Advanced accounting 10th by a beams athony ch11

publishing as Prentice Hall 11-2 Theories, Push-Down Accounting, and Joint Ventures: Objectives 1.. publishing as Prentice Hall 11-4 Parent Company Theory Consolidated financial statemen

Chapter 11: Consolidation Theories, Push-Down Accounting,

and Corporate Joint Ventures

by Jeanne M David, Ph.D., Univ of Detroit Mercy

to accompany

Advanced Accounting , 10th edition

by Floyd A Beams, Robin P Clement, Joseph H Anthony, and Suzanne Lowensohn

© Pearson Education, Inc publishing as Prentice

Hall

11-2

Theories, Push-Down Accounting, and Joint Ventures: Objectives

1 Compare and contrast the elements of

consolidation approaches under traditional

theory, parent-company theory, and contemporary

entity theory.

2 Adjust subsidiary assets and liabilities to fair

values using push-down accounting.

3 Account for corporate and unincorporated joint

ventures.

4 Identify variable interest entities.

5 Consolidate a variable interest entity.

1: Consolidation Theories

Consolidation Theories, Push-Down Accounting and

Corporate Joint Ventures

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11-4

Parent Company Theory

Consolidated financial statements are

• Extension of parent company statement

• Viewpoint of parent company shareholders

Prepare consolidated statements

• To benefit parent company shareholders

Noncontrolling interests

• Have the separate (subsidiary) statements

Entity Theory

Consolidated financial statements

• Viewpoint of the total business entity

• All resources of the entity are valued

consistently

– Impute the value of the firm from the

acquisition price

• Income of noncontrolling interests is a

distribution of the total business income

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11-6

Income Reporting

• Parent company theory and traditional theory

– Consolidated net income is income to the

parent company shareholders

• Entity theory

– Total consolidated income is to be shared

between the controlling and noncontrolling interests

Asset Valuation

• Parent company theory and traditional theory

– Assets and liabilities are adjusted to market value

at acquisition, but only to the extent of the

parent's ownership share.

• Land with a book value of $50 and fair value of $80

would be consolidated at $80 if the parent owned 100%, but at $71 (including only 70% of the $30 appreciation in value) if the parent owned 70%

• Entity theory

– Assets and liabilities are consolidated at fair value

• Land would be consolidated at $80 regardless of

ownership percentage.

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11-8

Unrealized Gains and Losses

• Parent company theory

– Unrealized gains and losses attributable to the

subsidiary are only eliminated to the extent of the parent's ownership

• 80% of the $10 unrealized profits on upstream sales would be

eliminated if the parent owned 80% of the subsidiary

• Entity theory and traditional theory

– Unrealized gains and losses are eliminated

• All theories treat downstream gains and losses the

same

Consolidated Stockholders' Equity

• Contemporary theory

– Noncontrolling interest is a single amount

and a part of stockholders' equity

• Entity theory

– Noncontrolling interest is also part of

stockholders' equity

– It would be decomposed into paid in capital,

retained earnings, etc.

• Other ideas being promoted

– Use footnote disclosure for CI and NCI

shares of consolidated income

– Use proportional consolidation, excluding

NCI from the statements

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11-10

2: Push-Down Accounting

Consolidation Theories, Push-Down Accounting and

Corporate Joint Ventures

SEC Requires Push-Down

• SEC requires push-down accounting for SEC

filings when the subsidiary

– Is substantially fully owned (97%), and

– Has substantially no public debt or preferred

stock

• Establishes a new basis for the assets and liabilities

– Based on acquisition price

• Arguments against

– Subsidiary is not party to the acquisition

– Subsidiary receives no new funds, sells no assets

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11-12

Push-Down Procedure

• Assets and liabilities are revalued

• Goodwill, if any, is recorded

• Retained earnings (prior to acquisition) are

eliminated

• Push-down capital replaces retained earnings

– Includes old retained earnings

– Any adjustments to assets and liabilities,

including goodwill

Push-Down Example

• Paly buys 90% of Sim Sim's book and fair values are:

• If Sim applies push-down accounting, it would revalue

its inventories, fixed assets, liabilities, and record

goodwill.

Plant assets 200 300   Retained earnings 90  

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11-14

Sim Uses Parent Company Theory

• Sim revalues assets and liabilities only to the

extent of Paly's ownership Only 90% of the

increases/decreases are recorded.

Sim Uses Entity Theory

• Sim fully revalues assets and liabilities 100% of

the increases/decreases are recorded.

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11-16

Push-Down Differences

• The example used 90% ownership by the parent

• SEC requires push-down accounting when the firm

3: Joint Ventures

Consolidation Theories, Push-Down Accounting and

Corporate Joint Ventures

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– Temporary or relatively permanent

• It is a business entity that is owned, operated

and jointly controlled by a small group of

investors for the conduct of a specific business undertaking that provides mutual benefit for

each of the venturers.

Corporate Joint Ventures

• Investors who participate in the overall management

of the joint venture (APB Opinion No 18)

– Use equity method for the joint venture

– If significant influence is not present, use the cost

method

• Investors with more than 50% of the voting stock

have a subsidiary, not a joint venture

– Consolidate the subsidiary

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11-20

Unincorporated Joint Ventures

• Although not specifically addressed by APB

Opinion No 18, application of the equity

method to unincorporated joint ventures is

appropriate

• Industry specific practice

– Proportional consolidation in oil & gas and

undivided interests in real estate ventures

4: Identify Variable Interest Entities

Consolidation Theories, Push-Down Accounting and

Corporate Joint Ventures

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11-22

Variable Interest (def.)

"Variable interests in a variable interest entity

are contractual, ownership, or other pecuniary interests in an entity that change with changes

in the fair value of the entity's net assets

exclusive of variable interests." (FIN 46(R),

para.2c)

The primary beneficiary of the variable interest entity (VIE) must consolidate the VIE.

Primary Beneficiary

• The entity that will

– Absorb the majority of the expected losses,

receive a majority of the expected gains or

both

– If separate entities are expected to absorb the profits and losses, the entity expected to

absorb the losses is the primary beneficiary

• The primary beneficiary may be an equity

holder and/or creditor of the VIE

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11-24

VIE Example

• Get Rich Quick is a VIE with equity contributed equally by

10 parties, including Corrine.

• The VIE will borrow additional amounts equal to twice the

equity The bank is the major creditor/investor!

• Corrine agrees to absorb 75% of the losses and will take 28%

of the profits The other nine investors will share equally.

– Corrine is the primary beneficiary and consolidates

the VIE.

– All 10 equity investors will have to make detailed

disclosures about their interests in this VIE.

5: Consolidate Variable Interest

Entities

Consolidation Theories, Push-Down Accounting and

Corporate Joint Ventures

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11-26

Special Consolidation Considerations

• VIEs are consolidated like other subsidiaries

– FASB Statement No 141

• Exception

– Goodwill can only be recorded if the VIE is

a "business" FIN 46(R)

– If the VIE is not a "business," the excess

paid is an extraordinary loss

• "business"

"Self-sustaining, integrated set of activities

and assets conducted and managed for providing a return to investors."

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