Electronic
Presentations
in Microsoft®
PowerPoint®
Prepared by
James Myers,
C.A.
University of
Toronto
© 2010 McGraw-Hill
Ryerson Limited
Chapter 9, Slide 1
© 2010 McGraw-Hill Ryerson Limited
Chapter 9
Other
Consolidation Reporting
Issues
Chapter 9, Slide 2
© 2010 McGraw-Hill Ryerson Limited
Learning Objectives
1.
2.
3.
Identify when a special-purpose entity should be
consolidated and prepare consolidated statements
for a sponsor and its controlled special-purpose
entities
Explain how the definitions of assets and liabilities
can be used to support the consolidation of specialpurpose entities
Describe and apply the current accounting standards
that govern the reporting of interests in joint
arrangements
Chapter 9, Slide 3
© 2010 McGraw-Hill Ryerson Limited
Learning Objectives
4.
5.
6.
Explain how the gain recognition principle supports
the recognition of a portion of gains occurring on
transactions between the venturer and the joint
venture
Understand the deferred tax implications of the
accounting for a business combination
Describe the IFRS requirements for segment
disclosures and apply the quantitative thresholds to
determine reportable segments
Chapter 9, Slide 4
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities



A Special-Purpose Entity (“SPE”) is an entity (e.g. a
corporation or partnership) set up by a sponsor to
accomplish a very specific and limited business activity
Using assets transferred to them by their sponsors,
SPE’s can often secure lower cost debt financing for the
sponsor because credit risk is limited to the SPE’s
assets, not the broader assets of the sponsor, and
because the business activity of the SPE is restricted
With the debt proceeds, the SPE can then pay the
sponsor for the transferred assets. The sponsor is
therefore “monetizing” previously illiquid assets, by
turning them into cash using the SPE
LO 1
Chapter 9, Slide 5
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities
In this example, the sponsor has created an SPE in order to
monetize a $100 million credit card receivable asset at a discount
of $4 million. The sponsor now has exchanged a non-cash asset
of $100 million for cash of $96 million obtained by the SPE’s lowercost borrowing and equity investors
LO 1
Chapter 9, Slide 6
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities

Before GAAP changes were made, the assets, liabilities,
and results of operation of SPE’s frequently were not
consolidated with the sponsor although the sponsor
effectively controlled the SPE by governing agreements


The failure of Enron in 2001, which controlled but did not
consolidate a number of SPE’s that led to its bankruptcy,
prompted changes in GAAP
Sponsors can obtain effective control of SPE’s through
“variable interests” (Exhibit 9.1); sponsors may own few,
if any, voting shares of the SPE

LO 1
Variable interests may indicate the sponsor retains the majority
of the risks and rewards of ownership of the assets of the SPE
Chapter 9, Slide 7
© 2010 McGraw-Hill Ryerson Limited
Exhibit 9.1 – Variable Interests
LO 1
Chapter 9, Slide 8
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities

The primary risks and rewards of ownership of an
SPE may not be based on equity ownership but rather
on the variable interests conveyed by contractual
arrangements



The equity investors typically receive a guaranteed rate of return
as a reward for providing the sponsor, or other primary
beneficiary, with contractual control of the SPE
A Variable Interest Entity (VIE) is an SPE that is
controlled by means other than voting interests
To determine if consolidation of the VIE is required, it is
first necessary to determine if there is a primary
beneficiary of the VIE
LO 1
Chapter 9, Slide 9
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities
IAS 27 defines control of an VIE (or “structured entity”)





How are the entity’s returns distributed?
How are decisions affecting returns and distributions made?
Who holds the authority to change the restrictions or strategic
operating and financing policies of the SPE?
Who has veto rights, if any, over the SPE’s activities?
Control of a VIE or structured entity is usually based on
who directs its key activities


LO 1
The more a reporting entity is exposed to the variability of returns
from its involvement with the VIE, the more power the reporting
entity is likely to have to direct the activities of the VIE
Chapter 9, Slide 10
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities


LO 2
Since the primary beneficiary controls the resources of
the VIE and will obtain future returns from these
resources, these resources meet the definition of an
asset and should be included on the consolidated
balance sheet of the primary beneficiary
Since the primary beneficiary usually bears the risk of
absorbing the majority of the expected losses of the
VIE, it is effectively assuming responsibility for the
VIE’s liabilities and therefore these liabilities should be
included on the consolidated balance sheet of the
primary beneficiary
Chapter 9, Slide 11
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities

