CHAPTER 16
ACCOUNTING FOR
MULTIPLE ENTITIES
Introduction


Businesses find it useful to combine
operations for efficiencies of scale
Accounting issues for
multiple entities:



Business combinations
Consolidations and segment reporting
Foreign currency translation
Business Combinations
Wyatt’s classifications

1.
2.
3.
Classical era
Second wave
Third era
Why do businesses combine?

1.
2.
3.
4.
5.
Tax consequences
Growth and diversification
Financial considerations
Competitive pressure
Profit and retirement
Business Combinations
Two methods of acquisition

1.
2.
cash
exchange of stock
Accounting Method
Accounting Treatment
Purchase
Fair Market Value
& Goodwill
Pooling of Interests
Book Value
Criticisms of the Pooling of
Interests Method

Accounting is distorted



Investment is not disclosed
Assets undervalued
Income overstated in
subsequent years

FASB decision

Economic consequences
arguments
The Fresh Start Method


Some combinations are a merger of
equals in which none of the combined
companies survive
Revalue all assets as if it were a newly
formed entity
The Purchase Method

Must be used



when one company acquires the net assets of a
business
and also obtains control over that business
SFAS No. 141 applies to both
incorporated and
unincorporated businesses
The Purchase Method
When a business combination is created by an
exchange of stock, SFAS No. 141 requires that the
following “pertinent facts and circumstances” be
taken into consideration:

a.
b.
c.
d.
e.

The relative voting rights
The existence of a large minority voting interest
The composition of the governing body
The composition of senior management
The terms of exchange of equity securities.
Subsequently allocate cost to all
identifiable assets with remainder to
goodwill
Business Combinations II

FASB – IASB project on business
combinations



Phase 1- Valuation of intangibles
Phase 2 – Develop a common set of principles
intended to improve the completeness, relevance
and comparability of financial information about
business combinations.
Tentative conclusion that business
combinations should be recorded at fair value
as defined is SFAS No. 157
Consolidation



When one business organization has control over
another they should report as a unified whole
Now required by SFAS No. 94
ARB No. 51 criteria






Parent-subsidiary relationship
Control
Maintenance of control
Operate as integrated unit
Approximate fiscal years
Principles


Cannot own or owe itself
Cannot make a profit by selling to itself
The Concept of Control

The power of one entity to direct or cause the direction of the
management and operating and financing policies of another
entity
Should control be presumed in
cases of less than 50% ownership?

Control is presumed when the parent
 Owns the majority of the subsidiary’s outstanding common
stock
 Has the ability to dominate the subsidiary’s board of directors
 Has the ability to dissolve the entity
The Modified Approach
to Control
FASB Exposure Draft
Asks the question:
Is consolidation required?


Is the entity a special purpose entity and is it a
transferor or its affiliate?
1.

Are the permitted activities and powers of the entity significantly
linked?
2.

If not the presumption of control exists
Are powers limited? Can the party change the entity’s purpose?
3.


4.
(Use SFAS No 140 criteria)
If so consolidate
Also consolidate if no new cash outlay or benefits exceed new cash
outlay
If step 3 does not require consolidation, assess whether variable
interests are significant
Theories of Consolidation
Entity theory
Emphasis is on control of a
group of legal entities operating
as a single unit
Parent company
theory
Purpose of consolidated
statements is to provide
information for parent company
stockholders
Noncontrolling Interest


Definition
Placement




Liability
Separately presented
Stockholder equity
Noncontrolling interest and theories of
consolidation



Doesn’t meet SFAC definition of liability
FASB ED suggests “non-controlling interest in
subsidiaries”
Report as separate component of stockholders’ equity
Additional Issues

Proportionate consolidation


ignore minority interest
Goodwill
Should it be attributed to
minority interest?

Drawbacks to consolidation

loss of information
Special Purpose Entities





Partnership, corporation, trust, or joint
venture
 created for a limited purpose
 limited life and limited activities
 designed to benefit a single company
Primary motive for most SPEs
 off-balance sheet financing
 often to avoid reporting capital leases under SFAS No. 13.
Companies are able to avoid consolidation of SPEs in which
they do not have a majority voting interest
SPE is created by an asset transfer
 The assets are sold to the SPE
To achieve off-balance sheet treatment
 minimum (previously 3%, now 10%) investment from an
independent third party investor is required
Special Purpose Entities

SFAS No. 140, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities”
Outlines requirements to qualify an SPE for non-consolidation


Transferor company, has surrendered control over the transferred
assets (and thus has a sale) when all of the following conditions are
met:
The transferred assets have been put beyond the reach of the transferor
and its creditors
Each transferee (SPE) has the right to pledge or exchange the assets and
no conditions constrain the transferee from taking advantage of its right to
pledge or exchange
The transferor does not maintain effective control over
the transferred assets through either
a.
b.
c.
1.
2.

an agreement that entitles and obligates the transferor to
repurchase or redeem the transferred assets before
maturity or
the ability to unilaterally cause the holder to return
specific assets, other than through a cleanup call
New FASB exposure draft
Segmental Reporting

How it became a factor



Why important?



