C. Consolidated Financial Statements

Concepts of Consolidated Statements

1. Are prepared as if the group of legal entities were one economic entity group. 2. Are presumed to be more meaningful for mgmt., owners, & creditors of the acquirer company & they are required for fair presentation of the financially related companies. 3. Individual company stmts should continue to be prepared for noncontrolling ownership & creditors of the acquire companies.

Variable Interest Entities

1. If an entity has a controlling financial interest in the VIE, the entity is considered the primary beneficiary of the VIE. 2. A primary beneficiary is required to consolidate the VIE in its F/S.

2 Models to Evaluate Consolidation

1. Voting Interest Entity Model 2. Variable Interest Model

Consolidated Balance Sheets

Typically prepared at the date of combination to determine the initial financial position of the economic entity. 1. Any intercompany accts between the acquirer & acquire must be eliminated against each other. 2. The "Investment in acquiree's stock" acct from the acquirer's books w/b eliminated against the reciprocal accts of the acquiree's SE. 3. The remaining accts are then combined to prepare the consolidated B/S.

Variable Interest Entities

A qualitative approach is used to determine if the entity has the power to control the VIE. 1. If a power is shared among unrelated parties & consent of the other parties is required to direct the activities of the VIE, then no one party has the power to direct the activities of the VIE. In cases where power is shared, none of the parties is required to consolidate the VIE. 2. If power is shared by unrelated parties & the nature of the activities directed by each party is not the same, then the entities must identify which party has the power to direct the activities that most significantly affect the VIE's economic performance. 3. If the party that has the power to direct the economic performance is also obligated to absorb the losses or receive the benefits, that entity is primary beneficiary& must consolidate the VIE.

Variable Interest Entities

A reporting entity that's not the primary beneficiary isn't required to consolidate the VIE, but must disclose the following: 1. The carrying amts & classification of the assets & liabilities that relate to the reporting entity's variable interest in the VIE. 2. The maximum exposure to loss from involvement w/ the VIE. 3. A comparison of the carrying amts of assets & liabilities & the maximum exposure to loss, together w/ supporting info. explaining the differences in amts. 4. Info about any liquidity arrangements, guarantees, or other commitments by 3rd parties that may affect the FV or risk of the interest in the VIE. 5. If applicable, significant factors considered & judgements in determining that the power to direct the activities of the VIE is shared.

Accounting Principles

Used to record & report events for a single legal entity are also applicable to a consolidated economic entity of 2 or more companies. 1. The concept of the reporting entity is expanded to include more than one company, but all other actg principles are applied in the same way as for an individual company. 2. The consolidation process eliminates reciprocal items that are shown on both the acquiree's & acquiree's books. These eliminations are necessary to avoid double counting the same items, which would misstate the financials of the combined economic entity.

Preparation of Consolidated Statements

Preparation after the date of combination becomes a little more complex because the acquirer & acquire I/S may include reciprocal intercompany accts, which must be eliminated.

Voting Interest Entity Model

Consolidation is generally required for investments of more than 50% of the outstanding voting stock except when the control is not held by the majority owner. Examples on noncontrol: 1. Investee is in legal reorganization or bankruptcy. 2. Investee operates in a foreign country, which has severe restrictions on the financial transactions of its business firms or is subject to material political or economic uncertainty that casts significant doubt on the parent's ability to control the subsidiary. a.) In these limited cases, the investment w/b reported as a long term investment in an unconsolidated subsidiary on the investor's B/S. b.) The cost method is used unless the acquirer qualifies to use the equity method or elects to use the FV option for reporting financial assets. 3. Consolidation isn't required for legal entities operating under the guidance rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.

Variable Interest Entities

1. *Participating rights* are the ability to block or participate in the actions of a reporting entity with power to direct the activities of the VIE. (examples incl. a.) control over the mgmt. responsible for implementing investee policies & procedures & b.) establishing operating & capital decisions of the investee. 2. *Protective rights* - Rights that protect the party holding the rights but don't give that party controlling financial interests. (examples incl. approval or veto rights & the ability to remove the reporting entity w/ controlling financial interest.