The following slide illustrates the differences between
an SPE (in the upper box) and a VIE (in the lower box)
 In the SPE the equity investors have equity at risk of
$15m, equal to 15% of the SPE’s assets. This has
been reduced to $5m, or 5% of the SPE’s assets, in
the VIE, significantly reducing the equity investors’
reward of ownership
 The sponsor has guaranteed the debt of the VIE
lenders, reducing the risk of the lenders and
significantly increasing the sponsor’s risk of loss
 The sponsor appears to be the primary beneficiary
LO 1
Chapter 9, Slide 12
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities
LO 1
Chapter 9, Slide 13
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities

Initial measurement issues – the financial reporting
principles for consolidating VIEs require assets,
liabilities, and non-controlling interests (NCIs) to be
initially recorded at fair values with two notable
exceptions:


LO 1
First, if any assets have been transferred from the primary
beneficiary to the VIE, these assets will be measured at the
carrying value before the transfer [i.e. the primary beneficiary
cannot record a gain on transfers to VIE’s]
Second, the asset valuation procedures in IAS 27 also rely on the
allocation principles described in IFRS 3 which identifies some
instances where assets and liabilities are not reported at fair
value
Chapter 9, Slide 14
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities


Since control was obtained by means other than
share ownership, need to determine implied
value (representing consideration given) of
100% of VIE = consideration paid by primary
beneficiary + reported values of any previously
held interests + fair value of NCIs of VIE
Compare implied value to assessed value
(consideration received) = carrying value of
amount invested by primary beneficiary + fair
value of VIE net assets prior to investment by
primary beneficiary
LO 1
Chapter 9, Slide 15
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities


If implied value < assessed value then difference
represents negative goodwill which is recorded as a gain
in consolidated income
If implied value > assessed value the difference is
reported as either (i) goodwill, when the VIE is a selfsustaining profit-oriented business or (ii) as a reduction
of assets acquired when the VIE is not a business

LO 1
A business is defined in IFRS 3 as an integrated set of activities
and assets that is capable of being conducted and managed for
the purpose of providing a return in the form of dividends
Chapter 9, Slide 16
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities

Consolidation issues subsequent to initial
measurement – after the initial measurement,
consolidation of VIEs with their primary beneficiary
should follow the same process as if the entity were
consolidated based on voting interests



LO 1
The implied acquisition differential must be amortized
All intercompany transactions must be eliminated
The income of the VIE must be allocated among the parties
involved, i.e. the equity-holders and the primary beneficiary,
based on contractual arrangements
Chapter 9, Slide 17
© 2010 McGraw-Hill Ryerson Limited
Special-Purpose Entities

Disclosure requirements for Special-Purpose Entities
and Variable Interest Entities are extensive:




Basis of control and accounting consequences
The extent of non-controlling interests
Nature and effect of restrictions on assets and liabilities held by
subsidiaries
Nature and extent of, and changes in, the market risk, credit risk,
and liquidity risk of the reporting entity’s involvement with SPE’s
that are not controlled and therefore not consolidated




LO 1
Market risk includes interest rate, prepayment, currency, and price
risk
Disclose the nature, purpose, and activities of the SPE
Disclose income from, and assets transferred, to the SPE
Other disclosures including estimated exposure to losses of SPE
Chapter 9, Slide 18
© 2010 McGraw-Hill Ryerson Limited
Joint Arrangements


Joint arrangements are a common mechanism where
two or more companies with common interests enter into
a contract to do business together on a “venture” basis,
generally on an expensive or risky project where they
can share expertise as well as risk
The venturers who enter into this joint arrangement
contract continue in their own businesses while the new
venture carries on a “new” business under the joint
supervision of the venturers
LO 3
Chapter 9, Slide 19
© 2010 McGraw-Hill Ryerson Limited
Joint Arrangements

Joint arrangements are classified into two types:

Joint operations - each venturer contributes the use of assets or
resources to the new activity but retains title to and control of
these assets and resources


LO 3
Often new entities are not created to conduct the new joint activity.
An example would be a case in which one venturer manufactures
part of a product, a second venturer completes the manufacturing
processes, and a third venturer handles the product’s marketing
Joint venture – a separate entity (e.g. corporation or
partnership) is formed to conduct the new activity, to which each
venturer contributes assets and resources. These assets and
resources are then legally owned by the separate entity (the “joint
venture”) and therefore the venturers do not retain title to these
assets and resources
Chapter 9, Slide 20
© 2010 McGraw-Hill Ryerson Limited
Joint Arrangements


A key feature of joint arrangements is “joint control”
Joint control is the contractually agreed sharing of
control by all parties to undertake an activity together




