STUDY UNIT FIFTEEN

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Deconsolidation

-A parent deconsolidates a subsidiary when it no longer has a controlling financial interest. -Deconsolidation ordinarily occurs when the parent no longer has more than 50% of the outstanding voting interests of the other entity.

Parent

-A parent is an entity that has a controlling financial interest in one or more subsidiaries. -A business consists of an integrated set of activities and assets that can be conducted to provide a return of economic benefits directly to investors or others. -The three elements of a business are inputs, processes, and outputs. -Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business. - To qualify as a business, the set must include an input and a substantive process that together significantly contribute to the ability to create output.

Costs Associated with Business Combinations

-Acquisition-related costs, such as finder's fees, professional and consulting fees, and general administrative costs, are expensed as incurred. Issue costs for securities are accounted for as follows: 1.Direct issue costs of equity (underwriting, legal, accounting, tax, registration, etc.) reduce additional paid-in capital. -Indirect costs of issue, records maintenance, and ownership transfers (e.g., a stock transfer agent's fees) are expensed. 2.Debt issue costs are reported in the balance sheet as a direct deduction from the carrying amount of the debt.

Year-End Consolidated Financial Statements

-After the close of the fiscal year in which the combination occurred, the consolidated entity prepares its first full set of consolidated financial statements. -Year-end consolidated equity is affected by the net income earned, items of other comprehensive income, and the dividends paid by the consolidating entities.

Variable Interest Entities (VIEs)

-An investor must consolidate an investee in which it has a controlling financial interest. -A controlling financial interest is the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise. -The usual condition for a controlling financial interest is ownership of a majority voting interest. Thus, ownership by one reporting entity, directly or indirectly, of more than 50% of the outstanding voting shares of another entity generally is a condition for consolidation.

Contingencies

-Assets and liabilities arising from contingencies are recognized and measured at acquisition-date fair values. -The asset (liability) is derecognized when the contingency is resolved. -The acquirer recognizes an indemnification asset when the seller contracts to pay for the result of a contingency or uncertainty related to an asset or liability.

Dividends Paid

-Consolidated dividends are those paid to parties outside the consolidated entity by the parent and the subsidiary. 1.Dividends declared by the parent decreases the amount of consolidated retained earnings. 2.The NCI's share of the subsidiary's dividends decreases the balance of the NCI.

Year-End Consolidated Financial Statements

-Consolidating entities routinely conduct business with each other. The effects of these intraentity transactions must be eliminated in full during the preparation of the consolidated financial statements. -Consolidated financial statements report the financial position, results of operations, and cash flows as if the consolidated entities were a single economic entity. 1.Thus, all line items in the consolidated financial statements must be presented at the amounts that would have been reported if the intraentity transactions had never occurred. -After adding together all the assets, liabilities, and income statement items of a parent and a subsidiary, eliminating journal entries for intraentity transactions must be recorded for proper presentation of the consolidated financial statements.

Control

-Control is a controlling financial interest. It is the direct or indirect ability to determine the direction of management and policies of the investee. This usually means one entity's direct or indirect ownership of more than 50% of the outstanding voting interests of another entity. -However, a controlling financial interest is not deemed to exist when control does not rest with the majority owner, such as when the entity is in bankruptcy, in legal reorganization, or under severe governmentally imposed uncertainties. -Control may be obtained in many ways, such as by (a) transferring assets (such as cash, cash equivalents, or other assets, including a business), (b) issuing equity interests, (c) incurring liabilities, and (d) combining two entities solely by contract.

Goodwill or Bargin purchase

-Goodwill is an intangible asset reflecting the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. -The acquirer may recognize goodwill at the acquisition date. Goodwill equals the excess of 1) over 2) below: 1.The sum of the acquisition-date fair values of The consideration transferred, Any noncontrolling interest, and Any previously held equity interest in the acquiree. 2.The net of the acquisition-date fair values of Identifiable assets acquired and Liabilities assumed.

