Consolidation Theories, Push Down Accounting, and Corporate Joint

Ventures Pertemuan 21-22

Mata kuliah : F0074 - Akuntansi Keuangan Lanjutan IITahun : 2010

1: Consolidation Theories1: Consolidation Theories

Consolidation Theories, Push-Down Accounting and Corporate Joint Ventures

Parent Company TheoryConsolidated financial statements are• Extension of parent company statement• Viewpoint of parent company shareholders

Prepare consolidated statements• To benefit parent company shareholders

Noncontrolling interests • Have the separate (subsidiary) statements

Entity TheoryConsolidated financial statements• Viewpoint of the total business entity• All resources of the entity are valued consistently

– Impute the value of the firm from the acquisition price

• Income of noncontrolling interests is a distribution of the total business income

Income Reporting• Parent company theory and traditional theory

– Consolidated net income is income to the parent company shareholders

• Entity theory– Total consolidated income is to be shared between the

controlling and noncontrolling interests

Asset Valuation• Parent company theory and traditional theory

– Assets and liabilities are adjusted to market value at acquisition, but only to the extent of the parent's ownership share.

• Land with a book value of $50 and fair value of $80 would be consolidated at $80 if the parent owned 100%, but at $71 (including only 70% of the $30 appreciation in value) if the parent owned 70%

• Entity theory– Assets and liabilities are consolidated at fair value

• Land would be consolidated at $80 regardless of ownership percentage.

Unrealized Gains and Losses• Parent company theory

– Unrealized gains and losses attributable to the subsidiary are only eliminated to the extent of the parent's ownership

• 80% of the $10 unrealized profits on upstream sales would be eliminated if the parent owned 80% of the subsidiary

• Entity theory and traditional theory– Unrealized gains and losses are eliminated

• All theories treat downstream gains and losses the same

Consolidated Stockholders' Equity

• Contemporary theory– Noncontrolling interest is a single amount and a part

of stockholders' equity• Entity theory

– Noncontrolling interest is also part of stockholders' equity

– It would be decomposed into paid in capital, retained earnings, etc.

• Other ideas being promoted– Use footnote disclosure for CI and NCI shares of

consolidated income– Use proportional consolidation, excluding NCI from

the statements

2: Push-Down Accounting2: Push-Down Accounting

Consolidation Theories, Push-Down Accounting and Corporate Joint Ventures

SEC Requires Push-Down• SEC requires push-down accounting for SEC

filings when the subsidiary– Is substantially fully owned (97%), and– Has substantially no public debt or preferred stock

• Establishes a new basis for the assets and liabilities– Based on acquisition price

• Arguments against– Subsidiary is not party to the acquisition – Subsidiary receives no new funds, sells no assets

Push-Down Procedure• Assets and liabilities are revalued• Goodwill, if any, is recorded• Retained earnings (prior to acquisition) are

eliminated• Push-down capital replaces retained earnings

– Includes old retained earnings– Any adjustments to assets and liabilities, including

goodwill

Push-Down Example• Paly buys 90% of Sim. Sim's book and fair values are:

• If Sim applies push-down accounting, it would revalue its inventories, fixed assets, liabilities, and record goodwill.

  BV FV     BV FVCash 5 5   Liabilities 25 30

Inventory 10 15   Capital stock100  

Plant assets

200

300  

Retained earnings 90  

Goodwill 0 50   Total215  

Total215

370        

Sim Uses Parent Company Theory• Sim revalues assets and liabilities only to the

extent of Paly's ownership. Only 90% of the increases/decreases are recorded.

Inventory 4.5  

Plant assets 90.0  

Goodwill 45.0  

Retained earnings 90.0  

Liabilities   4.5

Push-down capital   225.0

Sim Uses Entity Theory• Sim fully revalues assets and liabilities. 100% of

the increases/decreases are recorded.

Inventory 5  

Plant assets 100  

Goodwill 50  

Retained earnings 90  

Liabilities   5

Push-down capital   240

Push-Down Differences• The example used 90% ownership by the parent. • SEC requires push-down accounting when the

firm is substantially owned… 97%– Differences between the methods of application will be

considerably less

• Leveraged Buyouts with a change in controlling interest– Changing accounting basis may be appropriate

3: Joint Ventures3: Joint Ventures

Consolidation Theories, Push-Down Accounting and Corporate Joint Ventures

Joint Ventures (def.)

• Form– Partnership or corporate– Domestic or foreign– Temporary or relatively permanent

• It is a business entity that is owned, operated and jointly controlled by a small group of investors for the conduct of a specific business undertaking that provides mutual benefit for each of the venturers.

Corporate Joint Ventures• Investors who participate in the overall

management of the joint venture (APB Opinion No. 18)– Use equity method for the joint venture– If significant influence is not present, use the cost method

• Investors with more than 50% of the voting stock have a subsidiary, not a joint venture– Consolidate the subsidiary

Unincorporated Joint Ventures• Although not specifically addressed by APB

Opinion No. 18, application of the equity method to unincorporated joint ventures is appropriate

• Industry specific practice– Proportional consolidation in oil & gas and undivided

interests in real estate ventures

4: Identify Variable Interest Entities4: Identify Variable Interest Entities

Consolidation Theories, Push-Down Accounting and Corporate Joint Ventures

Variable Interest (def.)"Variable interests in a variable interest entity

are contractual, ownership, or other pecuniary interests in an entity that change with changes in the fair value of the entity's net assets exclusive of variable interests." (FIN 46(R), para.2c)

The primary beneficiary of the variable interest entity (VIE) must consolidate the VIE.

Primary Beneficiary• The entity that will

– Absorb the majority of the expected losses, receive a majority of the expected gains or both

– If separate entities are expected to absorb the profits and losses, the entity expected to absorb the losses is the primary beneficiary

• The primary beneficiary may be an equity holder and/or creditor of the VIE

VIE Example• Get Rich Quick is a VIE with equity contributed equally

by 10 parties, including Corrine.• The VIE will borrow additional amounts equal to twice

the equity. The bank is the major creditor/investor!• Corrine agrees to absorb 75% of the losses and will take

28% of the profits. The other nine investors will share equally.– Corrine is the primary beneficiary and consolidates

the VIE.– All 10 equity investors will have to make detailed

disclosures about their interests in this VIE.

5: Consolidate Variable Interest Entities5: Consolidate Variable Interest Entities

Consolidation Theories, Push-Down Accounting and Corporate Joint Ventures

Special Consolidation Considerations• VIEs are consolidated like other subsidiaries

– FASB Statement No. 141

• Exception– Goodwill can only be recorded if the VIE is a

"business" FIN 46(R)– If the VIE is not a "business," the excess paid is an

extraordinary loss

• "business""Self-sustaining, integrated set of activities and assets

conducted and managed for providing a return to investors."