LO 3
A contract is therefore required between the parties (the
“venturers”)
The contract specifies that no single venturer can unilaterally
control the joint arrangement regardless of the value of the assets
or resources it contributed to the joint arrangement
For example, one venturer could contribute 60% of the assets to
a joint venture, which would normally indicate control except for
the contract under which the venturer has agreed that it will share
control with the other venturers
Since there is no control there is no non-controlling interest and
no parent and subsidiary
Chapter 9, Slide 21
© 2010 McGraw-Hill Ryerson Limited
Accounting for Joint Operations


Joint operations are reported in the same fashion as the
existing activities of the venturer, which reports its
proportionate share of the assets, liabilities, revenues,
and expenses of the joint operation
When a venturer transfers the significant risks and
rewards of an asset that it owns for use in a joint
operation, IFRS 10 indicates that the venturer “shall
recognize only that portion of the gain or loss that is
attributable to the interests of the other venturers.”


Venturer cannot record a gain for its own portion of the operation
The full amount of losses must be recognized when there is
evidence of a reduction in net realizable value, or impairment
LO 3, 4
Chapter 9, Slide 22
© 2010 McGraw-Hill Ryerson Limited
Accounting for Joint Operations

SIC 13 and IAS 16 indicate that gains can be
recognized on non-monetary assets contributed, except
when one of the following conditions is present:



The significant risks and rewards have not been transferred
(guidance on risks and rewards is provided in IAS 18); or
The gain cannot be measured reliably; or
The contribution lacks commercial substance, where
commercial substance means:
1.
2.
3.
LO 3, 4
The amount, timing, and risk of future cash flows of the asset
received differ from those of the asset(s) transferred;
The after-tax cash flows of the part of the business affected by the
transaction have changed as a result of the exchange; and
The difference in (1) or (2) is significant relative to the fair values
of the assets exchanged
Chapter 9, Slide 23
© 2010 McGraw-Hill Ryerson Limited
Accounting for Joint Operations

Unrealized gains or losses on contributions to joint
operations are recorded by the contributing venturer in
an “unrealized gain” or “unrealized loss” contra-asset
account, which is netted against the related asset when
presented on the balance sheet.

LO 3
The unrealized gain or unrealized loss balance is not presented
separately on the balance sheet
Chapter 9, Slide 24
© 2010 McGraw-Hill Ryerson Limited
Accounting for an Interest in a Joint Venture



There will be no acquisition differential on a newly
formed joint venture (“JV”). Acquisition differentials on
joint venture interests that are purchased should be
determined, allocated, and amortized as previously
discussed
The venturer’s proportion of unrealized upstream as well
as downstream profits, revenues, expenses, receivables,
and payables with the JV are eliminated; the portion
representing the interest of the other arm’s-length
venturers can be considered realized
Under IFRS, the venturer uses the equity method to
record its interest in a JV
LO 3
Chapter 9, Slide 25
© 2010 McGraw-Hill Ryerson Limited
Accounting for an Interest in a Joint Venture

Determination of gain on assets contributed by a
venturer on formation of a joint venture:

Split the gain between the portion represented by the venturer’s
interest in the JV and the portion represented by the interest of
the other venturers




The other venturers’ portion is deemed to be sold and therefore may
recognize some in income upon contribution as described below
Record the gain in an “unrealized gain” contra-asset account
The unrealized or deferred gain is amortized to income over the
expected service life of the asset to the JV if the asset is being
used to generate positive net income from the JV
If a loss results on contribution of the asset, record the portion
representing the other venturers’ interest in income immediately

LO 3, 4
Record the entire loss immediately if evidence of impairment
Chapter 9, Slide 26
© 2010 McGraw-Hill Ryerson Limited
Accounting for an Interest in a Joint Venture

If the venturer receives cash from the other venturers for
the contributed asset a portion of the gain can be
recognized in income immediately


Receipt of cash from arm’s-length parties represents culmination
of earnings to the extent of the cash received as a percentage of
the fair value contributed
See following example
LO 3, 4
Chapter 9, Slide 27
© 2010 McGraw-Hill Ryerson Limited
Accounting for an Interest in a Joint Venture

Example of gain on assets contributed by a venturer on
formation of a joint venture:

Venturer A contributes equipment (fair value $700,000 - cost
$200,000 = gain $500,000) to JV and receives $130,000 in cash
while Venturer B contributes equipment with a fair value of
$725,000 and cash of $130,000 to JV. The JV’s balance sheet at
this point is as follows:
JOINT VENTURE BALANCE SHEET
ON FORMATION
ASSETS
Cash from B (= $130-$130)
EQUITY
-
A (= $700 - $130)
40%
570,000
Equipment from B
725,000
B (= $130 + $725)
60%
855,000
Equipment from A
700,000
1,425,000
1,425,000
LO 3
Chapter 9, Slide 28
© 2010 McGraw-Hill Ryerson Limited
Accounting for an Interest in a Joint Venture

