B. GENERAL PURPOSE FINANCIAL STATEMENTS - 7. CONSOLIDATED FINANCIAL STATEMENTS

Question 1

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How are Consolidated financials presented?

Answer 1

Presented the following way:

• parent company and its subsidiaries as one economic entity.
• assets, liabilities, equity,
• income, expenses, and
• cash flows

Question 2

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Some definitions:

Controlling interest-

Non-controlling interest-

Answer 2

Some definitions:

Controlling interest:

• One entity has control of another if it owns more than 50% of that entity.
• A parent company must consolidate any subsidiaries under its control.

Non-controlling interest:

• An ownership stake of less than 50% of an entity.

Question 3

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Some definitions:

Variable Interest Entity (VIE)

Answer 3

• An entity that is controlled by another entity, but not through voting rights.
• A VIE has a primary beneficiary, and
• when the beneficiary is a company, the company will consolidate the VIE’s holdings onto its balance sheet and produce consolidated financial statements.
• A VIE is usually setup by the controlling entity to perform a specific business purpose.

Question 4

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Some definitions:

Primary beneficiary:

Answer 4

Primary beneficiary: In this instance we’re talking about the primary beneficiary of a VIE. The “test” for being the controlling interest in a VIE is the following and requires all three:

1. The direct or indirect ability to make decisions about the entity’s activities through voting rights or similar right.
2. The obligation to absorb losses of the entity if they occur
3. The right to receive returns from the entity if they occur, which is compensation for taking the risk to absorb the entity’s losses

Question 5

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Some definitions:

A Private Company VIE rules:

Answer 5

A private company doesn’t need to apply these VIE rules if:

• the reporting entity and the legal entity aren’t a public company, and
• aren’t under common control of a public company.

Question 6

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How to consolidate financials at the date of consolidation:

Answer 6

Combine Assets and Liabilities of the parent and sub on the balance sheet,

• Recognize Cash transaction
• Recognize Goodwill on balance sheet (if any)

Remove Equity of Sub

Income Statement and Statement of Cash Flows will only show from the parent, because their operations weren’t combined until that date.

Example:

ABC purchases 100% of the common stock of XYZ for $100,000 when XYZ’s net assets are $75,000.

Since XYZ’s net assets are $75,000 and the price paid to acquire XYZ is $100,000, ABC recognizes $25,000 of goodwill. ABC’s cash goes down by $100,000, and XYZ’s equity is removed in the consolidated balance sheet.

Question 7

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Calculating Goodwill in a Consolidation

Answer 7

Cost of the acquired business less the fair value of the net assets.

• A lot of these types of problems will point out that one or more of the assets being acquired is listed on the books for less than its fair value.
• So you need to take the book value of the assets and add any fair value missing from the book value to get to the total fair value.
• This subtracted from the cost of the acquisition will give you the goodwill amount.

Example:
ABC purchased all the stock of XYZ for $500,000. XYZ’s net assets had a book value of $300,000, but a piece of land on the books had a fair value of $50,000 more than its book value. In this case, ABC would show goodwill of $150,000 after the acquisition: 500,000 - 350,000 total fair value of assets = $150,000.

Question 8

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How to recognize Issuance Costs and Legal Fees in a Consolidation?

Answer 8

Costs to register and issue stock to acquire another company are netted against the paid-in capital account upon consolidation.

Legal or consulting fees due to the consolidation are just expensed as incurred.

Question 9

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How to recognize Intercompany transactions in a Consolidation?

Answer 9

All intercompany transactions that are recognized on the Balance Sheet or Income Statement must be removed on consolidated statements, or else the level of activity would be overstated for both entities.

• A downstream transaction is when the parent sells to the sub.
• An upstream transaction is when the sub sells to the parent.

Examples:

• Intercompany receivables/payables
• Intercompany revenues/expenses
• Intercompany inventory
• Intercompany fixed assets
• Intercompany bonds