Introduction to Consolidated Financial Statements

(Start of CPAexcel Flashcards) List the methods a parent may use to carry investment in subsidiary to be consolidated.

1. Cost; 2. Equity; 3. Any other method it chooses.

What are the kinds of information needed to prepare consolidated financial statements?

1. Financial statements/Adjusted trial balances of affiliated entities; 2. Data as of date of acquisition, including: a. Book values of subsidiary's assets and liabilities; b. Fair values of subsidiary's assets and liabilities; c. Fair value of noncontrolling interest, if any; d. Fair value of precombination equity interest, if any. 3. Intercompany transaction data and balances.

Identify the general kinds of eliminating entries made in the consolidating process.

1. Investment eliminating entry. (Always); 2. Intercompany Receivables/Payables elimination(s); 3. Intercompany Revenues/Expenses elimination(s); 4. Intercompany Profit elimination(s).

What is the basic sequence of steps in the consolidating process?

1. Record trial balances on consolidating worksheet; 2. Record adjusting entries, if any; 3. Record eliminating entries; 4. Complete consolidating worksheet; 5. Prepare consolidated financial statements.

What are the alternative circumstances that affect adjustments and eliminations made in the consolidating process? (Disregard pooling of interests consideration.)

1. Whether the parent carries its investment using the cost or equity method; 2. Whether the consolidation is carried out at the date of the business combination or at a subsequent date; 3. Whether the parent owns 100% (all) of the voting stock of a subsidiary or less than 100% of the stock; 4. Whether transactions between the affiliated companies originate with the parent or subsidiary.

A Parent Must Report Entities under its Control in Consolidated Statements

A Parent Must Report Entities under its Control in Consolidated Statements A. The method a Parent uses to carry an "Investment" in a subsidiary on its books (cost, equity, or other) will affect only the consolidating process (entries). B. The method a Parent uses to carry an "Investment" in a subsidiary on its books (cost, equity, or other) will not affect final resulting Consolidated Statements. C. Consolidating Process Illustrated -- The following illustrates the use of alternative methods by a parent to carry its investment in a subsidiary (the cost method and the equity method) and the effects of those different methods on the consolidating process (different) and on the final consolidated statements (the same).

How does a parent company record a subsidiary?

As an "Investment".

Background

B. In either of the foregoing cases, the entities are separate legal entities, but are under common economic control. 1. The shareholders of the parent entity control that entity which, in turn, has control of the subsidiary entity. 2. The shareholders of the variable-interest holder entity control that entity which, in turn, has control of the variable-interest entity.

Consolidating Process

B. The basic sequence of steps in carrying out the consolidating process are (each of these requirements is covered in detail in the following lessons): 1. Record Trial Balances -- Record account titles and balances of the separate entities on the consolidating worksheet from the adjusted trial balances, separate statements, or other sources. 2. Record Adjusting Entries -- Develop and post to the worksheet consolidating adjusting entries, if any. 3. Record Eliminating Entries -- Develop and post to the worksheet consolidating eliminating entries; these entries are likely to include: a. Investment eliminating entry (always required); b. Intercompany receivables/payables elimination(s); c. Intercompany revenue/expense elimination(s); d. Intercompany profit elimination(s). 4. Complete consolidating worksheet. 5. Prepare formal consolidated financial statements from worksheet.

Background

Background A. Consolidated financial statements are required when one entity has effective control over another entity. 1. Controlling interest is usually present when an entity (investor/parent) has a greater than 50% ownership (directly or indirectly) of another entity (investee/subsidiary) and therefore can direct the activities of the investee/subsidiary; or 2. Control is also evident when an entity (variable-interest holder) is the principal beneficiary of a variable-interest entity.

Background

C. Because the entities are under common economic control, GAAP requires consolidated financial statements. 1. Consolidated financial statements present the financial information of two or more separate legal entities, usually a parent company and one or more if its subsidiaries, as though they were a single economic entity (remember the economic entity concept from the conceptual framework?!). 2. The consolidating process is the sequence of steps or activities carried out in order to combine the financial information of two or more entities. The consolidating process results in consolidated financial statements. D. The process of presenting consolidated financial statements can be represented graphically in the following way:

What is the requirement and justification for the use of consolidated financial statements?

Consolidated financial statements are required when one entity has effective control of another entity. Because the entities are under common control, GAAP requires that consolidated financial statements be the primary form of financial reporting for the affiliated entities. While in form the entities may be separate legal entities, because of the common control, in substance they are a single economic entity and their financial statements should be presented as a single economic entity.

Define "consolidated financial statements".

Consolidated financial statements present the financial information of two or more separate legal entities, usually a parent company and one or more of its subsidiaries, as though they were a single economic entity.

Consolidating Process

Consolidating Process A. The consolidating process is carried out on a consolidating worksheet, not on the books of any entity. 1. The basic information for the worksheet comes from the account balances of the separate entities. 2. The consolidating process is primarily concerned with adjusting and eliminating those balances to develop information that would report the separate entities as though they were a single entity. 3. The consolidating process and the results of that process are not recorded on the books of any of the affiliated entities. 4. The result of the consolidating process is the full set of consolidated financial statements.

