smoothly eliminating intercompany transactions in the consolidation process.

Modern robust applications simplify the reconciliation process by easily identifying discrepancies, categorizing them as critical or minor, uncovering their causes, and engaging responsible individuals to take appropriate actions.

Successful system setup and operation during analysis primarily involve clearly defining the reconciliation group of assets and liabilities, expenses and income, including their management and rules for handling transactions at the local company level.

How does consolidation work?

Consolidation is a process aimed at presenting the financial results, assets, and resources of a group of companies as if they were a single entity. If we were to unify the view of two companies with no economic or ownership connections between them, it would simply be a matter of adding up their financial results, assets, resources, and cash flows, which includes changes in cash positions and the statement of changes in equity.

In practice, for the vast majority of companies within a group, there are mutual connections through ownership, financing, or regular business relationships. For this reason, there’s a developed methodology and recommended procedure for each group of relationships.

Most common types of consolidation adjustments:

1. Translation of foreign entity transactions: A fundamental consolidation adjustment that unifies the view and presentation of all companies in the group from local currencies to the consolidation currency.
2. Elimination of intercompany transactions: The most extensive adjustment that removes intercompany receivables and liabilities in the balance sheet, and revenues and expenses in the income statement.
3. Elimination of group dividends: Excludes the income associated with the recording of dividends from the parent company’s income statement and restores the undistributed profits to their original level in the subsidiary.
4. Elimination of capital and investments: Excludes financial investments on the parent company’s side against the capital representing this investment in the subsidiary.
5. Elimination of the economic result from the resale of fixed assets: Adjusts the selling price of the respective fixed asset to the original acquisition cost, then amends the new depreciation schedules to match the original scheme.
6. Elimination of the margin from the resale of inventories: Provides an alternative to the previous adjustment, applied to inventories.
7. Recognition of goodwill: Occurs at the time of the acquisition of a business or part thereof and represents the difference between the individual valuation of the acquired assets reduced by liabilities and the corresponding purchase price.
8. Minority interests: Shares of shareholders outside the group in the net assets of subsidiary units.
9. Equity method consolidation: Represents the financial investment as the investor’s share in the equity of the associated enterprise.

The degree of automation in consolidation adjustments is always subject to analysis, derived from the readiness of data sources, the level of operation, and an assessment of the effort expended versus the expected effect. In practice, it is usually appropriate to automate consolidation adjustments as per points 1 to 4 in the list.

Beyond local presentation, the data model for group reporting must also enable a view of the entire group and its individual parts. The partner dimension, representing the view through suppliers and customers, separates the perspective of third parties and the so-called Intercompany group, which includes companies within the group, and possibly Related parties allowing for the inclusion or elimination of affiliated persons.

Intercompany transactions can be easily included or excluded with a click. Additionally, it features an independent Company dimension limiting the presentation to the currently required companies.

A system supporting consolidation must also allow for the transparent entry of manual consolidation and managerial adjustments according to approved access rights, at both local and consolidated levels. All such adjustments are recorded by the system and must be traceable. Manual inputs are also primarily used for entering a large number of non-financial indicators at both the planned and actual levels.