On the business combination date

-On the business combination date, contingent consideration must be recognized at its acquisition-date fair value. -The acquisition-date fair value of contingent consideration must be included in the total fair value of the consideration transferred and included in the calculation of goodwill. - Future settlement of the contingent consideration has no effect on the amount of goodwill that was recognized on the business combination date.

Retained Earnings

-Retained earnings of the consolidated entity at the acquisition date consist solely of the retained earnings of the parent. Equity amounts of the subsidiary are eliminated. -Retained earnings of the consolidated entity at a subsequent reporting date consist of (1) acquisition-date retained earnings, plus (2) the net income (loss) for the subsequent period(s) attributable to the shareholders of the parent, minus (3) dividends paid by the parent to entities outside the consolidated entity.

Acquisition method

-The acquirer is acquiring assets and assuming liabilities only. The acquiree's equity accounts are not relevant. -Only the acquiree's identifiable assets acquired and liabilities assumed are recognized. -Any goodwill on the books of the acquiree is not an identifiable asset recognized upon acquisition by the acquirer. -However, the acquirer may recognize certain intangible assets that did not qualify for recognition by the acquiree. For example, on the business combination date, the acquirer may recognize intangible assets, such as a brand name or in-process research and development (IPR&D). These internally developed intangible assets have not been recognized in the financial statements of the acquiree because the costs to develop them (e.g., R&D costs) were expensed as incurred. -Because assets and liabilities are recorded at fair value, valuation allowances are not recognized.

Recognition Principle

-The acquirer must recognize the identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree. -The assets and liabilities recognized must be part of the exchange and not the result of separate transactions. -The acquirer must recognize only the consideration transferred for the acquiree. -The acquirer also must identify amounts not part of the exchange and account for them according to their nature and relevant GAAP. -A precombination transaction that primarily benefits the acquirer is most likely to be accounted for separately from the exchange.

Consolidated Statement of Changes in Equity

-This statement satisfies the requirement for a presentation of a reconciliation of the beginning and ending balances of (1) total equity, (2) equity attributable to the parent, and (3) equity attributable to the NCI. -The following is Platonic's Year 1 consolidated statement of changes in equity:

Intraentity Noncurrent Assets Transactions

-Transfers of noncurrent assets require elimination of any gain or loss on sale recognized on the intraentity transaction. -All the accounts related to the asset transferred must be reported in the consolidated financial statements at the amounts that would have been reported if the intraentity transactions had never occurred. 1.Thus, the depreciation expense recognized in the consolidated financial statements must be the depreciation expense as it would have been recognized in the seller's separate financial statements. 2.If the original useful life and the depreciation method remain the same, the depreciation expense eliminated (added) is equal to the amount of gain (loss) on sale of equipment divided by the years of useful life remaining.

Consolidated Reporting

-When one entity controls another, consolidated financial statements must be issued regardless of the percentage of ownership. Consolidated statements are the general-purpose statements of a parent with one or more subsidiaries. -Consolidated statements present amounts for the parent and subsidiary as if they were a single economic entity. A parent and subsidiary may exist separately for an indefinite period, but annual consolidated financial statements must be issued that report them as a single entity. Required consolidated reporting is an example of substance over form. Even if the two entities remain legally separate, the financial statements are more meaningful to users if they see the effects of control by one over the other.

Contingent considerations

Contingent consideration is an obligation of the acquirer to transfer additional assets or equity securities to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. For example, on the business combination date, the acquirer promises to pay the former shareholders of the acquiree an additional $100,000 next year if the current-year consolidated net income is greater than $500,000.

An entity is a VIE if it meets any of the following criteria:

1.The total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support. 2.As a group, the holders of the equity investment at risk have one of the following three characteristics: -Lack the power, through voting rights, to direct the activities that most significantly affect the entity's economic performance. -Lack the obligation to absorb the entity's expected losses. -Lack the right to receive the entity's expected residual returns. 3.The entity is structured so that voting rights do not necessarily reflect the underlying economic reality. This situation occurs when -The voting rights of some investors are not proportional to their share in expected losses or expected residual returns of entity, and -Substantially all of the entity's activities are on behalf of an investor that has disproportionately few voting rights.

