Advanced Financial Reporting - Exam 2
Where in the consolidated balance sheet should noncontrolling interests be reported?
NCI should be reported in the consolidated statement of financial position within equity, separate from parent equity. It should be clearly identified and labeled. If more than one sub, the entity may aggregate interests in presentation
How much of deferred profit on inventory sales should be deferred?
Only the profit from the inventories that have not been sold during the period originating from I/C transfers. Profit2Defer = TotalDeferredProfit x %UnsoldInv
Describe the different effects on consolidated financial statements when dealing with upstream vs downstream I/C sales of depreciable assets
Regardless of direction, 100% of I/C must be eliminated. If upstream, portion of the eliminated gain/losscan be assigned to the NCI. If upstream, elimination of gain will influence bottom line net income attributable to controlling interest by P% and the income attributable to NCI by 1-P%
What is important to remember when dealing with transfers of depreciable noncurrent assets?
When affiliated companies transfer depreciable noncurrent assets, the consolidated financial statements will appear such that the intercompany transaction didn't occur.
Describe the effects of the [I-sales] and [I-COGS] consolidation entries (DR Sales CR COGS; DR COGS CR Inventories)
When combined the [I-Sales] and [I-COGS] entries eliminate the effects of sale of inventory. Sales and COGS are eliminated and inventory writeup (due to sale) is eliminated
Describe the accounting procedure for acquisitions that are done in stages (step acquisitions)
When the investor gains control is considered the DOA. On DOA all E/Investments made by investor must be revalued and any gain/loss as a result must be recognized. GW should also be measured
Should all intercompany profit or loss be eliminated?
Yes, all intra-entity profit or loss on assets remaining within the consolidated group should be eliminated
[ADJ] formula
[ADJ] = (P% x changeInSubREsinceDOAthruBOY) - accum P% AAP amort thru BOY - 100% x unconfirmed downstream I/C profit - P% x unconfirmed upstream I/C profit
P sells equip to S for X. Original cost is Y (resulting in loss) and accum dep is Z. P dep using "A" year life. S will use "B" year life. What is the corresponding JE?
[I-gain] DR Equipment (Y-X) CR Accum dep Z CR Loss on sale of equip (Y-Z-X)
How does the [I] consolidation entry differ for upstream and downstream intercompany sales of inventories?
If it is wholly owned then there is no difference between elimination in upstream and downstream transactions. Deferred profit is removed regardless of direction.
What is the procedure to follow when a subsidiary has a different fiscal-year-end from the parent
If the difference in the year end is more than about 3 months then the subsidiary should prepare financial statements for a period more close to the parent's fiscal year. If less than 3 months then the subsidiary financial statements can stand, although a disclosure should be made.
Describe how FASB ASC 810 (Consolidation) combines the analysis of variable and voting interest entities into a single consolidation model
If the entity does have variable interest, then the company must find if a "general scope exception" applies. If one of these exceptions applies then there cannot be a consolidation of the entity. If there is no general scope exception then it must be evaluated if there is a "business-related scope exception". If there is a business-related scope exception, then it is evaluated based on ownership, with a majority owned meaning it must be consolidated. If no business scope then it can evaluate if the entity is a VIE to be consolidated if the company is the primary beneficiary
P acquires bonds directly from S. Describe consolidation adjustments P must make to prepare consolidated financial statements in year of purchase. Describe consolidation adjustments P must make in following years. Would it be different if P and S were switched?
In year of purchase, bond related accounts must be eliminated from consolidated financial statements. Because P and S are dealing directly there is (usuallyP no gain/loss on constructive retirement of debt. In years following, bond related accoutns must continue to be eliminated from consol F/S. During the life of the bonds, amount eliminated will accrue to the face value of the bonds as any discounts/premiums are amortized in their respective books. No the process would be exactly the same.
P acquires from third party bonds that were issued by one of it's subsidiaries. Describe the consolidation adjustments the parent must make in preparing consolidated financial statements in the year of the purchase of the S bonds. Describe the consolidation adjustments in the following years. Would the process change if the P and S were switched?