Example of gain, cont’d:

Venturer A can therefore record in income immediately a gain
equal to:
Cash from other venturer
Fair value of asset contributed
x gain
= 130/700 x $500,000 = $92,857


The remaining deferred gain of $500,000 - $92,857 =
$407,143 is credited to investment in JV in A’s books, and is
offset against equipment on A’s consolidated balance sheet
In the following year A can amortize $407,143 / 10 years
= $40,714 of the unrealized gain balance into
consolidated income
LO 3
Chapter 9, Slide 29
© 2010 McGraw-Hill Ryerson Limited
Accounting for an Interest in a Joint Venture

Example of gain, cont’d:

If in the previous example A received $150,000 in cash
instead of $130,000 (for the same 40% interest in the JV), with
the additional $20,000 derived not from B but from a bank loan
received by the joint venture, 40% of the loan is considered as
being derived from A itself and 60% is derived from B. Only
the portion derived from B can be considered in the
calculation of the gain that A can recognize immediately, as
follows:
Cash from other venturer
Fair value of asset contributed
x gain
= (130 + (20,000 x 60%))/700 x $500,000 = $101,429
LO 3
Chapter 9, Slide 30
© 2010 McGraw-Hill Ryerson Limited
Deferred Income Taxes and Business Combinations



At any point in time, there may be differences between
the tax basis of an asset or liability and its carrying
amount, e.g. a capital asset’s net book value can differ
from its tax undepreciated capital cost temporarily, until
both are fully depreciated
Such differences occur when the acquisition differential
is allocated in a business combination; this affects the
consolidated book values but not the tax bases since
each company files separate, non-consolidated financial
statements for income tax purposes
The temporary difference in carrying value for book
purposes compared to tax purposes gives rise to
deferred income taxes which must be recognized in the
consolidated financial statements
LO 5
Chapter 9, Slide 31
© 2010 McGraw-Hill Ryerson Limited
Deferred Income Taxes and Business Combinations


Under IAS 12, the temporary differences between the
carrying value of an asset or liability and its tax base
must be accounted for as deferred income taxes
IAS 12 defines 2 types of temporary differences:




deductible temporary differences give rise to future tax
deductions, i.e. deferred income tax assets
Taxable temporary differences give rise to future taxable income,
i.e. deferred income tax liabilities
If asset book value < tax value, or liability book value >
tax value, deferred tax asset arises
If asset book value > tax value, or liability book value <
tax value, deferred tax liability arises
LO 5
Chapter 9, Slide 32
© 2010 McGraw-Hill Ryerson Limited
Deferred Income Taxes and Business Combinations


The differences between consolidated book values and
individual company tax values therefore give rise to
deferred income tax assets or deferred income tax
liabilities which should be reflected as part of the
acquisition differential allocation on acquisition of a
subsidiary
These “new” deferred income tax asset or deferred
income tax liability balances reflecting the acquisition
date fair values of the subsidiary’s assets and liabilities
replace the “old” future income taxes recorded by the
subsidiary company based on its historical costs
LO 5
Chapter 9, Slide 33
© 2010 McGraw-Hill Ryerson Limited
Deferred Income Taxes and Business Combinations

Example (assuming tax rate of 40%)




LO 5
In a business combination, the carrying amount of an asset is
reflected at its fair value of $20,000. In the general ledger of the
subsidiary, the asset has a book value of $12,000 and in the
subsidiary’s tax return it has a tax basis of $9,000, which is
unaffected by the business combination
The “old” deferred income tax liability of (12,000 - 9,000) * 40% =
$1,200 on the subsidiary’s books must be eliminated
A “new” deferred tax liability must be reported in the consolidated
financial statements in the amount of (20,000 - 9,000) * 40% =
$4,400
The “new” deferred tax liability is included in the acquisition
differential allocation and therefore goodwill increases
Chapter 9, Slide 34
© 2010 McGraw-Hill Ryerson Limited
Deferred Income Taxes and Business Combinations

A business combination may increase the future
likelihood that operating loss carry forwards may be
utilized, either as a result of intercompany revenues or
reduced costs as a result of the combination



LO 5
Previously unrecognized operating loss carry forwards of the
subsidiary may be recognized at the time of a business
combination as part of the allocation of the acquisition differential,
providing that it is probable that the benefits will be realized
Operating loss carry forwards previously recognized by the
subsidiary as deferred tax assets will be allowed to stand
Allocation of the acquisition differential to additional deferred
income taxes reduces goodwill
Chapter 9, Slide 35
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures

When consolidated financial statements of large and
diverse companies are prepared, a significant amount of
detail about the profitability of different products and
services, the geographic areas in which the consolidated
operates, and its customers is aggregated




Separate disclosure could provide useful predictive information
for analysts and other users of the financial statements
However, providing individual financial statements of subsidiaries
and consolidation adjustment details may overwhelm users
Managers do not wish competitors to have too much confidential
or sensitive data
Segmented reporting is an efficient method of
communicating enough but not excessive relevant data
LO 6
Chapter 9, Slide 36
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures

Operating segments of a consolidated enterprise are
identified based on the way management organizes that
the business components in order to assess
performance and make strategic decisions

An operating segment is defined as one:

That engages in business activities from which it may earn
revenues and incur expenses
Whose operating results are regularly reviewed by the chief
operating decision-maker to make decisions about resources to
be allocated to the segment and assess its performance

For which discrete financial information is available

LO 6
Chapter 9, Slide 37
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures

IFRS 8 requires separate disclosure for segments when
one or more of these thresholds is met:


Reported revenue, both external and intersegment, is 10 percent
or more of the combined revenue, internal and external, of all
segments
The absolute amount of reported profit or loss is 10 percent or
more of the greater, in absolute amount, of:



LO 6
the combined reported profit of all operating segments that did not
report a loss, or
the combined reported loss of all operating segments that did report
a loss
Its assets are 10 percent or more of the combined assets of all
operating segments
Chapter 9, Slide 38
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures

General information is required:

Factors used to identify the enterprise's reportable segments,
including the basis of organization



LO 6
Address whether management has organized the enterprise around
differences in products and services, geographic areas, regulatory
environments, or a combination of factors and whether operating
segments have been aggregated
Types of products and services from which each reportable
segment derives its revenues
Comparative balances for the prior year are presented
Chapter 9, Slide 39
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures


A measure of profit (loss)
Each of the following if the specific amount are
included in the measure of profit (loss) above








LO 6
Revenues from external customers
Intersegment revenues
Interest revenue and expense
Amortization of capital assets
Unusual revenues, expenses, and gains (losses)
Equity income from significant influence-investments and joint
ventures
Income taxes
Significant noncash items other that the amortization above
Chapter 9, Slide 40
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures




LO 6
The amount of investments in associates and joint ventures
accounted for by the equity method
The amounts of additions to non-current assets other than
financial instruments, deferred tax assets, and post-employment
benefits plans
Total expenditures for additions to capital assets and goodwill
An explanation of how a segment’s profit (loss) and assets have
been measured, and how common costs and jointly used assets
have been allocated, and of the accounting policies that have
been used
Chapter 9, Slide 41
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures

Reconciliation of the following





LO 6
Total segment revenue to consolidated revenues
Total segment profit (loss) to consolidated net income (loss)
Total segment assets to consolidated assets
Total segment liabilities to consolidated liabilities
Total segment amounts for every other material item to the same
consolidated amount for the same item
Chapter 9, Slide 42
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures

The following information must also be disclosed, even
when there is only one reportable segment, unless such
an information has already been clearly provided as part
of segment disclosures


The revenue from external customers for each product or service,
or for each group of similar products and services, when practical
The revenue from external customers broken down between
those from the company’s home country and those from all
foreign countries.

LO 6
Material revenues from an individual country must be disclosed
Chapter 9, Slide 43
© 2010 McGraw-Hill Ryerson Limited
Segment Disclosures

Goodwill and capital assets broken down between
those located in Canada and those located in foreign
countries


When a company’s sales to a single external customer
are 10% or more of total revenues, the company must
disclose this fact, as well as the total amount of
revenues from each customer and which operating
segment reported such revenues


LO 6
Where assets located in an individual country are material, it
must be separately disclosed
The identity of the customer does not have to be disclosed
Comparative totals for the last fiscal year are required
Chapter 9, Slide 44
© 2010 McGraw-Hill Ryerson Limited
GAAP for Private Enterprises



Can report their association with VIEs using full
consolidation, cost method, or equity method
Can report joint venture interests using proportionate
consolidation, cost method, or equity method
Can use the taxes payable method or the future income
tax payable method (similar to the deferred income taxes
method under IFRS) to account for income taxes


Must still prepare and disclose a reconciliation between statutory
tax rate and effective tax rate
Are not required to disclose any information about
operating segments
LO 1-6
Chapter 9, Slide 45
© 2010 McGraw-Hill Ryerson Limited