15.3 CONSOLIDATED FINANCIAL REPORTING -- ACQUISITION-DATE BALANCE SHEET

A balance sheet should be prepared that reports the financial position of the consolidated entity at the acquisition date. Step 1 -- Determine the amount of goodwill or gain from bargain purchase recognized on the business combination. Step 2 -- Prepare the assets section of the consolidated balance sheet. Assets and liabilities are reported at 100% of their fair value even though an NCI exists. Step 3 -- Prepare the liabilities section of the consolidated balance sheet. Step 4 -- Determine the NCI. An NCI is not reported for every asset and liability. The entire NCI is reported as a single component of consolidated equity. (The fair value of the NCI was given earlier as $30,000.) Step 5 -- Because a combination is an acquisition of net assets, the subsidiary's equity accounts are eliminated. Thus, in the absence of a bargain purchase, the equity of the consolidated entity immediately after acquisition is the equity of the parent just prior to acquisition plus the fair value of the noncontrolling interest. Step 6 -- Prepare the acquisition-date balance sheet. If the subsidiary holds shares of the common stock of the parent, this reciprocal investment must be eliminated. Subsidiary shareholdings in a parent are treated as treasury stock of the consolidated entity. Because no gain or loss on treasury stock transactions is recognized, reciprocal investments have no effect on the net income or retained earnings of the consolidated entity.

business combination

A business combination (hereafter called a combination) is "a transaction or other event in which an acquirer obtains control of one or more businesses." An acquirer gains control of the acquiree in a combination.

Business combination

A business combination must be accounted for using the acquisition method. It Determines the acquirer and the acquisition date. Recognizes and measures -Identifiable assets acquired, -Liabilities assumed, -Any noncontrolling interest, and -Goodwill or a gain from a bargain purchase.

IFRS Difference

A noncontrolling interest (NCI) may be measured at (1) fair value or (2) a proportionate share of the fair value of the acquiree's identifiable net assets.

Accounting for a Noncontrolling Interest (NCI)

A noncontrolling interest is the equity in a subsidiary not attributable to the parent. NCI is reported separately in the equity section of the parent's balance sheet.

IFRS difference

An acquirer must recognize a contingent liability at the acquisition date if (1) it is a present obligation arising from past events and (2) its fair value can be measured reliably. Recognition occurs even if it is not probable that an outflow of economic benefits will be needed to settle the obligation. In circumstances other than a business combination, a liability (called a provision) is recognized only if (1) the outflow of benefits is probable and (2) the other criteria are met.

Reciprocal Dividends

When consolidated entities hold reciprocal equity stakes, the portion of dividends paid to each other must be eliminated from the consolidated financial statements. The portion of the parent's dividends paid to outside parties reduces consolidated retained earnings. The portion of the subsidiary's dividends paid to outside parties reduces any noncontrolling interest.

Combine vs consolidated

Combined statements are prepared in the same way as consolidated statements. However, the financial data of the parent is not reported in these statements. When they are prepared for related entities, e.g., commonly controlled entities, intraentity transactions and gains or losses are eliminated. Moreover, consolidation procedures are applied to such matters as (a) noncontrolling interests, (b) foreign operations, (c) different fiscal periods, and (d) income taxes.

IFRS difference

Consolidated financial statements must be prepared using uniform accounting policies. If a member of the consolidated group uses different policies, adjustments must be made to its statements when preparing the consolidated statements.

