Consolidated Financial Statements | Date of Acquisition | Advanced Accounting | CPA Exam FAR

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Those lectures covers consolidated balance sheet and special purpose entities which are covered in an advanced accounting course and CPA exam.

Variable Interest Entity

Consolidated Balance Sheet| Elimination of Investment

When one firm (referred to as the parent) effectively controls the activities of another firm (the subsidiary) through the direct or indirect ownership of some or all of its voting stock or by some other means, consolidated financial statements are required.

The noncontrolling interest in a consolidated entity refers to the stock of the subsidiary firm, if any, which is not controlled by the parent. This interest appears as a component of equity in the consolidated balance sheet.

A firm may acquire stock by open market purchases or by cash tender offers to the subsidiary’s stockholders, thus avoiding the often lengthy and difficult negotiations that are required in a complete takeover. Control of the subsidiary’s operations can be accomplished with a much smaller investment, since not all of the stock need be acquired. Also, the separate legal existence of the individual affiliates provides an element of protection of the parent’s assets from attachment by creditors of the subsidiary.

In the consolidated balance sheet, the assets and liabilities of the subsidiary are combined with those of the parent on an item-by-item basis. Assets and liabilities are reflected at their fair market values, as determined at the date of acquisition, including goodwill, if any (and as subsequently depreciated, amortized, or adjusted for impairment).

Essentially all controlled corporations should be consolidated with the controlling entity. Exceptions include those situations where: the subsidiary is in legal reorganization or bankruptcy, or a foreign subsidiary operates in an environment that casts significant doubt about the parent’s effective control.

Consolidated financial statements are of limited use to noncontrolling stockholders, to subsidiary creditors, and possibly to regulatory agencies (e.g., if only the subsidiary is regulated). Also, when highly diversified companies operate across several industries, the aggregation of dissimilar data makes analysis difficult.

On the books of the parent company, the investment is recorded as a debit to Investment in Subsidiary and a credit to the appropriate account(s) based on the consideration used in the exchange (cash, debt, stock, or a combination). Any stock issued is recorded at its fair market value, and the investment is thus also recorded at the fair value of consideration paid. Direct and indirect acquisition costs, if any, are recorded (expensed) separately from the acquisition.

The consolidated workpapers serve to sum the assets and liabilities of the parent and subsidiary, with adjustments made to assets and liabilities of the subsidiary to “mark” their values to market values, based on the acquisition price implied for the entire subsidiary. These adjustments are accomplished via “eliminating and adjusting” entries, which also serve to eliminate the investment account against the subsidiary’s equity accounts, and to recognize the noncontrolling interest in equity.

The difference between implied and book values of the acquired firm’s equity is the amount by which the subsidiary’s assets and liabilities must be adjusted in total (including the recognition of good- will, if any). The use of an account by this name (difference between implied and book values) facilitates this process in the eliminating entries, and the differential account itself is eliminated.

Both U.S. GAAP and IFRS now require that all controlled SPEs (special purpose entities) be consolidated, but U.S. GAAP still recognize variable interest entities (VIEs), while IFRS do not. IFRS allow a choice in the valuation of the noncontrolling interest in equity and related goodwill, while FASB requires the implied fair valuation (as evidenced by the acquisition price) for both. IFRS require that parent and subsidiary accounting policies conform; U.S. GAAP do not. Both now require the capitalization of purchased in-process R&D.