In year of purchase, bond related accounts must be eliminated from consolidated financial statements. Gain/loss (equal to net of P & S discounts/premiums) on constructive retirement of debt must be recognized. In following years, bond related accounts continue to be eliminated. During life of the bonds, amount eliminated will accrue to face value of bonds as discounts/premiums are amortized. Assuming 100% of constructive gain/loss is allocated to P, there is no gain/loss allocated to NCI. Nope it's the same
Which intercompany transactions should be eliminated?
Intra-entity balances and transactions (including open account balances, security holdings, sales, purchases, interest, dividends ...)
How does the timing of the deferral and recognition of the profit differ between sales of inventories and sales of land and depreciable assets?
Inventory deferral and recognition is often occuring on a shorter time span. Inventories are usually recognized from the prior period and deferred from the current period. For land, the profit is deferred until it is sold outside. For depreciables, deferred gain/loss is gradually recognized during the useful life.
What is the purpose of the business-related scope exception in FASB ASC 810 (consolidation)?
It allows entities that are considered businesses to avoid complex variable interest entity evaluation. Unless in 4 scenarios 1. reporting entity/related parties participated significantly in design of legal entity 2. legal entity is designed so that substantively all activities involve or are on the behalf of the reporting entity/related parties 3. reporting entity/related parties provide more than half of subordinated financial support of legal entity (based on FV analysis) 4. activities of the legal entity are primarily related to securitizations or other asset backed financings or leasing arrangements
What approaches might a company take to value noncontrolling interests? (required to value NCIs on DOA)
It is required that the acquirer values the NCI at fair value on the DOA, sometimes through quoted fair market price for equity shares.
Wholly owned subsidiary reports sales of 500k and net income of 100k for year which it was acquired on 07/01. What amount of sales and net income are includable in the consolidated I/S in the year of acquisition assuming that sales and net income are earned evenly?
6 full months have passed so 1/2 of sales (250k) and 1/2 of net income (50k) will be recognized on the consolidated I/S
What is a variable interest?
A financial interest whose values depend on the change in value of an entity's net assets. Owners of variable interest within an entity must be entitled to the expected residual returns/losses
What is a special purpose entity?
A separate, legal, bankruptcy remote entity created by a sponsor (typically the operator) to fufill very specific and limited business objectives. Usually robot like entities that have no physical location, no independent management, and make no strategic business decisions.
What is a voting interest entity?
A voting interest entity is the typical "majority owned entity" as compared to the variable interest entity. Controlled through common equity holders. Less specialized
What is AAP?
Accounting Aquisition Premium (AAP) is the premium paid by acquiring entity to gain control. AAP = FV consideration transferred - BV net assets acquired
What are the primary benefits for operating companies in obtaining off-balance-sheet treatment for assets with regards to SPEs?
By shifting assets off the balance sheet, the company can improve metrics that investors use to evaluate companies. This results in increased valuation of the company.
Cost of Goods Sold
COGS = beg Inv + purchases - ending inv
When preparing consolidated financial statements, what's the main reason why we eliminate all I/C transactions between parent and subs?
Commonly controlled affiliates represent a single economic entity. These entities cannot engage in economically substantive transactions with themselves
When a parent acquires a subsidiary's debt instruments from a third party, how is the consolidated gain/loss on constructive retirement of the debt calculated? In what period should the gain/loss be recognized in the consolidated financial statements?
Gain/loss on constructive retirement = CV of sub debt - amount for which P purchased debt. It is also equal to the net of the unamortized discount/premium for both sub and parent on date of bond purchase. Entire gain/loss should be recognized in the period where the parent intitially invests in I/C debt
P owns 100% of S. P sells land to S for X with an original cost of Y. P uses equity method. What is the associated JE?
DR Equity Investment (X-Y) CR Land X-Y (To defer gain on sale of X-Y and bring Land account back to pre-sale reported amount)
What is the purpose of DR Gain on sale DR Equipment CR Accum Dep in relation to I/C sales of depreciable assets during sale period?
