Advanced accounting, 5th edition international student version ch03

33 Consolidated Financial Statements—Date of Acquisition Advanced Accounting, Fifth Edition Slide 3-1 Learning Learning Objectives Objectives Slide 3-2 Understand the concept of control as used in reference to consolidations Explain the role of a noncontrolling interest in business combinations Describe the reasons why a company acquires a subsidiary rather than its net assets Describe the valuation and classification of accounts in consolidated financial statements List the requirements for inclusion of a subsidiary in consolidated financial statements Discuss the limitations of consolidated financial statements Record the investment in the subsidiary on the parent’s books at the date of acquisition Prepare the consolidated workpapers and eliminating entries at the date of acquisition Compute and allocate the difference between implied value and book value of the acquired firm’s equity 10 Discuss some of the similarities and differences between U.S GAAP and IFRS with respect to the preparation of consolidated financial statements at the date of acquisition Stock Stock Acquisition Acquisition Chapter Focus - Accounting for Stock Acquisitions When one company controls another company through direct or indirect ownership of its voting stock Acquiring company referred to as the parent Acquired company referred to as the subsidiary Other shareholders considered noncontrolling interest Parent records interest in subsidiary as an investment If a subsidiary owns a controlling interest in one or more other companies, a chain of ownership is forged by which the parent company controls other companies Slide 3-3 LO Noncontrolling interest (NCI) Definitions Definitions of of Subsidiary Subsidiary and and Control Control The Securities and Exchange Commission defines a subsidiary as an affiliate controlled by another entity, directly or indirectly, through one or more intermediaries Control means the possession, direct or indirect, of the power to direct management and policies of another entity, whether through the ownership of voting shares, by contract, or otherwise Slide 3-4 LO Meaning of control Definitions Definitions of of Subsidiary Subsidiary and and Control Control Control using U.S GAAP: the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise FASB ASC paragraph 810-10-15-8 states: the usual condition for a controlling financial interest is ownership of a majority voting interest Slide 3-5 LO Meaning of control Definitions Definitions of of Subsidiary Subsidiary and and Control Control However, application of the majority voting interest requirement may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that not involve voting interests The first step in determining whether the financial statements should be consolidated is to determine if the reporting entity has a variable interest in another entity, referred to as a potential variable interest entity (VIE) Slide 3-6 LO Meaning of control Definitions Definitions of of Control Control Slide 3-7 LO Meaning of control Requirements Requirements for for the the Inclusion Inclusion of of Subsidiaries Subsidiaries in in the the Consolidated Consolidated Financial Financial Statements Statements Purpose of consolidated statements - to present the operating results and the financial position of a parent and all its subsidiaries as if they are one economic entity Circumstances when majority-owned subsidiaries should be excluded from the consolidated statements: Control does not rest with the majority owner Slide 3-8 Subsidiary operates under governmentally imposed uncertainty so severe as to raise significant doubt LO Requirements regarding consolidation of subsidiaries about the parent’s control Reasons Reasons For For Subsidiary Subsidiary Companies Companies Advantages to acquiring a controlling interest in another company Stock acquisition is relatively simple Control of subsidiary can be accomplished with a smaller investment Separate legal existence of affiliates provides an element of protection of the parent’s assets Slide 3-9 LO Acquiring assets or stock Consolidated Consolidated Financial Financial Statements Statements Statements prepared for a parent company and its subsidiaries are called consolidated financial statements Ignore legal aspects of separate entities, focus on economic entity under “control” of management Substance rather than form Not substitute for statements prepared by separate subsidiaries, which may be used by: Slide 3-10  Creditors  Noncontrolling stockholders  Regulatory agencies LO Valuation and classification of subsidiary assets and Consolidated Consolidated Balance Balance Sheets: Sheets: Use Use of of Workpapers Workpapers Subsidiary Treasury Stock Holdings A subsidiary may hold some of its own shares as treasury stock at the time the parent company acquires its interest Because the treasury stock