Advanced Financial Midterm #1

Because subsidiaries are legally separate from their parents...

- the creditors and stockholders of a subsidiary generally have no claim on the assets of the parent, and - the subsidiary's stockholders do not share in the profits of the parent.

What are some limitations of consolidated financial statements?

- Can mask poor performance since the individual companies results aren't disclosed - Limited availability of resources - Unrepresentative combined financial ratios (meaning the consolidated ratios aren't representative of any single company) - A lack of uniformity (companies can calculate certain accounts differently) - Lack of detailed disclosures

Where does NCI in NA of Sub account get reported?

Equity section under RE

How do you calculate goodwill?

FV of consideration given + FV of NCI = total FV of Sub - FV of net identifiable assets = Goodwill

What does the equity method do well?

Reflect the underlying economics

What might the preacquisition and dividend consolidation entry look like?

Sales xxx COGS xxx Dep Exp xxx Other Exp xxx Div Declared xxx RE xxx

What are the four consolidation entries? What are their purposes?

1. Basic consolidation - Remove book value of income from S and inv in S 2. Excess value reclass entry - Provide the detail of what makes up the differential 3. Amortized excess reclass entry - Reclass the equity method amortization of cost in excess of book from Income from Sub to the appropriate expense accounts where the costs would have been had the sub used FMV instead of BV. 4. Acc Depreciation entry

What are the two types of traditional ways a parent can control a sub?

- Direct (P owns majority of S) - Indirect (pyramiding)

What are reasons for enterprise expansion?

- Economies of scale - New earnings potential - Earning stability through diversification - Greater management reward for a bigger company size - Prestige of having a larger company size

Describe the NCI in NA of Sub account

- Equity of unrelated owners - "Net assets on our balance sheet not belonging to us"

What are motivating factors for creating a new business entity?

- Establish clear lines of control and facilitate clear evaluation of operating results - Special tax incentives - Regulatory reasons - Protection from legal liability - Dispose of a portion of existing operations

Describe the primary beneficiary principle for VIEs

- Only one primary beneficiary can exist for a VIE - The primary beneficiary is the entity that has a controlling financial interest - The primary beneficiary of a VIE must consolidate the VIE.

Two reasons consolidation of a subsidiary is not appropriate:

- Subsidiary is in legal reorganization or bankruptcy - Foreign country restricts remittance of subsidiary profits to domestic parent company

What are the two types of expansion?

1. Internal expansion 2. External expansion

In the past, there were two methods of accounting for business combinations which were...

1. Pooling of interests method (not allowed anymore) 2. Purchase method

What methods can a Parent use if they pay more than the book value of the subs assets?

1. Push down accounting (sub revalues at FMV) 2. Non-push-down accounting (Account for differential separately in consolidation)

What are the three primary legal forms of business combinations?

1. Statutory merger 2. Statutory consolidation 3. Stock acquisition

When should a parent stop consolidating a subsidiary?

When the parent can no longer exercise control.

When do you use equity accounting?

When you significant influence AND control (20% and up)

Is it possible to have control of a company without owning >50% of the voting shares?

Yes - contractual agreements or financial arrangements

When NCI is present (P doesn't own 100% of S) should 100% be consolidated? If so, what accounts appear?

Yes - required by GAAP Two accounts appear in consolidated statements: 1. NCI in NI of Sub 2. NCI in Net Assets of Sub

What is contingent consideration? How should it be treated?

consideration exchanged by the acquirer in a business combination is not fixed in amount, but rather is contingent on future events. Should be valued at acquisition date and recorded

A form of consideration that is not allowed in acquisition accounting is: a. Cash. b. Bonds. c. Preferred stock. d. Common stock. e. None of the above.

e

P owns 60 percent of X and 75 percent of Y. If X and Y jointly own 100 percent of Z, under what circumstance would P not be deemed to control Z? a. Z is a bank. b. Z's products are largely sold overseas. c. Z is currently in Chapter 11 bankruptcy. d. Z has a CEO known to have a bad temper and a serious gambling habit. e. None of the above

C

The noncontrolling interest in a corporation can best be described as: a. a group of disinterested shareholders who rarely vote on company issues. b. all employees below the manager level. c. all shareholders other than the parent company. d. a group of investors who plan to sell their stock within the next twelve months. e. None of the above.

C

The primary difference when consolidating a less‐ than‐wholly‐owned subsidiary is: a. only the parent's % is consolidated. b. extra columns are added to split the subsidiary into two or more pieces. c. extra rows are added to divide the net income and net assets of the sub between the parent and NCI shareholders. d. There is no difference

C

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CHAPTER 1

CHAPTER 1

CHAPTER 2

CHAPTER 2

If a company were to, for some reason, stop consolidating a sub (likely because of selling off stock), what process would the go through to (1) account for the sale and (2) properly account for their interest going forward?

