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Klára Honzíková | January 24, 2023

Are you obliged to consolidate?

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We begin by briefly explaining what consolidated financial statements are. Generally, consolidated financial statements mean the preparation of financial statements for a group of entities that are linked by ownership. From the perspective of Act No. 563/1991 Coll., on Accounting (hereinafter referred to as “the Act” or “the Accounting Act”), these are financial statements compiled and adjusted using consolidation methods. The aim is to present the outputs mainly in the form of financial reports, as if it were a single company and not several separate companies. Although it may seem that the obligation to prepare consolidated financial statements applies only to multinational groups, this is not the case. In the following paragraphs we will show, which companies are subject to this obligation under Czech law.

Who is or is not subject to the obligation to consolidate?

We determine the consolidation obligation according to several basic criteria. First of all, it is important to know that the obligation to consolidate applies only to legal entities. The preparation of consolidated financial statements is compulsory by law for accounting units that are trading companies and are also so-called controlling persons.

In the Accounting Act we can learn that the obligation to compile consolidated financial statements does not apply to a small group of accounting entities. An entity is considered to be a small group if, on a consolidated basis, it does not exceed at least 2 of the following thresholds as of the balance sheet date:

  • total assets (net) exceeding CZK 100 million,
  • an annual consolidated net turnover exceeding CZK 200 million,
  • an average annual number of employees in full-time equivalents exceeding 50.

Exceptions are small groups of entities, where an entity in the group is a public interest entity (such as banks, insurance companies or companies with securities traded at a public exchange, etc.). In this case, consolidated financial statements must always be prepared, wherever the entity is a controlling person.

Thus, for a group of entities, where a group exceeding the criteria in the period under review is formed, the obligation to compile consolidated financial statements also arises in the period under review.

If the group has been in existence for some time, the same rules apply for changing the category of the group of accounting entities as for individual financial statements, i.e. if the criteria are exceeded in 2 periods, the category is changed from the following period (the 3rd period).

Definition of the consolidation unit and methods of consolidation

If an accounting entity determines that it is subject to the obligation to compile consolidated financial statements, it must define the consolidated group, i.e. determine which companies will be included in the consolidation unit and what method it will choose for including an entity in the consolidation.

The methods of consolidation depend mainly on the ownership stakes as well as the opportunities presented mainly by the control agreements defining management and decision-making.

  • The term controlling person refers to a person, who can either directly or indirectly exercise decisive influence in the controlled business corporation. According to article 75 of Act No. 90/2012 Coll., on Business Corporations, control is defined in particular as the ability to appoint and dismiss the statutory and controlling bodies of a business corporation and also (but not at the same time) as the disposal of a share of voting rights in the scope of at least 40 % of all votes. Controlled persons are consolidated in this linkage using the full method.
  • Another possibility is joint control, i.e. a situation where ideally two (or even more) partners jointly control the controlled person. In this situation, where neither partner can exercise ownership rights without the assistance of the other, the proportional method is used for consolidation.
  • The last method of including companies in consolidation is the equity method, which is used in the case of significant influence, i.e. for associated companies. Significant influence is defined in the Act as that which is neither decisive nor joint and constitutes significant influence over the management or operation of an entity with at least 20 % of the voting rights. However, significant influence must also be assessed in the light of the specifics mentioned above and any control agreements, because it is not only the voting rights that determine the degree of influence.

As regards the question of insignificance, if the subsidiaries are insignificant, individually and in total, the parent company is not obliged to consolidate. For example, a company that has no or minimal activity for a long time can be considered insignificant. On the basis of insignificance, a decision may be taken not to include the selected company in the consolidated group. In this case, the information and the reasons for the exclusion of the company from the consolidating entity needs to be stated in the notes to the consolidated financial statements.

Among other things, the law regulates situations, in which an entity does not need to be included in consolidation, in particular the following:

  • inability to obtain information about the subsidiary,
  • holding shares for the sole purpose of sale,
  • impossibility of exercising property rights.

Who is subject to the obligation to “allow himself to be consolidated”?

The preparation of consolidated financial statements entails the obligation of the companies included in the consolidating entity to provide supporting documents for compiling the consolidation. This obligation applies to persons regardless of their registered office, if they are:

  • “a consolidated accounting entity” – a controlled entity (with exceptions),
  • “an entity under common control” – i.e. a person in which a consolidating or consolidated accounting entity exercises joint control,
  • “an associate accounting unit” – that is, a person, in which the consolidating entity exercises significant influence.

What about the audit obligation?

In case of an obligation of compiling consolidated financial statements, these are also subject to mandatory audit. Ensuring that the financial statements are audited by an auditor is the responsibility of the accounting entity that has the statutory obligation to compile them.

What are the exceptions?

We have set out in general terms, who is obliged to compile consolidated financial statements. However, there are also situations, where the controlling person is not required to compile consolidated financial statements. If an entity would normally have an obligation to compile consolidated financial statements, but at the same time a higher parent accounting entity has this obligation, then the (controlled) accounting entity avoids the obligation, if it meets the statutory obligations. However, the parent company must be governed by the law of a Member State of the European Union.

As an example, consider a situation, where a company in the Czech Republic has a parent company based in Germany, which is the consolidating entity. Even if the Czech company had another subsidiary, it would not be obliged to consolidate within the Czech Republic. However, the fact that it is part of a larger consolidated group would need to be stated in the individual financial statements, along with other details. At the same time, the condition must be met that the annual report is audited in Germany and published in the Czech language in the collection of documents maintained by the registry court.

What else should we be careful about?

As we know from the preceding paragraphs, one of the criteria for assessing the obligation to consolidate is the annual aggregate consolidated net turnover. This represents the amount of revenues minus sales discounts. In case the period was shorter or longer than 12 months, it is necessary to recalculate and consider the revenues for 12 months.

The criteria for assessing the obligations related to determining the size of groups of accounting entities are determined on a consolidated basis, i.e. after making all consolidation adjustments, i.e. eliminating intercompany transactions, interests, relationships, showing consolidation differences, etc. So in practice, to determine if you have this obligation, you basically need to compile consolidation first.

In conclusion

If your company is also part of a whole and you need help checking whether or not you are obliged to consolidate, you need help with your first consolidation, or you already have everything in place and are looking for a new auditor, we are here for you.

Autor: Klára Honzíková