CH 3 ADV

Noncontrolling Interest

- Only a controlling interest is needed for the parent to consolidate the subsidiary—not 100% interest. - Shareholders of the subsidiary other than the parent are referred to as "noncontrolling" shareholders. - Noncontrolling interest refers to the claim of these shareholders on the income and net assets of the subsidiary.

Consolidation: The Concept

- Parent creates or gains control of the subsidiary. - The result: a single reporting entity.

Special Purpose Entities

See SPE/VIE Handout

Variable Interest Entities (VIEs)

See SPE/VIE Handout

Ability to Exercise Control

-Sometimes, majority stockholders may not be able to exercise control even though they hold more than 50 percent of the outstanding voting stock, such as: > Subsidiary is in legal reorganization or bankruptcy. >Foreign country restrictions, such as remittance of subsidiary profits to a parent company based in another country. -An unconsolidated subsidiary is reported as an intercorporate investment

Differences in Fiscal Periods

- Difference in the fiscal periods of a parent and subsidiary should not preclude consolidation. > Often the fiscal period of the subsidiary is changed to coincide with that of the parent. > Another alternative is to adjust the financial data of the subsidiary each period to a basis consistent with the fiscal period of the parent.

Traditional view of control includes:

- Direct control that occurs when one company owns a majority of another company's common stock. - Indirect control or pyramiding that occurs when a company's common stock is owned by one or more other companies that are all under common control.

Issue 1: Should 100% be Consolidated?

- Full consolidation required by US GAAP (100%) -This means two special accounts appear in consolidated statements: > NCI in Net Income of Sub (I/S) Like an "expense" in the consolidated income statement "Reported income that doesn't belong to us." >NCI in Net Assets of Sub (B/S - Equity) Equity of unrelated owners Net assets on our balance sheet not belonging to us."

Issue 2: Where to report NCI in Net Assets?

- Old rules: Could report it in equity, liabilities, or the "mezzanine" (no man's land) between liabilities and equity. - New rules: Must report in equity. ASC 810-10-55 makes clear that the noncontrolling interest's claim on net assets is an element of equity, not a liability.

Make calculations and prepare basic elimination entries for the consolidation of a less-than-wholly-owned subsidiary.

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The Reporting Entity and Consolidation of Less-than-Wholly-Owned Subsidiaries with No Differential

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Variable Interest Relationships

* Situations in which an entity receives benefits and/or is exposed to risks similar to those associated with a majority ownership interest. * Result from contractual arrangements: - Options - Leases - Guarantees of asset recovery values - Guarantees of debt repayment * Such contractual arrangements may exist simultaneously with a less than majority ownership in a VIE.

VIEs: The Primary Beneficiary

* The primary beneficiary of a VIE must consolidate the VIE. * The primary beneficiary is the entity that - has the power to direct the activities of a VIE that most significantly impact the VIE's economic performance. -will absorb losses or receive the benefits from the VIE that could potentially be significant to the VIE. * Only one primary beneficiary can exist for a VIE (by definition).

Combined Financial Statements

* The procedures used to prepare combined financial statements are essentially the same as those used in preparing consolidated financial statements: -Eliminate all intercompany receivables, payables, transactions, unrealized profits and losses, ownership, and the associated portion of stockholders' equity. -The remaining stockholders' equity is divided into the portions accruing to the controlling and non-controlling interests.

Special Purpose Entities (SPEs)

* What is normally the business purpose? -Bundle peripheral activities and have them done by an independent, but close, associate. -Move liabilities off the balance sheet. -Provide favorable terms for certain transactions (financing, leasing, etc.). Examples: >Acquire financing for a project. >Package receivables and sell them to third parties.

Combined Financial Statements

*Combined financial statements are sometimes prepared for a group of companies when no one company in the group controls any other company in the group, such as when -an individual, not a corporation, owns or controls multiple companies. -a parent company prepares financial statements that only include subsidiaries, and not itself. -a parent company prepares financial statements for its subsidiaries by operating group.

Different Approaches to Consolidation

*Theories that might serve as a basis for preparing consolidated financial statements: - Proprietary theory - pro-rata consolidation -Parent company theory - separate recognition of NCI claim on net assets and earnings -Entity theory - emphasis on consolidated entity * With the issuance of ASC 805, the FASB's approach to consolidation primarily reflects the entity theory.

Noncontrolling Interest

- Computation of income to the noncontrolling interest >In uncomplicated situations, it is a simple proportionate share of the subsidiary's net income. -Presentation >ASC 810-10-50 requires that * the term "consolidated net income" be applied to the income available to all stockholders, *with the allocation of that income between the controlling and noncontrolling stockholders shown.

Subsidiary Financial Statements

- Creditors, preferred stockholders, and noncontrolling common stockholders of subsidiaries are most interested in separate financial statements of entities in which they have an interest. - Because subsidiaries are legally separate from their parents, >the creditors and stockholders of a subsidiary generally have no claim against the parent, and >the stockholders of the subsidiary do not share in the profits of the parent.

Understand and explain differences in the consolidation process when the subsidiary is not wholly owned.

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Understand and explain how direct and indirect control influence the consolidation of a subsidiary.

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Understand and explain rules related to the consolidation of variable interest entities

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Understand and explain the differences in theories of consolidation

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Understand and explain the purpose of combined financial statements and how they differ from consolidated financial statements.

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Understand and explain the usefulness and limitations of consolidated financial statements.

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