Calculation: (a) Proceeds received xxx (b) FV of P's remaining equity in S xxx (c) Total FV xxx (d) P's total int in S at date of sale xxx Gain on sale = c - d Cash xxx Inv in S xxx Gain on sale xxx (2) the remaining interest's value would be adjusted to FV

What does the basic elimination entry look like with NCI?

Common Stock APIC RE (BB) Income from S NCI in NI of Sub Dividends declared by S Investment in S NCI in NA of Sub

Which of the following costs can be added to the cost of an acquisition? a. Legal fees. b. Accounting fees. c. Costs of issuing common stock. d. A pro rata portion of the CEO's salary. e. Travel costs. f. Costs of the M&A department. g. None of the above.

G

If an entity has an existing interest in a sub and then acquires more of the sub to qualify for consolidation - how should the previously existing interest in sub be treated?

The previously existing interest would be adjusted to FV at acquisition date and a gain/loss would be recognized

Why do we do the accumulated depreciation entry for consolidation purposes?

To show the Buildings and Equipment "as if" they have been recorded on the Sub's books as new assets at book value

True/False - The investor begins accruing income from the investee under the equity method at the date of acquisition.

True

True/False - The investor may not accrue income earned by the investee before the date of acquisition of the investment.

True

Where would the OCI section go on the consolidation worksheet?

Bottom with a single line below RE that has the totals from the AOCI section

What is normally the business purpose of Special Purpose Entities (SPEs)?

Bundle peripheral business activities and have them done by an independent, but close, friend

When a sub is acquired at more than Book Value, what's the difference between the parents and the subs books?

Parent - recorded at FMV Sub - Recorded at Book Value

If the parent loses control but does maintain a noncontrolling equity interest in the former subsidiary what do they do?

Parent must recognize a gain or loss for the difference, at the date control is lost, between: - the sum of any proceeds received by the parent and the fair value of its remaining equity interest in the former subsidiary - the carrying amount of the parent's total interest in the subsidiary.

If a parent loses control of a sub and no longer holds an equity interest in the sub what do they do?

Parent recognizes a gain or loss for the difference between - any proceeds received from the event leading to loss of control, and - the carrying amount of the parent's equity interest.

Is an SPE financed more by debt or equity?

SPE's are typically financed primarily by debt, while equity financing is only a small portion. SPE's tend to be very highly leveraged

If an entity is carrying their investment at fair value and the sub pays out a dividend how would that dividend be treated by the parent?

Simply as dividend income. Would NOT affect the investment in S account.

If an acquirer is going to receive in-process R&D, how should it be treated?

The R&D should be classified as an asset with an indefinite life and would be subsequently tested for impairment.

What is a statutory merger? What is the result?

The acquired company's assets and liabilities are transferred to the acquiring company, and the acquired company is dissolved, or liquidated. Operations of the previous separate companies are carried on in a single legal entity. Result: one legal entity survives

A way to force out a target company's dissenting shareholders is to use: a. acquisition accounting. b. pooling-of-interests accounting. c. a statutory merger. d. a statutory consolidation. e. none of the above.

C

If a bargain purchase occurs what happens?

Acquirer would recognize a gain on Acquisition

If OCI is present, what would you do?

Additional consolidation entry: OCI from S OCI to NCI Inv in S NCI in NA of S

What is a statutory consolidation? What is the result?

Both combining companies are dissolved and the assets and liabilities of both companies are transferred to a newly created corporation. Result: one "new" legal entity survives

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CH 10

What are the three formation types for SPEs?

Corporations, trusts, or partnership

If an entity is carrying their investment at fair value and the inv in sub is determined to have appreciated in value how would that appreciation be treated?

Inv. in S xxx Unrealized Gain on S Stock xxx

Which entity is the primary beneficiary of a VIE?

The entity that... 1. has the power to direct the activities of a VIE that most significantly impact the VIE's economic performance. 2. will absorb losses of the VIE that could potentially be significant to the VIE or will receive the benefits from the VIE that could potentially be significant to the VIE

What should the consolidated NI and RE equal?

The parent's

What do we need to do when there is an interim acquisition?

We need to make a preacquisition and dividend consolidation entry. The purpose is to essentially close the income statement to RE for all activity before the acquisition date.

Are subs legally separate from their parent?

