Consolidation: what is the difference between Legal & Management Consolidation – Part II?

By Trijotech Team/ December 15, 2018

Legal Consolidation

One of our Textiles clients wanted to consolidate their various companies into one Consolidation Group – Super Textile Group of Companies.

• Super Textiles – Holding
• Subsid1 Textiles – Subsidiary
• Assoc1 Textiles – Associates

*Names of companies are indicative, not real names.

All these Entities / Companies actually exist in MCA – Ministry of Corporate Affairs (or in your country the relevant Legal body), so these are Legal Entities and the client wanted to see the Consolidated Financial Statements of Super Textiles Group of Companies.

What is done in Legal Consolidation?

We combine the Balance Sheet, P&L / Income Statement and Cash Flow Statements to get the Consolidated Reporting.

Intercompany Receivables & Payables are eliminated (transactions are removed in the consolidated statements and net balance sits in the Reconciliation Account) in the Balance Sheet.

Intercompany Sales & Purchases are eliminated from the Profit & Loss / Income Statement to ensure there are no inflated sales / purchases happening between the group companies.

Goodwill / Badwill is calculated during the consolidation process based on difference between Investment of Holding company versus the Share Capital of Subsidiary being purchased at a premium or discount. Goodwill is taken to Balance Sheet and Badwill / Negative Goodwill is generally adjusted in the Income Statement.

Minority / Non-Controlling Interest is Calculated for the portion of Equity of the Subsidiary owned by external parties (not by the holding company).

Relevant Accounting Standards

IFRS 10 – Consolidated Financial Statements is applied · https://www.iasplus.com/en/standards/ifrs/ifrs10

IFRS 3 – Business Combination is applied · https://www.iasplus.com/en/standards/ifrs/ifrs3

IFRS 11 – Joint Arrangements & Joint Control · https://www.iasplus.com/en/standards/ifrs/ifrs11

IAS 27 – Consolidated & Separate Financial Statements · https://www.iasplus.com/en/standards/ias/ias27

How do we set up Legal Consolidation / Prepare Consolidated Financial Statements using SAP Tools like SAP BPC or S/4 Hana Group Reporting?

Setup the Consolidation Master Data pertaining to:

Configure Consolidation Methods to identify the types of Legal Entities/Companies (numbers are not fixed, you can define your own method code):

Setup the Consolidation Group / Ownership Structure and maintain ownership percentages e.g. Holding Company H Owns 90% in subsidiary S. This must be captured in the Consolidation Group, e.g.:

Perform Balance Carry Forward to bring in opening balances using closing balance of last year.

Load the Closing Balances for P&L and Balance Sheet & Movements on Balance Sheet like Additions/ Reduction / Transfers etc. on fixed assets.

Perform Currency Translation (convert the standalone local currencies balances to group currency).

Setup the reclassification / elimination Rules to perform:

Prepare the Consolidated Financial Statements:

Then What is Management Consolidation?

As you saw above, Legal Consolidation focuses on Legal / Statutory requirements of consolidation of financial statements (it is mandatory for companies exercising control over subsidiaries by virtue of their investments).

But Management Consolidation / Managerial Consolidation does something similar, but it is not mandatory or binding to the company. It is more from the Internal Control / Internal Management Reporting perspective. Additionally, the Consolidation of Investment is not a key or required area for Management Consolidation. Focus is more to:

Eliminate Inter-Unit Transactions

The Legal Entity structure is not the same in case of Management consolidation. Generally, Management Consolidation is performed to know Segment / Division wise P&L or Balance Sheet. We define the Group Structure in such a way that it can help in identification and removal of intra-segment transactions irrespective of whether they happen in the same company or different ones.

What does that mean? Let’s take an example:

A Group Company having Management Consolidation Group Structure with following segments:

· Trucks

· Bus

· Cars

And 3 Legal Entities:

· E1 – Smart Wagon Europe

· E2 – Smart Wagon US

· E3 – Smart Wagon UK

We get the following pairs of Entities for Management Consolidation based on the table below:

	Bus	Truck	Cars
E1	Yes	Yes
E2		Yes	Yes
E3	Yes		Yes

Management Consolidation entities:

· E1_BUS

· E1_TRUCK

· E2_TRUCK

· E2_CARS

· E3_BUS

· E3_CARS

Now assume an Intra Segment Sales happen between:

GL Account	CONSOL Unit	Partner Unit	Time	Amount
IC Sales	E1_BUS	E3_BUS	202001	1000

This will inflate the sales numbers of Segment BUS. So, we will have to eliminate such intra-segment transactions for BUS Segment.

The Purpose of Management Consolidation is to:

Analyse the performance of different segments of the company / Group Companies.

Analyse the Profitability by BU / Segment.

Apply Guidelines of Internal Management for Consolidation of Business Units / Segments & Generate Financial Statements of Consolidation Unit.

In certain cases, it can be pure roll up of entities to Segment where inter-segment scenarios are not significant and reporting can be simply done just by Entity hierarchy rollup.

In many cases the Entities Hierarchy is defined differently for Management Consolidation compared to Legal Consolidation (most of the time).

Some additional Consolidation scenarios like Zakat Calculation in Middle East use Management Consolidation approach.

A travel company with offices in multiple geographies wants to consolidate its units by segment. These offices are not always created as legal entities, so Legal Consolidation might not be suitable.

Additionally, Managerial Consolidation provides scenarios for performing allocations of revenue/costs, etc., when using shared services from a partner entity. For example, a Textile Company with a subsidiary for Paper Manufacturing & Power Generation. Power Unit sells to both Textiles & Paper and also to 3rd Party Companies.

The most common use case involves obtaining profitability by segment, typically utilizing the Profit Center object for that purpose. In Managerial Consolidation, the Consolidation Unit is defined using Compcode + Profit Center.

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Disclaimer: All the opinions are solely for information purposes, and the author doesn’t recommend or reject any tools. It should be done after your own due diligence.