Finance Leasing Manual - FLM49.12

Purpose of consolidation

One object of consolidation is to eliminate profits or losses on dealings within the group. Suppose parent X has two 100% subsidiaries Y and Z, who are both traders. Y buys raw materials for £100, makes trading stock and sells it to Z (a wholesaler) at its market value of £120. At the year end Z has not yet sold the stock; so the stock is included in its own accounts at the lower of cost or market value - £120. Y has made a profit for the purposes of its accounts (and for tax) of £20.

But from the group's angle the profit is not real - on consolidation it disappears:

• the consolidated profit and loss accounts would show materials bought for £100 as an expense (debit) and the stock as £100 (as a credit) - no profit no loss;

• the consolidated balance sheet will show the stock of £100 as an asset.

Note that the consolidated accounts are not the results of any single company, including the parent (X in the example above). They are the results which would follow if X, Y and Z were not separate companies but one single entity. (Paragraph 39 of FRS 2.) The consolidated accounts are not used at present for any tax purpose. Tax looks at the actual accounts of each company.