As evidenced by some of the newer standards which have been released, U.S. generally accepted accounting principles (U.S. GAAP) can include huge volumes of information about specific topics. However, there are situations where the guidance available is either extremely limited or nonexistent. Thanks to recent questions submitted by our members, in this report, we’ll look at issues in one of the areas with limited guidance, combined financial statements.
As the name implies, combined financial statements are the result of taking the financial information of two entities and combining it into one set of financial statements. While there is not a robust amount of guidance, the glossary does provide some guidelines as to which entities can and cannot be combined:
The financial statements of a combined group of commonly controlled entities or commonly managed entities presented as those of a single economic entity. The combined group does not include the parent.
While the wording is sparse, there are a few takeaways as to what types of entities can and cannot be included in a combined financial statement. First, you cannot just pick two entities, create a financial statement, and refer to it as a combined financial statement. The definition requires the entities to be either “commonly controlled” or “commonly managed.” Neither of those terms are defined in this context, which leaves it a little more open to interpretation. In our December report, ASU 2018-17: New Private Company VIE Alternative, which can be found here, we noted that combined financial statements may more frequently be used as a result of the alternative introduced by that ASU being an all or nothing election. As a result, we anticipate that some entities may elect the alternative and, then, selectively combine one or more entities under common control while excluding others.
The glossary definition also makes it clear that the combined group does not include the parent, and that’s an important distinction to make. If the financial statement includes the parent entity (including the primary beneficiary of a variable interest entity [VIE]) and its subsidiaries, it is no longer a combined financial statement but, instead, a consolidated financial statement.
A key difference in combined vs. consolidated financial statements is the issue of control. In consolidated financial statements, one entity has a controlling financial interest in the other entities consolidated. Based on the definition, in combined financial statements, controlling financial interest cannot be present between the entities.
The only other authoritative guidance in preparing combined financial statements is outlined in FASB Accounting Standards Codification (FASB ASC) 810-10-55-1B:
There are circumstances, however, in which combined financial statements (as distinguished from consolidated financial statements) of commonly controlled entities are likely to be more meaningful than their separate financial statements. For example, combined financial statements would be useful if one individual owns a controlling financial interest in several entities that are related in their operations. Combined financial statements might also be used to present the financial position and results of operations of entities under common management.
While the above sums up the authoritative guidance on what types of situations would result in combined financial statements being appropriate, there are a few additional sources of guidance that provide some examples. One of the most respected resources to consider in this area is the nonauthoritative AICPA Technical Questions and Answers (TQAs), which address whether combined financial statements would be appropriate in a few situations (note the text below has been edited for simplicity, please refer to the publication linked above for complete text):
Inquiry —Company A and Company B are new car dealers with A selling an American made car and B selling a foreign made car. One individual owns 100 percent of the outstanding stock of both companies. Both companies A and B are at the same location with separate buildings for sales staffs. Company A maintains the parts and service departments for both companies with the parts inventory, warranty and service receivables of Company B on Company A's books. In return, Company B pays Company A a per car fee for services to be performed on each new car sold by B.
Reply- Based on the guidance in FASB ASC 810, Consolidation, combined financial statements of the companies would be appropriate, and there is no necessity for presenting separate statements for the companies.
Inquiry —S Corporation has 2000 common shares and 1000 preferred shares outstanding. The preferred shareholders have the same rights as the common shareholders, except the right to vote. Of the 2000 common shares outstanding, 1000 shares are owned by P Corporation and 1000 shares are owned by I (an individual) who also owns all of the outstanding common shares of P Corporation. The preferred shares of S Corporation are owned by an outside party. Should P Corporation consolidate S Corporation for financial reporting purposes?
Reply —In this situation P does not control S directly or indirectly and therefore consolidation is not appropriate. Combined financial statements could be presented if the circumstances are such that combined financial statements of S Corporation and P Corporation are more meaningful than separate financial statements.
Inquiry —If a reporting entity is the primary beneficiary of a variable interest entity (VIE) under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 810, Consolidation, would it be appropriate to issue combined financial statements rather than consolidated financial statements?
Reply —No. Combined financial statements are permitted in certain situations in which consolidated financial statements are not required. However, FASB ASC 810-10-25-38 states that “an entity shall consolidate a variable interest entity if that entity has a variable interest (or combination of variable interests) that will absorb a majority of the variable interest entity’s expected losses, receive a majority of the variable interest entity’s expected residual returns, or both.” Furthermore, the starting point for the preparation of combined financial statements is two or more sets of financial statements that are prepared in accordance with GAAP; in the case of a primary beneficiary of a VIE, financial statements prepared in accordance with GAAP would be consolidated financial statements.
