Consolidated Statements Exam 2 (CH 4-6)
Benefits of VIE:
-Often eligible for a lower interest rate -Low-cost financing of assets
Entry *G
Buyer's Cost of Goods Sold and seller's Retained Earnings accounts as of the beginning of Year 2 contain intra-entity profit and must both be reduced. results in a debit to retained earnings and credit to COGS for the same amount as the previous year Entry G.
Governing agreements limit activities and decision making.
Enterprise that created VIE may not own any of its voting stock.
The consolidation process is substantially the same as consolidation without a noncontrolling interest.
However, a column will be added to the worksheet to record the noncontrolling interest in the subsidiary.
Accounts affected by intra-entity transactions:
Revenues Cost of Goods Sold Net Income Attributable to the Noncontrolling Interest Retained Earnings at the Beginning of the Year Inventory Noncontrolling Interest in Subsidiary at End of Year
IF: 1)The original transfer is downstream (parent's) AND 2) The parent applies the equity method for internal accounting purposes
THEN: Investment in Subsidiary account replaces parent's beginning Retained Earnings in consolidation entry *G.
when the original sale is downstream and the parent has applied the equity method
The reduction in Retained Earnings is changed to an increase in the Investment in Subsidiary account
The noncontrolling shareholders' portion of consolidated net income is limited to their percent share of adjusted subsidiary income.
They own a percent interest in the subsidiary company but NO ownership in the parent firm.
The statement of changes in owners' equity provides details of the ownership changes for the year for
both the controlling and noncontrolling interest shareholders.
Investors are the owners of the VIE
but they may retain little responsibility of ownership risk and benefits.
Downstream Transfers (Entry *G)
results in a debit to Investment in Subsidiary and credit to COGS.
For a downstream transfer, Entry *TA replaces the parent's Retained Earnings with
the Investment in Subsidiary account.
If the parent doesn't own 100 percent of the company, outside owners are referred to as
a noncontrolling interest.
Intra-Entity Gross Profit—Year Following Transfer
a overstatement remains in the separate financial records of the buyer and seller. The overstatement is removed from beginning inventory in the financial statements with Entry *G. The asterisk indicates that a previous year transfer created the intra-entity gross profits.
The primary beneficiary will absorb
a significant share of the VIE's losses or receive a significant share of the VIE's residual returns or both.
Once a firm has a relationship with a VIE
the firm must determine whether it qualifies as the VIE's primary beneficiary.
In producing consolidated financial statements
transfers are eliminated.
Contractual arrangements may limit returns to equity holders,
yet participation rights provide increased profit potential and risks to the primary beneficiary.
Entry G Portion of Inventory Remains
(Gross Profit/Transfer Price) x the portion of inventory remaining. results in a debit to COGS and credit to inventory.
the primary beneficiary contributes
substantial resources—loans and/or guarantees—to enable the VIE to secure additional financing to accomplish its purpose
The total fair value of a subsidiary is measured as the
sum of the respective fair values of the controlling and noncontrolling interest.
If the noncontrolling interest's proportionate share of subsidiary's fair values exceeds its total fair value
the excess reduces goodwill recognized by the parent.
The impact on net income created by upstream sales must be considered in
computing the balances attributed to these outside owners.
Complete elimination of the intra-entity profit or loss is
consistent with the underlying assumption that consolidated financial statements represent the financial position and operating results of a single economic entity.
Prior to current consolidation requirements,
enterprises left VIEs unconsolidated in their financial reports.
The parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed
fair value at the date control is obtained.
Removal of the sale/purchase is often just the
first in a series of consolidation entries necessitated by inventory transfers.
Downstream sales are assumed to have
no effect on any noncontrolling interest values.
The effects of the original sale of land transaction
remain in the financial records of the individual companies for as long as the property is held.
When intra-entity transfers are downstream,
deferred intra-entity gross profits relate solely to the parent company and have no effect on the subsidiary or outside ownership.
Equipment is carried on the individual books at a
different amount than on the consolidated books.
Entry ED
eliminates overstatement of depreciation expense caused by the inflated price. Results in a debit to accumulated depreciation and credit to depreciation expense for the difference between the buyer's recorded depreciation expense and the original carrying amount of seller divided by the remaining years.
If after obtaining control, the parent increases its ownership interest in the subsidiary
no further remeasurement takes place.
When the inventory transfers are upstream from subsidiary to parent
only ownership percentage of the profit deferral and subsequent recognition is allocated to the parent's equity earnings and investment account.
Consolidated statements reflect
only transactions with outside parties.
