Business Combos/Consolidations; Cost Method

Question 1

Consolidated Financial Statements

Answer 1

Consolidated FS ignore important legal relationships and emphasize economic substance over form. Consolidated FS are an economic truth but a legal fiction.

Question 2

Limitations of Consolidated FS

Answer 2

• Noncontrolling interest SHs, creditors, and bondholders of the sub remain uninformed regarding the sub’s separate FS.
• Weak performance of one company may be offset by the strong performance of another company.
• Ratio analysis of consolidated data is not reliable.
• RE available for parent SHs are not segregated nor otherwise indicated.

Question 3

Criteria of When To and When NOT To Consolidate

Answer 3

• Consolidate ALL majority-owned subs to have one mgt and one economic entity.
• DO NOT consolidate when control is not with owners.
• Companies that have different year ends can be consolidated.
• Do not consolidate where bankruptcy is involved.

Question 4

Consolidation

Answer 4

A combo of the FS of two or more entities into a single set of FS representing a single economic unit. For external reporting.

Question 5

Cost Method/Do Not Consolidate

Answer 5

• No significant influence (typically < 20%)

- aka fair value method, available-for-sale method

Question 6

Equity Method/Do Not Consolidate

Answer 6

• Significant influence but 50% or less ownership (typically 20-50%)

Question 7

Consolidate

Answer 7

• Control ( > 50% ownership)

- prepare consolidated FS

Question 8

Frequently tested “cost” concepts

Answer 8

• The “Investment in Investee” is not adjusted for investee earnings.
• The “Investment in Investee” is adjusted to FV.
• Cash dividends from the investee are reported as income by the investor (parent).