Voting Interest Entity Model

1. Acquisition of more than 50% of the outstanding voting stock will normally result in control & require the preparation of consolidated F/S. 2. Limited partnerships follow similar voting interest & variable interest entity (VIE) models. 3. The investment acct w/b eliminated in the consolidation working papers & w/b replaced w/ the specific assets & liabilities of the investee corp.

Variable Interest Entities

1. An entity should determine whether it's the primary beneficiary on the date it becomes involved w/ VIE. The reporting entity must also reassess whether it's the primary beneficiary throughout its involvement w/ the VIE. For single decision makers, primary beneficiary determination is impacted by the direct economic interests & indirect economic interests held through related parties. 2. *Kick-out rights* are the ability to remove the reporting entity who has the power to direct the activities that most significantly impact the VIE's economic performance.

Variable Interest Entities

1. Kick-out & participating rights won't affect an entity from being considered the primary beneficiary unless those rights are held by a single equity holder who has the ability to exercise those rights. Protective rights affect an entity from being considered the primary beneficiary. 2. Usual & customary fees pd may be excluded from primary beneficiary determination.

Variable Interest Entities

Additional disclosures are required for entities that have interests in VIE's. 1. the primary beneficiary that's required to consolidate the VIE must present separately on the face of the stmt of financial position the assets of the VIE that can be used only to settle obligations of the consolidated VIE & the liabilities of the VIE for which creditors don't have recourse in the general credit of the primary beneficiary. 2. Disclosures in the notes to F/S by the primary beneficiary that consolidates the VIE are: a.) The carrying amts & classification of the VIE's assets & liabilities that are consolidated as well as qualitative info. about the assets & restrictions on the assets. b.) Lack of recourse if creditors have no recourse to the general credit of the primary beneficiary. c.) Terms of arrangements.

Variable Interest Entities

All entities with interests in VIEs(both primary beneficiaries & other holders of variable interests in VIEs that are not required to consolidate) must disclose the following: 1. The methodology for determining whether the reporting entity is the primary beneficiary of a VIE. 2. If facts & circumstances regarding consolidation of VIE have changed. 3. Whether the reporting entity has provided financial or other support to the VIE that was not contractually required during the periods presented. 4. Qualitative & quantitative info. about the reporting entity's involvement w/ the VIE, including nature, purpose, size, & activities of the VIE, & how the VIE is financed.

Variable Interest Entities

An entity has a controlling financial interest in a VIE if both of the following conditions exist: 1. The entity has the power to direct the activities of a VIE that most significantly impact the VIE's economic performance. 2. the entity has the obligation to absorb losses of the VIE that could potentially be significant to the VIE, or has the right to receive benefits from the VIE that could potentially be significant to the VIE.

Variable Interest Entities

1. In some instances, control over an entity may be achieved through arrangements that don't involve ownership or voting interests. 2. Special rules apply to variable interest entities in which control is achieved based on contractual, ownership, or other pecuniary interests that change with changes in the entity's net asset value. 3. The initial determination of whether a legal entity is a VIE is made on the date the reporting entity becomes involved with the legal entity. 4. The status of a VIE is reconsidered if certain events occur such as a change in the legal entity's contractual arrangements or characteristics, a change in the equity investment by investors, or changes in facts & circumstances that change the power from voting rights or similar rights to direct the activities of the VIE.

Consolidated Financial Statements

Prepared from worksheets, which begin w/ the trial balances of the acquirer & acquire companies. 1.Eliminating w/s entries are made to reflect the 2 separate companies' results of operations & financial position as one combined economic entity. 2. The entire consolidation process takes place only on a w/s. No consolidation elimination entries are ever recorded on either the parent's or subsidiary's books.