Ch03: Consolidated Statements

Question 1

Acquiring firm

Answer 1

Parent

Question 2

Acquired firm

Answer 2

Subsidiary

Question 3

Consolidated Financial Statements

Parent + Subsidiary

Answer 3

Consolidation treats the financial statements of the parent and subsidiary as one entity. This is done for the convenience of the combined entity’s creditors and owners.

Question 4

Acquisition: Equity Method

Answer 4

The investee’s firm’s assets and liabilities are not reported with the buying firm’s balance sheet:
Assets = ( - cash) + (assets of the seller); no change
Liabilities = no change
Equity = no change

Question 5

Acquisition: Consolidation

Answer 5

The acquired firm’s equity isn’t rolled onto the parent’s balance sheet:
Assets = Parent + Subsidiary
Liabilities = Parent + Subsidiary
Equity = Parent

Question 6

Control: Equity Ownership

ASC 810

Answer 6

Voting Interest Model: Control is usually obtained via owning 50% or more of the outstanding voting shares of a firm, but control may exist with less than 50%.

Exceptions:
Control is temporary
Control is not present

Question 7

Special Purpose Entity, SPE

Answer 7

An SPE is a legal entity formed for a business purpose: little to no equity in the entity is involved; SPE’s are not consolidated; characteristics of an SPE:

obtained via debt
it doesn’t have a separate management team or group of employees
often involves having a small equity interest with a secure return or little risk
an SPE allows the firm to hide debt or losses from investors.

1. A VIE cannot function on its own; it needs guarantees from other parties to obtain financing
2. Shareholders of a VIE don’t enjoy the usual rights of equity ownership

Question 8

SPE, Securitization

Answer 8

A financial services firm will:

1. issue debt secured by the receivables it’s going to buy from its clients
2. use the cash received by the debt issue to buy its clients’ receivables (clients would do this to receive immediate cash rather than have to collect the cash on its receivables)
3. the financial services firm will collect the cash on the receivables it purchased to pay the interest and principal on the debt it issued

Question 9

SPE, Leasing

Answer 9

Allows the parent to report its leases as operating leases:

1. the parent sets up an SPE to purchase Lt-Assets
2. SPE makes acquisitions via debt
3. SPE leases the Lt-Assets to the parent
4. The parent makes lease payments to the SPE; the SPE uses the lease payments against the loan payments for the debt it took on to acquire the Lt-Assets

Question 10

Consolidation Working Paper

Answer 10

1. Identify the acquisition cost
2. Identify the BVE of the target
3. Subtract the target’s BVE from the acquisition cost: (Acquisition Cost - Acquired BVE) = Cost in excess of BVE
4. Record the differences between the target’s fair-value and book value (each asset and liability) –> (Fair-value - Book Value)
5. Calculate Goodwill –> (Cost in excess of BVE + Sum of the differences)
6. The target’s equity balances are eliminated
7. Recognize the differences between the target’s fair-value and book value via debits and credits

Question 11

Goodwill

Working Paper

Answer 11

If the seller’s BVE is negative on its own books, the equity value is added to the acquisition cost; if the BVE is positive, it’s subtracted from the acquisition cost.

Question 12

Variable Interest Entity, VIE

Answer 12

Similar to control via stock acquisition, yet VIE is via legal relationships (not stock ownership); an equity investment in the entity of less than 10% of total assets usually connotes a VIE

Primary beneficiary consolidates

If the investee cannot finance its activities without additional support from its investor or affiliates, it’s a VIE