While those situations are helpful, from our experience with technical inquiries submitted by our members, a frequent question is:Does the reporting entity need to have any basis for including certain entities undercommon control (and potentially excluding others under common control) when presenting combined financial statements?
As discussed above, the FASB ASC 810-10-55-1b discusses circumstances in which financial statements are more meaningful if combined financial statements are presented for entities under common control. Some have read this as requiring a “more meaningful” test for combined financial statements and this appears to be supported by the nonauthoritative TQA 1400.26 above. Others note that FASB ASC 810-10-55-1b later notes that common management is provided as an additional reason for combined financial statements (without addressing whether this is “more meaningful”). This question of a “more meaningful” test is not addressed by the FASB ASC. The Basis for Conclusions for ASU 2018-17 (BC 23) indicated that a reporting entity has the option to combine entities under common control particularly in situations in which users wish to see the combined results of the reporting entity and another legal entity under common control. BC 23 does not directly mention a “more meaningful” test for combined financial statements under common control.
In our view, the FASB ASC appears to provide entities with significant flexibility in the entities included in combined financial statements for entities under common control and is not bounded by a “more meaningful” test. This view also is consistent with a response to a technical inquiry on the question to FASB staff.
Technically, yes— but there are some potentially unpleasant consequences since doing so would result in the financial statements not being consistent in terms of which entities are being included in each period. FASB ASC 250, Accounting Changes and Error Corrections, notes that presenting combined financial statements in place of the individual entity financial statements and changing the entities included in combined financial statements meet the FASB ASC Master Glossary definition of Change in the Reporting Entity. FASB ASC 250-10-45-21 notes that when an accounting change results in financial statements that are, in effect, the statements of a different reporting entity, the change shall be retrospectively applied to the financial statements of all prior periods presented to show financial information for the new reporting entity for those periods.
Also, FASB ASC 250-10-50-6 notes that when there has been a change in the reporting entity, the financial statements of the period of the change shall describe the nature of the change and the reason for it. In addition, the effect of the change on income from continuing operations, net income (or other appropriate captions of changes in the applicable net assets or performance indicator), other comprehensive income, and any related per-share amounts (if applicable) shall be disclosed for all periods presented. If a change in reporting entity does not have a material effect in the period of change but is reasonably certain to have a material effect in later periods, the nature of and reason for the change shall be disclosed whenever the financial statements of the period of change are presented.
The only guidance from authoritative sources having to do with the presentation of combined financial statements is that they should be treated in the same way as consolidated financial statements in FASB ASC 810-10-45-10:
If combined financial statements are prepared for a group of related entities, such as a group of commonly controlled entities, intra-entity transactions and profits or losses shall be eliminated, and noncontrolling interests, foreign operations, different fiscal periods, or income taxes shall be treated in the same manner as in consolidated financial statements.
Following that same logic, combined financial statements also should include statements of financial position, results of operations, and cash flow as well as the related notes to the financials.
Preparers of combined financials also may want to consider what the appropriate title for the financial statements should be so as not to confuse users as to what the relationship is between the entities included. To that end PPC/Checkpoint suggests a heading that reflects the economic nature of the entity, such as XYZ Corporation and Affiliates, as seen in this SEC filing. However there is room for judgment in this area, as options such as using the names of all entities combined also would be appropriate, as seen in this SEC filing, among others.
Since many financial statements are not drafted from scratch and instead use a template from a similar client, we would expect many preparers to start with a consolidated set of financials and then modify as appropriate. If that’s the case, make sure that all references throughout the financials and opinion to ‘consolidated financial statements’ are replaced with ‘combined financial statements.’ Making the replacement with a CTRL + H is an easy way to prevent such a mistake from slipping through the cracks
An additional area which may cause headaches from a preparation standpoint is the presentation of the equity section of the balance sheet. When all the entities included in the combined financial statements have the same legal structure (like both SEC filings noted above), the equity section very likely would look similar to any other equity section. However, judgment will be required on how equity should be presented when, for example, the entities being combined are a corporation and a partnership.
Finally, combined financial statements are not required to show the amounts attributable to each of the entities separately throughout the financial statements. However, entities may choose to include combining information within the financial statements if they believe that users will find it meaningful.
The CPEA provides non-authoritative guidance on accounting, auditing, attestation, and SSARS standards. Official AICPA positions are determined through certain specific committee procedures, due process and extensive deliberation. The views expressed by CPEA staff in this report are expressed for the purposes of providing member services and other purposes, but not for the purposes of providing accounting services or practicing public accounting. The CPEA makes no warranties or representations concerning the accuracy of any reports issued.
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