Variable Interest Entities (VIEs)
Voting Interest Assessment
Voting Interest Assessment C. Unless a parent lacks effective control of a subsidiary, the subsidiary's financial statements must be consolidated with parent's financial statements for public reporting. D. If a majority owned subsidiary is not consolidated because the investor lacks effective control (for one of the reasons given above), the subsidiary is an "unconsolidated subsidiary." 1. An unconsolidated subsidiary would be reported as an "Investment" asset by the parent. 2. The parent would account for its investment in an unconsolidated subsidiary using either fair value or the equity method, depending on the extent of influence that it can exercise over the investee.
Voting Interest Assessment
Voting Interest Assessment If an entity being considered for consolidation (e.g., an investee) is not a variable-interest entity, it would be assessed to determine whether or not an investor has majority ownership of its voting securities and, if so, that nothing prevents the investor from exercising its control of the operating and financial activities of the investee.
In which one of the following cases is the subsidiary most likely to be reported as an unconsolidated subsidiary? A. The subsidiary is in an industry unrelated to the parent. B. The subsidiary has a fiscal year-end that is one month different from the parent's year-end. C. The subsidiary is in legal bankruptcy. D. The subsidiary has a controlling interest in another entity.
C. The subsidiary is in legal bankruptcy. When a subsidiary is in bankruptcy, it is under the control of the bankruptcy court and, therefore, not under the control of the parent. When a parent cannot exercise financial and/or operating control of a subsidiary, the subsidiary would not be consolidated, but would be reported as an unconsolidated subsidiary by the parent.
Parco has the following three subsidiaries: Finco, Serco, and Euroco. Finco is a 100% owned finance subsidiary. Serco is an 80% owned service company. Euroco is a 100% owned foreign subsidiary that conducts operations in Western Europe. Which one of the following is the most likely number of entities, including Parco, to be included in Parco's consolidated financial statements?
The consolidated statements would include not only Parco, but also all three of its subsidiaries, for a total of four.
Voting Interest Assessment
Voting Interest Assessment B. A majority owned (> 50% of voting stock, controlled either directly or indirectly) subsidiary must be consolidated with its parent unless the parent lacks the ability to exercise its majority ownership to control the operating and financial activities of the subsidiary (i.e., the parent lacks effective control of the subsidiary). 1. Effective control may be lacking due to: a. Foreign subsidiary being largely controlled by the foreign government through: i. Prohibition on paying dividends; ii. Control of day-to-day operations. b. Domestic subsidiary in bankruptcy and under the control of the courts.
What is the only legal form of business combination requiring consolidated statements?
Business Combination resulting from a legal acquisition.
Which of the following statements concerning the primary beneficiary of a variable-interest entity is/are correct? I. The primary beneficiary has the ability to direct the most significant economic activities of the variable-interest entity. II. Only one entity can be the primary beneficiary of a variable-interest entity. III. The investor that has the greatest equity ownership in a variable-interest entity will be the primary beneficiary of the entity.
Both Statement I and Statement II are correct; Statement III is not correct. By definition, the primary beneficiary of a variable-interest entity is the entity that is able to direct the most significant economic activities of the variable-interest entity (Statement I). Only one entity can be the primary beneficiary of a variable-interest entity, because only one entity will have the ability to direct the activities of the variable-interest entity that most significantly impacts its economic performance (Statement II).
What are the differences between a legal merger or legal consolidation and a legal acquisition that determine whether or not consolidated statements will be required?
In a legal merger or legal consolidation only one entity exists after the combination; therefore, there is no need for a consolidated statement. In a legal acquisition two separate legal entities survive, but under common control. Their financial statements must be consolidated.
Which one of the following is not a characteristic of a variable-interest entity? A. A variable-interest entity is thinly capitalized. B. The equity holders in a variable-interest entity control the entity. C. The risks and rewards associated with a variable-interest entity mostly accrue to the variable-interest holders. D. The value of a variable-interest entity depends on the net asset value of the variable-interest entity.
The equity holders in a variable-interest entity control the entity. The equity holders in a variable-interest entity do not control the entity. Control of the activities and decision-making in a variable-interest entity generally resides with the variable-interest holders (not the equity holders) as established by agreement or other instrument.
What is a majority-owned subsidiary that is not consolidated called and how is it accounted for?
A majority-owned subsidiary that is not consolidated is an "unconsolidated subsidiary" and would be accounted for as an investment asset by the parent, using either fair value or the equity method of accounting.