Consolidation procedures

Consolidation procedures. The following steps must be performed when preparing consolidated financial statements: 1.All line items of assets, liabilities, revenues, expenses, gains, losses, and OCI of a subsidiary are added item by item to those of the parent. These items are reported at the consolidated amounts. 2.No investment in the subsidiary account is presented in the consolidated financial statements. Consolidated statements report the assets and liabilities of the subsidiary and the parent as if they are a single economic entity. 3.All the equity of the subsidiary is eliminated (not presented in the consolidated financial statements). 4.The periodic net income or loss and OCI of a consolidated subsidiary attributable to NCIs are presented separately from the periodic net income or loss and OCI attributable to the shareholders of the parent. 5.Goodwill from the acquisition of a subsidiary is presented separately in noncurrent assets. 6.Intraentity balances, transactions, income, and expenses must be eliminated in full (discussed in Subunit 15.5). 7.NCI is reported separately in one line item in the equity section. The NCI must be adjusted for its proportionate share of -The subsidiary's net income (an increase) or net loss (a decrease), -Dividends declared by the subsidiary (a decrease), and -Items of OCI recognized by the subsidiary. 8.Adjustments should be made to report the subsidiary's assets and liabilities at amounts based on their acquisition-date fair values.

Dividends consolidation break down

Dividends Consolidated Treatment Parent's dividends to subsidiary: Eliminated Subsidiary's dividends to parent: Eliminated Parent's dividends to third parties: Reduces retained earnings Subsidiary's dividends to third parties: Reduces NCI

Reciprocal Balances

In a consolidated balance sheet, reciprocal balances, such as receivables and payables, between a parent and a subsidiary are eliminated in their entirety, regardless of the portion of the subsidiary's stock held by the parent.

Intraentity Inventory Transactions -- Gross Profit

Intraentity transactions that give rise to gross profit require more complex treatment. 1. Profit from the sale of inventory between consolidating entities is a component of the net income of the entity that sold the inventory. 2.However, the consolidated entity recognizes profit on this exchange only in proportion to the inventory that is sold to nonaffiliated parties. Accordingly, the gross profit included in the inventory remaining on the purchaser's books must be eliminated from consolidated net income. 3.The year-end eliminating journal entry eliminates the gross profit recognized for the inventory remaining on the purchaser's books and reduces the inventory account to the balance it would have had if the intraentity transactions had never occurred. -The sales account is debited (decreased) for the amount recognized by the seller on the intraentity sale. -The inventory account is credited (decreased) for the amount equal to the unrealized intraentity gross profit (seller's gross profit percentage × inventory remaining on purchaser's books). -The cost of goods sold account is credited (decreased) for the difference between a) and b). The total decrease in both the sales account and cost of goods sold account is exactly equal to the amount of gross profit eliminated. 4. if no inventory from an intraentity transaction remains on the purchaser's books at the end of the reporting period, no adjustment is necessary for unrealized gross profit in ending inventory. The only adjustment for the intraentity sale is to eliminate (1) the sale recognized by the seller and (2) the cost of goods sold recognized by the purchaser.

Measurement principle

Measurement principle. The identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree must be measured at acquisition-date fair value.

Performed at the consolidation date

When control over the subsidiary is lost, the parent must cease to present consolidated financial statements and should perform all of the following at the deconsolidation date: 1.Derecognize all the assets (including goodwill) and liabilities of the subsidiary at their carrying amounts. 2.Derecognize the NCI in the former subsidiary at its carrying amount. 3.Recognize the fair value of any consideration received from the transaction that results in deconsolidation. 4.Recognize any gain or loss from the disposal transaction. 5.Recognize any investment retained in the former subsidiary at its fair value.

DEBT

When one entity holds the debt securities of another entity with which it is consolidated, the elimination is treated as an extinguishment of debt, with recognition of any resulting gain or loss. All accounts related to the debt, such as the maturity amount, interest receivable (payable), and interest income (expense), must be eliminated. The premium or discount on the debtor's and creditor's books, and any related amortization, is eliminated and recognized as a gain or loss on extinguishment in the period of purchase.

Noncontrolling Interest

The NCI must be adjusted for its proportionate share of (1) the net income of the subsidiary included in consolidated net income, (2) items of consolidated other comprehensive income attributable to the subsidiary, and (3) dividends paid by the subsidiary.

