The two most common reporting entities are a single legal entity preparing unconsolidated or company accounts or a group of legal entities preparing consolidated financial statements. Consolidation can be done at different levels, the most common being at the ultimate parent legal company level (the highest legal entity that controls any number of other legal entities) or at a sub-holding level by a reporting entity obliged to consolidate all legal entities it controls at this level.
If a reporting entity comprises two or more entities that are not all linked by a parent-subsidiary relationship, the reporting entity’s financial statements are referred to as ‘combined financial statements’.
Boundaries of other reporting entities
Determining the appropriate boundary of a reporting entity can be difficult if the reporting entity:
- is not a legal entity; and
- does not comprise only legal entities linked by a parent-subsidiary relationship.
In such cases, determining the boundary of the reporting entity is driven by the information needs of the primary users of the reporting entity’s financial statements. Those users need relevant information that faithfully represents what it purports to represent. Faithful representation requires that:
- the boundary of the reporting entity does not contain an arbitrary or incomplete set of economic activities;
- including that set of economic activities within the boundary of the reporting entity results in neutral information; and
- a description is provided of how the boundary of the reporting entity was determined and of what constitutes the reporting entity.
A well-known example of boundaries and consolidation represents the situation of one shareholder holding 100% of two or more parents of two groups of companies. From a legal point of view the reasoning is that the top parent of each group should prepare consolidated financial statements, but if and when the two groups employ related activities and record (significant) transactions between the two groups it is quite logical to combine the two groups into one combined set of consolidated financial statements.
A shareholder holds 100% of the parent company, Construct Inc., of a group of companies active in building and construction. The same shareholder also holds 100% of the shares of the parent company, Invest Inc. of a group of companies active in owning and operating investment properties. Invest Inc. on a regular basis hires Construct Inc. to build and construct properties to be operated by Invest Inc. Especially when the construction pipeline of Construct Inc. shows gaps Invest Inc. fills these gaps with own construction orders. But also if Construct Inc. develops a property at its own risk but market demand has disappeared (or was never there) or the client is unable to take control of a property (lack of funding or unexpected significant extra work) Invest Inc. buys these properties. In the past the companies/groups were intertwingled, but as part of succession planning Construct Inc. was prepared for a sale as a construction company and Invest Inc. was kept as a investment/family vehicle and not combined/consolidated.