Eligibility for Consolidated Financial Statements
Eligibility for Consolidated Financial Statements Whether or not an entity (e.g., an investee), in which another entity (e.g., an investor) has an interest, must be consolidated or not, depends on the nature of the relationship between entities. GAAP establishes a two-step (or two-tier) process for determining whether or not the relationship requires an entity be consolidated with another entity. The entity being considered for consolidation must be assessed to determine (1) if it is a variable-interest entity (VIE) and, if so, the primary beneficiary of the VIE, and (2) if the entity is not a VIE, whether or not an investor has equity ownership that enables it to exercise control of the investee.
(Start of CPAexcel Exam Questions) Which of the following legal forms of business combination will result in the need to prepare consolidated financial statements?Merger, Acquisition, Consolidation
Only an acquisition form of business combination will require the preparation of consolidated financial statements. In the merger and consolidation forms of business combination, only one firm will remain after the combination. Therefore, there will not be two (or more) sets of financial statements to consolidate.
(The Start of the CPAexcel Flashcards) When are consolidated statements required?
Under two major circumstances: 1. When a firm is the primary beneficiary of a variable-interest entity (VIE), the VIE must be consolidated with the primary beneficiary; 2. When a firm has a majority owned (>50% of voting stock) subsidiary, the subsidiary must be consolidated with its parent unless the parent lacks actual effective operating or financial control.
Variable-Interest Entity Assessment
Variable-Interest Entity Assessment B. Structurally, a VIE may be a legal trust, partnership, joint venture, limited company or corporation. 1. Typically, a VIE is established by another entity or entities (the sponsors) to carry out a well-defined, limited business purpose, with the sponsor(s) - also the variable-interest holders - providing most resources to the VIE, often in the form of loans or loan guarantees. 2. The activities of and decision-making in a VIE are governed largely by the agreement that establishes the entity and generally resides with the variable-interest holders; non-sponsor equity owners may play little role in the operation of the entity. 3. The risks and rewards associated with the VIE are largely attributable to the variable-interest holders, not the equity owners who may bear little risk and receive only a small rate of return. 4. The value of the VIE to the variable-interest holders depends on (varies with) the success of the VIE; the variable-interest holders' interest increases if the net asset value of the VIE increases or decreases if the net asset value of the VIE decreases.
Variable-Interest Entity Assessment
Variable-Interest Entity Assessment C. In summary, even though the equity investors in a VIE are its legal owners, because of contractual or other arrangements they play little role in the operation of the entity and carry little risk or receive little benefit from ownership; those risks and benefits accrue to the variable-interest holders (usually also the sponsors). Thus, a VIE is an entity in which another entity has a controlling interest achieved by a means other than holding a majority of the voting rights. D. An entity with a variable interest in a VIE must qualitatively assess whether or not it is the primary beneficiary of the VIE; if so, it is deemed to have a controlling financial interest in the VIE.
Variable-Interest Entity Assessment
Variable-Interest Entity Assessment E. An entity will be considered the primary beneficiary of a VIE if it meets both of the following conditions: 1. It has the power to direct activities of the VIE that most significantly impact the VIEs economic performance (called the power criterion), and 2. It has the obligation to absorb losses from or right to receive benefits of the VIE that potentially could be significant to the VIE (called the losses/benefits or risks/rewards criterion).
Variable-Interest Entity Assessment
Variable-Interest Entity Assessment F. Only one entity (e.g., sponsor), if any, will be the primary beneficiary of a VIE. G. An entity that is determined to be the primary beneficiary of a VIE (and therefore has a controlling financial interest) will consolidate the financial statements of the VIE. H. An entity that is determined to be the primary beneficiary of a VIE and, therefore, consolidates its financial statements, must assess whether or not it continues to be the primary beneficiary on an on-going basis.
Variable-Interest Entity Assessment
Variable-Interest Entity Assessment Each entity that is considered for consolidation must first be evaluated to determine if it is a variable-interest entity (VIE) and, if it is, which other entity is its primary beneficiary. A. A VIE is a legal entity which by design either: 1. Cannot finance its activities without additional subordinated financial support (i.e., its expected losses exceed its total equity investment at risk), or 2. Its equity holders, as a group, do not have the direct or indirect ability to make decisions about the VIE's activities.
Voting Interest Assessment
Voting Interest Assessment A. Controlling ownership of an investee by an investor results from a business combination carried out in the form of a legal acquisition. 1. A business combination carried out as a legal merger or legal consolidation results in only one remaining firm. Financial statements are prepared for that single firm; there are no sets of financial statements to consolidate. 2. A business combination carried out as a legal acquisition results in one legal entity (the parent) having majority ownership, either directly or indirectly, of the other legal entity (the subsidiary). Each firm is a separate legal (and accounting) entity, but under the common control of the parent shareholder. 3. In form, the parent and subsidiary are separate legal entities; in substance, they are a single "economic entity." If the parent can exercise its majority ownership to control the operating and financial activities of the subsidiary, consolidated parent-subsidiary financial statements must be the primary form of financial reporting for the entities.