YES

Describe Push Down Accounting

- Adjust assets and liabilities to FV based on the parent's acquisition price - Record goodwill - Record "Revaluation Capital" for the difference Basically you just force the sub up front to revalue to FMV so the parent doesn't need to

Describe the NCI in NI of Sub account

- Appears in consolidated financial statements when NCI is present - Like an expense in the consolidated income statement - "Reported income that doesn't belong to the parent"

What are the two typical ways of effecting a business combination?

1. Acquisition of assets (Statutory merger/consolidation) 2. Acquisition of stock

The primary difference in consolidating a less‐than‐wholly‐ owned subsidiary relative to a wholly owned subsidiary is: a. income and net assets of the subsidiary must be divided between the parent and the NCI shareholders. b. the title of the worksheet must specify "Less than wholly owned." c. you only consolidate the parent's % ownership. d. There is no difference.

A

Under which concept is goodwill assigned to the noncontrolling interest for consolidated financial reporting purposes? a. The entity concept. b. The parent company concept. c. Both a and b. d. None of the above.

A

What are the 2 major advantages/disadvantages of acquiring common stock?

Advantages 1. Easy transfer 2. May inherit nontransferable contracts Disadvantages 1. May inherit contingent liabilities or unwanted labor union connection 2. May acquire unwanted facilities/units 3. Will likely be hard to access target's cash

What are the 2 major advantages/disadvantages of acquiring assets?

Advantages 1. Will not inherit a target's contingent liabilities (excluding environmental) 2. Will not inherit a target's unwanted labor union Disadvantages 1. Transfer of titles on real estate and other assets can be time-consuming 2. Transfer of contracts may not be possible

What is a Special Purpose Entity? (SPE)? What are their purpose?

Corporations, trusts, or partnerships created for a single, specified purpose. Usually have no substantive operations and are used only for financing purposes.`

A primary benefit of consolidated financial statements is that they... a. provide information directly applicable to the needs of regulators. b. obscure data of individual companies. c. present data of two or more entities that clearly reports their individual performance. d. give a picture of the use of resources under the parent's control. e. None of the above

D

If Company A purchases 45% of the outstanding common stock of Company B, the investment in Company B should be accounted for: a. at fair value b. at cost c. as a consolidated subsidiary d. as an equity method investment e. None of the above.

D

In acquisition accounting: a. common stock must be the consideration given. b. goodwill is not reported. c. a statutory merger occurs. d. a change of basis in accounting occurs. e. none of the above.

D

In equity method accounting do declared or paid dividends affect the investment in sub account?

Declared.

What are the only costs that are not expenses in the acquisition period? What do you do with them?

Direct costs of issuing stock - charge them to APIC

To qualify for acquisition accounting treatment, a. one company must acquire common stock of the other combining company. b. a statutory consolidation must occur. c. each company must be approximately the same size. d. a stock-for-stock exchange must occur. e. none of the above.

E

What is done with all forms of intercompany receivables and payables?

Eliminated when consolidated financial statements are prepared. In Consolidated worksheet: AP xxx AR xxx

How do dividends effect an equity method acquisition vs. a fair value?

Equity - decreases the investment in Sub Fair value - Recognized as dividend income

ABC Company acquires 20 percent of XYZ Company's common stock for $100,000 at the beginning of the year but does not gain significant influence over XYZ. During the year, XYZ has net income of $60,000 and declares dividends of $20,000. The fair value of ABC's investment in XYZ stock is $98,000 at the end of the year. ABC Company records the following entries:

Inv in XYZ Stock 100,000 Cash 100,000 Cash 4,000 Div Income 4,000 Unrealized Loss on Inv in XYZ 2,000 Inv in XYZ Stock 2,000

Of these costs - what would be charged to acquisition expense and what would be charged to APIC? Legal fees (acquisition), Accounting fees (acquisition) ,Travel expenses, Legal fees (stock issuance), Accounting fees (stock issue), SEC filing fees

Legal fees (stock issuance), Accounting fees (stock issue), SEC Filing fees

What does net assets equal?

Net assets = owners equity

What is a stock acquisition? What is the result?

One company acquires the voting shares of another company and the two companies continue to operate as separate, but related, legal entities. Result: The acquiring company accounts for its ownership interest in the other company as an investment. A parent-sub relationship is created.

One type of uncertainty in business combinations arises from numerous required fair value measurements. Because the acquirer may not have sufficient information available immediately to properly ascertain fair values, ASC 805 allows for a period of time, called the measurement period. How long is the measurement period?

Up to one year after acquisition (the value of the assets obtained in the acquisition can change during that year)