Exceptions

Exceptions B. Certain entities are precluded from consolidating controlled entities by industry-specific guidelines, including: 1. Registered investment companies. 2. Brokers/dealers in securities. C. A variable-interest (investment) or subsidiary (unconsolidated subsidiary) that is not included in consolidated statements would be reported as an "Investment" by the interest-holder/investor. 1. The variable-interest investment would be measured as the entity's claim to the net asset value of the variable-interest entity. 2. The unconsolidated subsidiary investment would be measured using either fair value or the equity method of accounting, depending on the extent of influence that can be exercise over the subsidiary by the parent.

Exceptions

Exceptions There are certain limited exceptions to when an entity must consolidate another entity. Those exceptions include: A. If an investor/parent has majority ownership of an investee/subsidiary (> 50% of the voting stock of the investee), but is prevented from exercising that majority ownership to control the financial and operating policies or activities of the subsidiary, it will not consolidate the subsidiary. Effective control may be lacking (even for a majority owned subsidiary) when it is: 1. A foreign subsidiary largely controlled by the foreign government through prohibition on paying dividends, control of day-to-day operations, or other impediments to control. 2. A domestic subsidiary in bankruptcy and under the control of the courts.

Factors Effecting the Consolidation Process

Factors Effecting the Consolidation Process While the general process is the same for carrying out all consolidating processes, the specific adjustments, eliminations and related amounts depend on the specific circumstances. The following alternatives will affect the specific adjustments and eliminations made during the consolidating process: A. Whether the consolidating process is being carried out at the date of the business combination or at a subsequent date. B. Whether the parent owns 100% (all) of the voting stock of a subsidiary or less than 100% of the voting stock. C. Whether on its books the parent carries its investment in a subsidiary using the cost or equity method of accounting. D. Whether transactions between the affiliated entities (parent and its subsidiaries) originate with the parent or with a subsidiary.

Under U.S. GAAP, what process must be followed to determine if an entity should be consolidated?

First, it must be determined if the entity is a variable-interest entity (VIE). If it is, the reporting entity must determine if it is the primary beneficiary of the VIE and, if so, consolidate the VIE. Then, if the entity is not a VIE, the reporting entity must determine if it has controlling voting interest in the entity. If so, and nothing prevents the exercise of that control, the reporting entity (parent) must consolidate the entity (subsidiary).

Which one of the following kinds of accounts is least likely to be eliminated through an eliminating entry on the consolidating worksheet? A. Receivables. B. Investment. C. Goodwill. D. Payables.

Goodwill may be recognized by the entry that eliminates the parent's investment in the subsidiary against the parent's share of the subsidiary's shareholders' equity, but goodwill will not be eliminated through an eliminating entry.

Information Requirements

Information Requirements In order to consolidate the financial statements of two or more entities, certain specific information is needed, including: A. Financial statements (or adjusted trial balances) of the separate affiliated entities to be consolidated. B. Data as of the date of a business combination (i.e., acquisition date): 1. Book values of assets acquired and liabilities assumed as of the acquisition date. 2. Fair values of assets acquired and liabilities assumed as of the acquisition date. 3. Fair value of any noncontrolling interest in the acquired entity as of the acquisition date. 4. Fair value of any equity interest in the acquired entity owned by the parent prior to the acquisition date. C. Intercompany (i.e., between the companies being consolidated) transaction data (for the operating period) and intercompany balances (as of period end).

Justification

Justification The preparation and presentation of consolidated financial statements is justified based on: A. The presumption that consolidated statements are more meaningful than separate financial statements. 1. "There is a presumption that consolidated statements are more meaningful than separate statements and that they are usually necessary for a fair presentation when one of the entities in the group directly or indirectly has a controlling financial interest in the other entities" (ASC 810-10-1). B. The supposition that economic substance (common controlling interest) take precedence over legal form (separate legal entities)

Note 20 more Questions on CPAexcel

Note 20 more Questions on CPAexcel

Where is the consolidating process carried out?

On a consolidating worksheet; not on the books of any entity.

Parent's Accounting for a Subsidiary to be Consolidated

Parent's Accounting for a Subsidiary to be Consolidated A. A Parent records a subsidiary on its books as an "Investment" (in Subsidiary). B. Subsequently, a Parent may carry an "Investment" in a subsidiary that will be consolidated on its books using: 1. Cost Method; 2. Equity Method; 3. Any other method it chooses.

Which of the following statements, if any, concerning the preparation of consolidated financial statements is/are correct? I. The consolidating process is carried out on the books of the parent entity. II. The consolidated financial statements report two or more legal entities as though they are a single economic entity.

The consolidated financial statements report two or more legal entities (a parent and its subsidiary/ies) as though they are a single economic entity. Because the entities are under the common economic control of the parent's shareholders, GAAP requires that consolidated statements be the primary form of financial statement disclosure.