Debiting Gain on sale reverses the gain on sale so that the profit isn't in Con. I/S. Debiting equipment and crediting accum dep. returns balances to pre-sale amounts
What is the purpose of DR Accum Dep and CR Dep Exp relating to I/C sales of depreciable assets after the sale?
Depreciation reported by the buyer is different than what the seller reports if the sale didn't happen. This entry adjusts the accum dep and dep exp back to pre-sale amounts
What is the purpose of DR Equity Investment CR Land that is made each period after I/C sale of land until it is sold outside?
During the sale period, gain is reversed and land is adjusted back down to pre-sale balance. After the sale period (but before outside sale), reduce RE to remove gain from sale
What does it mean when we say a special purpose entity is bankruptcy remote?
Even if the sponsor goes bankrupt, the assets under the SPE are protected from creditors of the sponsor. If both the SPE and the sponsor go bankrupt then the assets of the SPE are only accessable by owners of the SPE
Describe how conceptually the [C] entry for the equity method and cost methods of preconsolidated bookkeeping are the same
Even though they involve different accounts, the [C] entry rolls back changes in the parent's financial statements by taking into consideration the equity investment. (Equity method: investment income & dividends) (Cost method: dividends)
What is the procedure for when losses attributable to a noncontrolling interest exceed the equity balance? (negative balance for NCI equity)
Excess (and further losses) attributable to parent and NCI shall be attributed to those interests. NCI will continue to be attributed its share of losses even if it results in a negative NCI balance
What are expected losses and expected residual returns?
Expected losses are characterized by expected negative variability in the FV of a legal entity's net assets (not from income/loss) Expected residual returns are expected positive variation in the FV of a legal entity's net assets (also not income/loss)
P acquires from third party outstanding bonds of its sub. In consolidated financial statements, this transaction resulted in a loss on constructive retirement of debt equal to 100k. How should this loss be allocated to the CI and NCI? Why?
FASB ASC 810 doesn't mandate a specific proportion of elimination to be attributed to the P or S. We assign 100% of the I/C bond elimination to the parent's interest in the sub. This matches with the parent being in control, and therefore being responsible for the constructive retirement of the debt.
Why does Ford Motor Credit's use of SPEs suggest that there are legitimate financing benefits to transferring assets to SPEs?
FMC can borrow against the assets of the less risky SPE, allowing for a much lower interest rate
Describe the [C] entry when the parent uses cost vs equity method of preconsolidation bookkeeping
For both, [C] is used to remove the effect of the P investement accounting during the year and establish the change in NCI during the year. For cost, income from investee = P% x investee dividends, this removes the P% portion of dividends from P I/S. This also establishes the change in the NCI by establishing the income attributable to NCI and reducing the noncontrolling interest for 1-P5 portion of S dividends
What is the difference between consolidated GW and NCI when the P chooses the IFRS alternatives of "full fair value" recognition vs "proportionate share" recognition?
Full fair value: consolidated GW and NCI reflect 100% values of CI and NCI. Proportionate share: NCI is assigned acq. date CV equal to proportionate (1-P%) interest in FV of identifiable net assets, thus no GW is assigned to NCI
When a parent acquires a subsidiary's debt instruments from a third party, consolidated F/S should recognize gain/loss on the constructive retirement of the debt. On the date of the bond purchase, how does this gain/loss relate to the discount/premium accounts recognized on the separate pre-consol F/S of P and S?
Gain/loss on constructive retirement = CV of sub debt - amount for which P purchased debt. It is also equal to the net of the unamortized discount/premium for both sub and parent on date of bond purchase.
When a parent acquires a subsidiary's debt instruments from a third party, consolidated F/S should recognize gain/loss on the constructive retirement of the debt. Over the remaining life of the bonds, how does this gain/loss get recognized in the separate pre-consol F/S of P and S?
Gain/loss on constructive retirement = CV of sub debt - amount for which P purchased debt. It is also equal to the net of the unamortized discount/premium for both sub and parent on date of bond purchase. Consolidated gain/loss on constructive retirement of debt is recognized in separate pre-consol books of P and S in interest income and interest expense through the amortization of the bond discount/premium by P and S
What is the underlying assumption of consolidated financial statements?
