Chapter 3: intercorporate investments, not wholly owned (no differential)

Question 1

Characteristics that determine if an entity has a controlling financial interest in a variable interest entity

Answer 1

• the power to direct the activities of a VIE that most significantly impact its economic performance
• obligation to absorb potentially significant losses to or rights to receive potentially significant benefits from VIE (significant is not necessarily a quantitative value)

obligations may include things like loan guarantees

Question 2

Combined financial statements

Answer 2

Financial statements for a group of related companies without including a parent company

common when an individual (rather than a corporation) owns or controls multiple companies

essentially the same procedures as for consolidated financial statements: all intercompany transactions must be eliminated

Question 3

Variable interest entities

Answer 3

a legal structure, used for business purposes (usually a trust, corporation, or partnership) that either:
1) does not have equity investors with voting rights/ that share in profits and losses
or 2) has equity investments that do not provide sufficient resources to support the entity’s activities

agreements may exist limiting equity investors share of profits, losses, exercise of control

Question 4

Consolidation of a VIE

Answer 4

Amounts to be consolidated with primary beneficiary based on fair values at date it first becomes the primary beneficiary

(assets and liabilities transferred TO a VIE from primary beneficiary at book value - no gain or loss

after that consolidated in the normal way

Question 5

Senior debt vs subordinate debt

Answer 5

Senior debt: money a company must repay first if it goes out of business. prioritized returns

subordinate debt: unsecured borrowing. paid after any senior debt obligations are paid but before shareholders (variable returns)

Question 6

Special-purpose entities

Answer 6

SPEs

corporations, trusts, or partnerships created for a single, specified purpose
- usually have no substantive operations
- often only for financing purposes

Question 7

Change to consolidation process in 2nd and subsequent year of ownership

Answer 7

must check to ensure beginning consolidated retained earnings = previous year’s ending consolidated retained earnings

Question 8

Accounts to be eliminated in initial year of ownership: consolidation worksheet

Answer 8

Assuming book value = fair value & equity method is used
- subsidiary’s stockholder’s equity accounts (including dividends declared)
- parent’s investment in subsidiary
- parent’s income from subsidiary

Question 9

Basic consolidation entry: 1st year of less than total ownership

Answer 9

Dr Subsidiary’s common stock
Dr Subsidiary’s retained earnings
Dr Parent’s income from subsidiary
Dr Non-controlling interest in net income of subsidiary
Cr. Subsidiary dividends declared
Cr Parent’s investment in subsidiary
CR Non-controlling interest in net assets of subsidiary

Non-controlling interest lines must be added to account for their portion of the subsidiary’s equity being removed

Question 10

Non-controlling interest consolidation entries

Answer 10

In consolidation entries total debits and credits for each section are ADDED no matter what the formula is on the actual statment

Question 11

Changes to consolidation worksheet for partially owned subsidiary

Answer 11

Net income
- calculates total consolidated net income
- subtracts NCI in net income
= controlling interest net income (should be the same as parent net income if equity method is used)

Balance sheet:
- addition of NCI in net assets of subsidiary to end of equity section of balance sheet for total liability and equity

Question 12

Calculated consolidated retained earnings with NCI

Answer 12

Parent’s retained earnings from own operations
+ parent’s share of subsidiary cumulative net income since acquisition
(excluding any income from subsidiary already included in parent’s retained earnings
MINUS parent’s share of any differential write-off

Question 13

Retained earnings on a consolidated balance sheet (with NCI)

Answer 13

The portion of the consolidated entity’s undistributed earnings accruing to the parent company’s stockholders

if parent uses fully adjusted equity method this should be equal to parent’s retained earnings

ONLY includes parent’s share of subsidiary’s net income since combination

Question 14

Adjustments to consolidation worksheet for a less-than-wholly owned subsidiary

Answer 14

Noncontrolling interests claim on income of the subsidiary is deducted from consolidated net income at the bottom of the income statement section

Noncontrolling interest’s claim on subsidiary’s net assets placed at the bottom of balance sheet section (to be included in total liabilities and equity)

Question 15

Signs often indicating a variable interest

Answer 15

• subordinate loans to a VIE
• equity interests in a VIE (50% or less)
• Guarantees to a VIE’s lenders or equity holders
• guarantees of asset recover values
• written put options on VIE’s assets held by a VIE or its lenders or equity holders
• forward contracts on purchases and sales

Question 16

Consolidation of VIEs

Answer 16

The entity that must consolidate the VIE will be the single entity that is determined to be the primary beneficiary of the VIE

requires an assessment to determine

If multiple entities could be primary beneficiary only one entity will have power to impact VIEs activities

Question 17

Qualifications to be considered a primary beneficiary of another enterprise

Answer 17

1) have the power to direct the activities of the enterprise that most significantly impact its economic performance

2) has the obligation to absorb losses or right to receive benefits that could potentially be significant to the enterprise

if yes, then must consolidate statements

Question 18

Limitations of consolidated financial statements

Answer 18

• masking of poor performance by individual companies
• limited availability of resources (not available for dividends)
• unrepresentative combined financial ratios (not truly representative of any company in the mix)
• lack of uniformity
• lack of detailed disclosures

Question 19

Accounting for a subsidiary when it is not appropriate to consolidate

Answer 19

When parent is precluded from exercising control the subsidary is reported as an intercompany investment

Question 20

Direct vs indirect control

Answer 20

Direct control: typically when one company owns a majority of another company’s common stock

Indirect control (pyramiding): when a company’s common stock is owned by one or more companies that are all under common control

Question 21

Accounting when parent and subsidiary have different reporting periods

Answer 21

• subsidiary’s fiscal period may be changed or financial statement data of subsidiary adjusted to place data on basis consistent with parent’s fiscal period

per GAAP & SEC data does not need to be adjusted if period differs by 3 months or less as long as any material intervening events are recognized

Question 22

Noncontrolling interest

Answer 22

Shareholders of a subsidiary other than the parent (noncontrolling shareholders)
+
the claim of these shareholders on the income and net assets of the subsidiary

NCI shareholders

Question 23

Accounting for noncontrolling interest in equity

Answer 23

Controlling interest:
Common stock
APIC
RE
= total controlling interest
+ Noncontrolling interest in net assets of subsidiary
= total consolidated stockholder’s equity

Question 24

Accounting for consolidated net income with NCI

Answer 24

Income available to ALL stockholders.

on consolidated income statement

consolidated net income
less: consolidated net income attributable to NCI in subsidiary (proportionate amoount)
= consolidated net income attributable to controlling interest in subsidiary

Question 25

Calculating income attributable to noncontrolling interest

Answer 25

Subsidiary’s net income * proportion of NCI shares = income attributable to noncontrolling interest

subtract from consolidated net income on consolidated income statement

Question 26

Basic consolidation entry when subsidiary is less than wholly owned

Answer 26

(NO DIFFERENTIAL)

Subsidiary’s common stock
Subsidiary’s retained earnings
Parent’s investment in subsidiary
Non-controlling interest in net assets of subsidiary

entry removes the subsidiary’s equity accounts and parent’s investment account and takes into consideration the Non-controlling interest equity in the subsidiary

Question 27

Consolidated balance sheet as of acquisition date

Answer 27

no income statement or statement of retained earnings done BECAUSE no operations have yet occurred between the acquisition date and balance sheet prepared on that date