The intra-entity gain and excess depreciation expense
remain on the separate books and are closed into Retained Earnings of the respective companies at year-end.
Entry TA (year of transfer)
removes intra-entity gain and returns equipment accounts to balances based on original historical cost. Debit: Gain on Sale of Equip. Equipment (Difference) Credit: Accum. Depr.
Variable interests increase a firm's risk as the
resources it provides (or guarantees) to the VIE increase.
Entry TL
results in a debit to Gain on Sale of Land and credit to land for the full gain.
The parent accounts for additional subsidiary shares acquired as an equity transaction
consistent with transactions with other owners, as opposed to outsiders.
Because the transaction did not occur with an outside party
recognition of profit is not appropriate for the combination as a whole.
Any resulting gain or loss from the remeasurement should be
recognized in the parent's net income.
Allocated goodwill will not always be proportional to the percentages owned.
The parent first allocates goodwill to its controlling interest for the excess of the fair value of its equity interest over its share of the fair value of the net assets.
If the total fair value of the acquired firm is LESS than the collective sum of its identifiable net assets:
A bargain purchase occurs. Parent recognizes the entire gain in current income. No gain is ever allocated to the noncontrolling interest.
With increased risks come incentives to restrict the VIE's decision making.
A firm with variable interests will regularly limit the equity investors' power through the VIE's governance documents.
U.S. GAAP requires fair value measurement.
Acquisition-date fair value provides a basis for reporting noncontrolling interest, which is adjusted for its share of subsidiary income and dividends subsequent to acquisition.
Variable Interest Entities
Commonly known as special purpose entities. Most are established for valid business purposes. sometimes have no independent management or employees.
The consolidation process for inventory transfers is designed to
defer the intra-entity gross profit remaining in ending inventory from the year of transfer into the year of disposal or consumption.
Common examples of VIE activities:
-Transfers of financial assets -Leasing -Hedging financial instruments -Research and development
An entity qualifies as a VIE if EITHER of the following conditions exists:
1. Total equity at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders. 2. Equity investors in VIE, as a group, lack any one of three characteristics of a controlling financial interest: - The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity's economic performance. - The obligation to absorb the expected losses of the entity. - The right to receive expected residual returns of the entity
Consolidation Entry TI
Cost of Goods Sold is reduced under the assumption that the Purchases account usually is closed out prior to the consolidation process. Total recorded (intra-entity) sales is deleted regardless of whether the transfer was downstream (from parent to subsidiary) or upstream (from subsidiary to parent). Results in a Debit to Sales and Credit to COGS for the full inventory sale amount.
Worksheet Entry TI and Entry G are standard, regardless of the circumstances of the consolidation, but
Entry *G differs.
Accounting and reporting for business combinations between U.S. and international standards has converged with
FASB ASC Topic 805 and IFRS 3R, each of which carries the title "Business Combinations" and ASC Topic 810: "Consolidation."
The amounts change each year as depreciation is computed.
For every subsequent period, separately reported figures must be adjusted on the worksheet to present the consolidated totals from a single entity's perspective.
Entry G All Inventory Remains at Year-End
If ALL transferred inventory IS retained by the business combination at year-end, Entry G eliminates the effects of the seller's gross profit that is unrealized in the buyer's ending inventory in Year 1. Results in a debit to COGS and a credit to Inventory for the difference in sale price and historical cost (aka gross profit).
Amount of intra-entity profit or loss to be eliminated is
NOT affected by the existence of a noncontrolling interest.
When control of a subsidiary is acquired at a midyear date:
New parent must compute the subsidiary's book value as of acquisition date to determine excess total fair value over book value allocations Excess amortization expenses, any equity accrual, and dividend distributions are recognized for a period of less than a year Because only net income earned by the subsidiary after the acquisition date accrues to the new owners, it is appropriate to include only postacquisition revenues and expenses in consolidated totals.
The parent company must determine and enter each of these figures when constructing a worksheet:
Noncontrolling interest in subsidiary at beginning of current year. Net income attributable to noncontrolling interest. Subsidiary dividends attributable to noncontrolling interest. Noncontrolling interest as of the end of the year (three balances above combined).
To report ownership equity in consolidated financial statements
acquisition-date goodwill is apportioned across controlling and noncontrolling interests.
If the parent previously held a noncontrolling interest in the acquired firm
the parent remeasures its interest to fair value and recognizes a gain or loss.
If the transfer is downstream and the parent uses the equity method,
then their Retained Earnings balance has already been reduced for the gain, and we adjust the Investment account instead.
Role of equity investors can be minor
they may serve simply to allow the VIE to function as a legal entity.