SEC line-of-business reporting
NYSE recommendations
Various operations may have differing prospects for growth
rate of profitability and degrees of risk
Assessment of decentralized management
What to disclose



Operations in different industries
Foreign operations
Major customers
SFAS No 14 Criteria

Definition





Identity segment
Reportable segment
Revenue
Operating profit or
loss
Identifiable assets

Reporting guidelines



Reportable segments
Information to be
disclosed
Where to disclose
SFAS No. 131



Operating segment
Report balance sheet
and income statement
information about each operating segment
Include other specified information



if it is included in the measurement of segment profit
Include other geographic information
Include reliance on major customers
Foreign Currency Translation



Foreign currency translation issues
 Increase of foreign operations
 Allowing dollar to float on world market
Necessary to state financial statements in a
common measuring unit
Problems:



When do you measure difference?
How do you translate specific assets and liabilities
Methods of translation




Current – Noncurrent
Monetary – Nonmonetary
Current
Temporal
FASB and Foreign Currency Translation

SFAS No. 8







Closely follows the temporal method
Measure in conformity with US GAAP
Record transactions at initial exchange rate
Use balance sheet date or measurement date as
basis for translation of balance sheet items
Use transaction date for revenues and expenses
Exchange gains and losses in income
Gains and losses from foreign exchange contracts in
income
FASB and Foreign Currency Translation

SFAS No. 52







SFAS No. 8 produced distortions
SFAS No. 52 adopted functional currency
approach
Record transactions in functional currency
Adjust, if necessary to comply with GAAP
Translate into currency of reporting
company
Transaction gains and losses reported in
OCI
If local currency is not functional currency
- gains and losses in income
Foreign Currency Translation – Additional Issues

Translation vs. Remeasurement



Translation – expressing amounts denominated
or measured in a different currency
Remeasurement – measuring transactions
originally denominated in a different unit of
currency (use temporal method
Foreign currency hedges



Fair value hedge
Cash flow hedge
Hedge of net investment in foreign operations
International Accounting Standards

The IASC has issued standards dealing with the
following issues:
IAS No. 27: Consolidated Financial Statements and
Accounting for Investments in Subsidiaries



Revised statement does not change the
fundamental approach to accounting for
business combinations
Parent companies should present
consolidated financial statements
 when it has the ability to control its subsidiaries which is
similar to U. S. GAAP.
Concept of control is defined somewhat differently.
 IAS No. 27 defines control as the power to govern a
subsidiary
 U. S. GAAP focuses on ownership of a majority voting
interest
Major Revisions to IAS No. 27
IAS No. 27 permits wholly
owned (and virtually
wholly-owned)
subsidiaries to be
excluded from
consolidation
If the exemption is
applied, an entity should
disclose:
1.
2.
a.
b.
the reason for not
publishing consolidated
financial statements
the name of the parent
that publishes
consolidated financial
statements that comply
with IFRS.
3.
4.
Minority interests should
be presented in equity,
separately from parent
shareholders' equity.
The exemptions from
consolidation are
tightened
IAS No 21: The Effects of Changes in
Foreign Exchange Rates


Initially record transactions at historical cost
Use monetary - nonmonetary method for subsequent transactions
 Translate monetary items at current rate
 Translate nonmonetary items at either historical or current rate
depending upon when they were measured
 Exchange gains and losses reported as a component of stockholders’
equity
IFRS No 3: Business Combinations

Requires all business combinations to be accounted
for using the purchase method


The pooling of interests method is prohibited
Acquirer must be
identified for all
business
combinations
IFRS No 3: Business Combinations

The acquirer measures the cost of
a business combination

at the sum of the fair values,
at the date of exchange, of



assets given,
liabilities incurred or assumed,
and equity instruments issued
by the acquirer

The acquirer recognizes
separately, at the acquisition date,
 the acquiree's identifiable assets,
 liabilities
 and contingent liabilities
 that satisfy specified recognition
criteria
ISRS No. 8: Operating Segments


Adopts requirements of SFRS
No. 131 except for some
terminology
“Management Approach”

Operating segments become
reportable based on threshold
tests related to




Revenues
Results
Assets
Requires disclosure of
“measure” of profit or loss and
total assets
Prepared by
Kathryn Yarbrough, MBA
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