Calssification of contingent considerations

The classification of contingent consideration in the consolidated financial statements and the accounting for it subsequent to initial recognition depend on the way the contingent consideration is settled. 1.Contingent consideration that is settled with assets (e.g., the acquirer promises to pay additional cash if some future event occurs) is classified as a liability in the financial statements. - This liability must be remeasured to fair value at each balance sheet date until it is settled. -Changes in the fair value are recognized in the income statement. 2.Contingent consideration that is settled with equity securities (e.g., the acquirer promises to issue additional shares of common stock if some future event occurs) is classified as equity (i.e., additional paid-in capital) in the financial statements. -Contingent consideration that is classified as equity must not be remeasured to fair value subsequent to its initial recognition.

Considerations transferred in a business combination

The consideration transferred in a business combination must be measured at acquisition-date fair value. It includes the 1.Fair value of the assets transferred by the acquirer, 2.Fair value of liabilities incurred by the acquirer to former owners of the acquiree (e.g., a liability for contingent consideration), and 3.Fair value of equity interests (e.g., shares of common stock) issued by the acquirer.

Consolidated Net Income

The consolidated income statement must present separate amounts for the following: 1.Total consolidated net income 2.Net income attributable to the NCI 3.Net income attributable to the shareholders of the parent If an acquisition occurs after the first business day of the year, revenues, expenses, gains, losses, and OCI of the subsidiary are included in the financial statements of the consolidated entity only from the date of the acquisition.

Primary Beneficiary

The primary beneficiary is the reporting entity that is required to consolidate the VIE. Only one reporting entity (if any) is expected to be identified as the primary beneficiary of a VIE. 1.The primary beneficiary has a controlling financial interest in a VIE if it has -The power to direct activities that most significantly affect the economic performance of the VIE and -The obligation to absorb losses or the right to receive benefits of the VIE that potentially could be significant to the VIE

Variable interest model

The variable interest model was developed to determine whether a controlling financial interest exists through arrangements that are not based solely on voting interests. Under this model, the party that has the power to direct the entity's most significant economic activities and the ability to participate in the entity's economic risks and rewards must consolidate the entity. This model includes the following steps: Identify the variable interest in the entity. Determine whether the entity is a variable interest entity (VIE). Identify the primary beneficiary of the VIE (the party that must consolidate the VIE).

Some times voting interest test is not sufficient

Under certain circumstances, the voting interest test is not sufficient to determine which party has a controlling financial interest in the entity. For example, -The entity's (investee's) equity is not sufficient to finance its activities without incurring additional debt (e.g., an entity's capital structure consists of 2% equity and 98% debt). -The equity instruments (i.e., shares of common stock) do not have the normal equity characteristics that provide its holders with a potential controlling interest.

Upon Deconsolidation

Upon deconsolidation, the parent recognizes a gain or loss in the income statement. It equals the difference at the deconsolidation date between 1) and 2) below. The sum of the -Fair value of the consideration received -Fair value of any retained investment -Carrying amount of any NCI -The carrying amount of the subsidiary (including the carrying amount of goodwill). If b.1) is greater than b.2), a gain is recognized for the difference. If b.2) is greater than b.1), a loss is recognized.

Private companies

When recognizing intangible assets in a business combination, a private company may Use the general FASB codification guidance that applies to all entities or Elect to apply the intangible assets accounting alternative. Under this accounting alternative, (1) customer-related intangible assets that are not capable of being sold or licensed independently from other business assets and (2) noncompetition agreements are not separately identifiable assets. These assets must not be recognized separately from goodwill. A private company that elects this accounting alternative also must elect the goodwill accounting alternative that requires an amortization of goodwill.

When it does not constitute a buisness combination

When substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set acquired does not constitute a business. This transaction is a regular asset acquisition. The table below presents the differences between the accounting for (a) asset acquisitions and (b) business combinations.