A VIE can take the form of a
trust, partnership, joint venture, or corporation.
Primary beneficiary
typically exercises its financial control through governance documents or contractual agreements giving it decision-making authority over the VIE.
The noncontrolling interest's share of consolidated net income is
unaffected by the downstream intra-entity profit deferral and subsequent recognition.
VIEs generally have
assets, liabilities, and investors with equity interests.
Using the equity method for internal reporting, the parent:
1) Recognizes beginning inventory gross profits. 2) Defers intra-entity ending inventory gross profits. Debiting the Investment account allows parent's net income and retained earnings to appropriately reflect consolidated balances.
The ending inventory portion of intra-entity gross profit must be adjusted in two successive years:
1)From ending inventory in the year of transfer. 2)From beginning inventory of the next period.
An enterprise with a variable interest with a controlling financial interest in a VIE is the primary beneficiary and will have BOTH of the following characteristics:
1)The power to direct the activities of a VIE that most significantly impact the entity's economic performance. 2)The obligation to absorb losses that could potentially be significant to the VIE or the right to receive benefits from it that could be significant to the VIE.
Identifiable assets acquired and liabilities assumed are
adjusted to their full individual fair values at the acquisition date.
Elimination of the intra-entity profit or loss may be
allocated proportionately between the parent and noncontrolling interests.
If appropriate, each component of other comprehensive income is
allocated to the controlling and noncontrolling interests.
If the price per share paid by the parent equals the noncontrolling interest per share fair value
goodwill is recognized proportionately across the two ownership groups.
Beneficiary's economic interests vary depending on the VIE's success
hence the term variable interest entity.
Consolidated net income is computed at the combined entity level and
allocated to the noncontrolling and controlling interests.
For securities, the use of specific identification based on serial numbers is acceptable
although averaging or FIFO assumptions often are applied.
Entry *G removes the:
amount from beginning inventory (within Cost of Goods Sold) and increases current net income. Intra-entity gross profit in ending inventory (recognized by the seller in the year of transfer) so that the profit is reported in the period when a sale to an outside party takes place.
Primary beneficiary must consolidate in its financial statements the VIE's
assets, liabilities, revenues, expenses, and noncontrolling interest.
The acquisition method measures the acquired firm (including the noncontrolling interest)
at fair value at the date control is obtained.
For every subsequent consolidation until the land is eventually sold,
the elimination process must be repeated.
From a consolidated perspective, an intra-entity transfer is
the internal movement of inventory that creates no net change in the financial position of the business combination taken as a whole.
If the former parent retains any of its former subsidiary's shares,
the investment should be remeasured to fair value on the date control is lost.
The accounting effect from selling subsidiary shares depends on whether
the parent continues to maintain control after the sale.
Investors may cede financial control of a VIE to the variable interests in exchange for a
guaranteed rate of return.
The entire impact of the intra-entity transfer must be
identified and then removed.
consolidated net income
includes 100 percent of both the parent's and the subsidiary's net income, adjusted for excess acquisition-date fair value over book value amortizations.
Because they bear relatively low economic risk
investors may be provided only a small rate of return.
The noncontrolling interest share of adjusted subsidiary net income
is equivalent to the noncontrolling interest share of consolidated net income, which is then subtracted from consolidated net income to determine the parent's interest in consolidated net income.
If the original sale of land was a DOWNSTREAM transaction
it has no effect on the noncontrolling interest.
If the transfer of land is made UPSTREAM
it is attributed to the subsidiary and the noncontrolling interest.
When the company eventually sells the land to an outsider,
it must recognize the gain deferred at the time of the original transfer.
If the parent maintains control
it recognizes no gains or losses - the sale is shown in the equity section. The parent records any difference between proceeds of the sale and carrying amount as additional paid-in capital.
Noncontrolling interests' ownership pertains only to the subsidiary
its share of consolidated net income is limited to a share of the adjusted subsidiary's net income.
A step acquisition
occurs when control is achieved in a series of equity acquisitions.
Risks and rewards are not distributed according to stock ownership but according to
other variable interests.
If it sells less than the entire investment
parent must select a cost-flow assumption if it has made more than one purchase.
If the sale results in the loss of control
parent recognizes any resulting gain or loss in consolidated net income.
Entry *GL (every year following transfer)
results in debit of retained earnings and a credit to Land for the gross profit.
Entry *TA (year following transfer)
results in debit to equipment and retained earnings and a credit to accumulated depreciation.
Primary beneficiary may guarantee
the VIE's debt, assuming the risk of default.