account represents a contra stockholders’ equity account, it must be eliminated by a credit when the investment account and subsidiary company’s equity accounts are eliminated on the workpaper Slide 3-43 LO Computing and allocating the difference between implied and Consolidated Consolidated Balance Balance Sheets: Sheets: Use Use of of Workpapers Workpapers Other Intercompany Balance Sheet Eliminations Intercompany accounts receivable, notes receivable, and interest receivable, for example, must be eliminated against the reciprocal accounts payable, notes payable, and interest payable The full amount of all intercompany receivables and payables is eliminated without regard to the percentage of control held by the parent company Slide 3-44 LO Computing and allocating the difference between implied and Consolidated Consolidated Balance Balance Sheets: Sheets: Use Use of of Workpapers Workpapers Adjusting Entries Prior to Eliminating Entries At times, workpaper adjustments to accounting data may be needed before appropriate eliminating entries can be accomplished Make on workpaper in eliminations columns or Adjust the subsidiary’s statements prior to their entry on the workpaper Slide 3-45 LO Computing and allocating the difference between implied and Consolidated Consolidated Balance Balance Sheets: Sheets: Use Use of of Workpapers Workpapers Review Question Which of the following adjustments not occur in the consolidating process? a Elimination of parent’s retained earnings b Elimination of intra-company balances c Allocations of difference between implied and book values d Elimination of the investment account Slide 3-46 LO Computing and allocating the difference between implied and Limitations Limitations of of Consolidated Consolidated Statements Statements For Example: Little information of value in consolidated statements because they contain insufficient detail about the individual subsidiaries Highly diversified companies operating across several industries, often the result of mergers and acquisitions, are difficult to analyze or compare Slide 3-47 LO Limitations of consolidated statements IFRS IFRS Versus Versus U.S U.S GAAP GAAP Slide 3-48 LO 10 Similarities and differences between U.S GAAP and IFRS IFRS IFRS Versus Versus U.S U.S GAAP GAAP Slide 3-49 LO 10 Similarities and differences between U.S GAAP and IFRS IFRS IFRS Versus Versus U.S U.S GAAP GAAP Slide 3-50 LO 10 Similarities and differences between U.S GAAP and IFRS Deferred Deferred Taxes Taxes on on the the Date Date of of Acquisition Acquisition APPENDIX A If a purchase acquisition is tax-free to the seller  Tax bases of the acquired assets and liabilities are carried forward at historical book values  Assets and liabilities of the acquired company are recorded on the consolidated books at adjusted fair value Under current guidelines, the tax effects of the difference between consolidated book values and the tax bases must be recorded as deferred tax liabilities or assets Slide 3-51 Deferred Deferred Taxes Taxes on on the the Date Date of of Acquisition Acquisition Illustration: Suppose that Purchasing Company acquires 90% of Selling Company by issuing stock valued at $800,000 The only difference between book value and fair value relates to depreciable plant and equipment Plant and equipment has a market value of $400,000 and a book value of $250,000 All other book values approximate market values Assume that the combination qualifies as a nontaxable exchange On the date of acquisition, Selling Company’s book value of equity is $600,000, which includes $150,000 of common stock and $450,000 of retained earnings Assume a 30% tax rate Consider the following Computation and Allocation Schedule with and without considering deferred taxes Slide 3-52 Deferred Deferred Taxes Taxes on on the the Date Date of of Acquisition Acquisition Slide 3-53 Deferred Deferred Taxes Taxes on on the the Date Date of of Acquisition Acquisition Slide 3-54 Deferred Deferred Taxes Taxes on on the the Date Date of of Acquisition Acquisition The workpaper entry to eliminate the investment account is as follows: Entries for allocation with and without deferred taxes Slide 3-55 Consolidation Consolidation of of Variable Variable Interest Interest Entities Entities APPENDIX B FASB has issued guidance for the consolidation of specialpurpose entities (SPEs) through Interpretation No 46(R) “Consolidation of Variable Interest Entities” and SFAS No 167, “Amendments to FASB Interpretation No 46(R)[ASC 810–10–30].” An enterprise shall consolidate a variable interest entity (VIE) when that enterprise has a variable interest (or combination of variable interests) that provides the enterprise with a controlling financial interest on the basis of the certain provisions (listed below) FASB Statement No 167 requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity 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