That they represent the financial position and operations of a single economic entity
Describe the process of the [ADJ] consolidation entry when the parent applies the cost method of pre-consolidation bookkeeping
The adjusting entry updates the parent's BOY RE to reflect the consolidated BOY RE. The offset is the investment account which is eliminated during consolidation. The real goal is to make the parent's BOY RE look like the equiity method was used (or appear to be consolidated)
What is a noncontrolling interest?
The portion of equity interest in a subsidiary not attributable to the parent company, also called minority interest
What is the primary benefit most likely obtained by the sponsor of a special purpose entity when the sponsor transfers assets to a SPE?
The primary goal when a primary transfers assets to a SPE is to reduce capital costs for the business. This is achieved through transferring a group of assets with predictible cash flows to a legally isolated entity. Thus the SPE is less risky compared to the operations of the whole business, reducing return that creditors expect from the SPE
What is a primary beneficiary?
The reporting company that has a controlling financial interest of the VIE. Determination of the primary beneficiary determines whether or not a VIE must be consolidated by the reporting company
Explain the process by which assets are written up (or down) on intercompany asset transfers and why GAAP prohibits recognition of profit in intercompany transfers of assets
The sale price of an asset is the buyer's purchase cost. When sold the asset is written up or down from original cost to market value. This write up/down in the CV is reflected in the I/S as profit or loss. GAAP doesn't allow recognition on I/C transfers because it happens within a single economic entity.
If an operating company is the primary beneficiary of a variable interest entity, why do we need to know whether the variable interest entity meets the definition of a business?
To determine the recognition of goodwill. If the reporting company is the primary beneficiary then it should be consolidated. However, the reporting company should only recognize GW if the VIE can be defined as a business
What is the objective and primary audience of consolidated financial statements?
To present the results of operations and the group's financial position to shareholders and creditors of the parent entity.
If a legal entity does not qualify for the business-related scope exception, what are the criteria that determine whether a legal entity is a VIE?
Total equity at risk is not sufficient to permit the entity to finance its activities OR The equity holders lack any of: 1. Power to direct activities of legal entity that most significantly impact the entity's performance 2. Obligation to absorb expected losses 3. Right to recieve expected returns
Describe the reason why the [ADJ] consolidating entry is necessary when preparing consolidating financial statements for a parent company that applies the cost method of pre-consolidation bookkeeping
Under cost, P doesn't adjust pre-consol E/Investment after DOA, P also doesn't recognize equity method I/S effects in pre-consol I/S. This means that the P pre-consol RE will be moved further away from the amount of the consolidated beginning RE. Thus the [ADJ] entry is needed to true up beginning RE
When a parent acquires a subsidiary's debt instruments from a third party, consolidated F/S should recognize gain/loss on the constructive retirement of the debt. Afterward, the [I-bond] consolidation entry is required to correct the beginning balance of the equity investment account. Why is this adjustment needed? Why does this adjustment gradually decrease over the life of the bonds?
Under full equity method, gain/loss on constructive retirement of I/C debt is recognized by P in pre-consol books (meaning gain/loss is part of the investment account). When consolidating, the investment account is eliminated. This amount gradually declines over the remaining life of the bonds so that when the bond matures, the difference will be fully amortized and the CV and face value of the bond will match
What is a variable interest entity?
Variable interest entities (VIEs) were first introduced by FASB in 2003 after the Enron/WorldCom/Andersen scandal. A VIE is an entity in which the investor holds a controlling interest that is not based on the majority of voting rights
Describe the procedure for de-consolidiation of a subsidiary
When P loses control and de-consolidates, E/Investment process has finished and P recognizes a gain/loss from de-consolidation
What conditions determine whether a reporting entity is the primary beneficiary of a VIE?
When a controlling financial interest exists due to power to direct economic activities, obligation to absorb losses, and recieve gains of the VIE.
