Chapter 3
The Reporting Entity and
the Consolidation of
Less-than-Wholly-Owned
Subsidiaries with No
Differential
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 3-1
Understand and explain the
usefulness and limitations of
consolidated
financial statements.
3-2
Consolidation: The Concept
 Parent creates or gains control of the subsidiary.
 The result: a single reporting entity.
P
S
3-3
Review
How do we report the results of subsidiaries?
Parent
Company
80%
Sub A
51%
Sub B
21%
Sub C
Consolidation
Equity Method
(plus the Equity Method)
3-4
Consolidated Financial Statements
Consolidated financial statements present the
financial position and results of operations for



a parent (controlling entity) and
one or more subsidiaries (controlled entities)
as if the individual entities actually were a single
company or entity.
3-5
Benefits of Consolidated Financial Statements
 Presented primarily for those parties having a
long-run interest in the parent company:

shareholders,

long-term creditors, or

other resource providers.
 Provide a means of obtaining a clear picture of the
total resources of the combined entity that are
under the parent's control.
3-6
Limitations of Consolidated Financial Statements
 Results of individual companies not
disclosed (hides poor performance).
 Financial ratios are not necessarily
representative of any single company in the
consolidation.
 Similar accounts of different companies may
not be entirely comparable.
 Information is lost any time data sets are
aggregated.
3-7
Subsidiary Financial Statements
 Creditors, preferred stockholders, and
noncontrolling common stockholders of subsidiaries
are most interested in the separate financial
statements of the subsidiaries in which they have an
interest.
 Because subsidiaries are legally separate from their
parents,


the creditors and stockholders of a subsidiary generally
have no claim on the parent, and
the stockholders of the subsidiary do not share in the
profits of the parent.
3-8
Practice Quiz Question #1
A primary benefit of consolidated
financial statements is that they
a. provide information directly applicable
to the needs of regulators.
b. obscure data of individual companies.
c. present data of two or more entities that
clearly reports their individual
performance.
d. give a picture of the use of resources
under the parent’s control.
e. none of the above.
3-9
Learning Objective 3-2
Understand and explain how
direct and indirect control
influence the
consolidation of a
subsidiary.
3-10
Concepts and Standards
 Traditional view of control includes:


Direct control that occurs when one company
owns a majority of another company’s common
stock.
Indirect control or pyramiding that occurs when
a company’s common stock is owned by one or
more other companies that are all under common
control.
3-11
Indirect Control Example
Does X control Y? Yes
X
51%
75%
Y
Z
20%
Does Y control K? No
Does X control Z? Yes
40%
K
Does Z control K? No
Does X control K?
Yes, indirectly through Y and Z!
X must consolidate Y, Z, and K.
3-12
Concepts and Standards
 Ability to Exercise Control

Sometimes, majority stockholders may
not be able to exercise control even
though they hold more than 50
percent of outstanding voting stock.



X
90%
Y
Subsidiary is in legal reorganization or bankruptcy
Foreign country restricts remittance of subsidiary
profits to domestic parent company
The unconsolidated subsidiary is reported
as an intercorporate investment.
3-13
Concepts and Standards
 Differences in Fiscal Periods



Difference in the fiscal periods of a parent and
subsidiary should not preclude consolidation.
Often the fiscal period of the subsidiary is
changed to coincide with that of the parent.
Another alternative is to adjust the financial
statement data of the subsidiary each period to
place the data on a basis consistent with the
fiscal period of the parent.
3-14
Concepts and Standards
 Changing Concept of the Reporting Entity


Guidance in ASC 810-10-55, requiring consolidation
of all majority-owned subsidiaries, was issued to
eliminate the inconsistencies found in practice until
a more comprehensive standard could be issued.
Completion of the FASB’s consolidation project has
been hampered by, among other things, issues
related to

control

reporting entity
3-15
Concepts and Standards
 The FASB has been attempting to move
toward a consolidation requirement for
entities under effective control.

Ability to direct the policies of another entity
even though majority ownership is lacking.
 Even though ASC 805-10-55 indicates that
control can be achieved without majority
ownership, a comprehensive consolidation
policy has yet to be achieved.
3-16
Concepts and Standards
 Defining the accounting entity would help
resolve the issue of when to prepare
consolidated financial statements and what
entities should be included.
 ASC 810 deals only with selected issues
related to consolidated financial statements,
leaving a comprehensive consolidation policy
until a later time.
3-17
Practice Quiz Question #2
P owns 60% of X and 75% of Y. If X
and Y jointly own 100% of Z, under
what circumstance would P not be
deemed to control Z?
a.
b.
c.
d.
Z is a bank.
Z’s products are largely sold overseas.
Z is currently in Chapter 11 bankruptcy.
Z has a CEO known to have a bad temper
and a serious gambling habit.
e. none of the above.
3-18
Learning Objective 3-3
Understand and explain
differences in the
consolidation process when
the subsidiary is not wholly
owned.
3-19
Noncontrolling Interest
 Only a controlling interest is needed for the parent
to consolidate the subsidiary—not 100% interest.
 Shareholders of the subsidiary other than the parent
are referred to as “noncontrolling” shareholders.
 Noncontrolling interest refers to the claim of these
shareholders on the income and net assets of the
subsidiary.
Parent
NCI
<50%
>50%
Sub
3-20
Noncontrolling Interest (NCI)
 What is a noncontrolling interest (NCI)?


Voting shares not owned by the parent company
NCI was formerly called the “Minority Interest”
Parent
NCI
<50%
>50%
Sub
Two Issues:
(1) Should 100% of the
financial statements
be consolidated?
(2) Where to report NCI
in the financial
statements?
3-21
Issue 1: Should 100% be Consolidated?
Proportional
Consolidation
Full
Consolidation
Percent
Consolidated?
Reports NCI
Amounts?
Complies with
US GAAP?
Relative
Complexity?
3-22
Issue 1: Should 100% be Consolidated?
 Full consolidation required by US GAAP
(100%)
 This means two special accounts appear in
consolidated statements:

NCI in Net Income of Sub



Like an “expense” in the consolidated income
statement
“Reported income that doesn’t belong to us.”
NCI in Net Assets of Sub


Equity of unrelated owners
“Net assets on our balance sheet not belonging to us.”
3-23
Issue 2: Where to report NCI in Net Assets?
 Old rules: Could report it in equity,
liabilities, or “no man’s land” between
liabilities and equity.
 New rules: Must report in equity

ASC 810-10-55 makes clear that the
noncontrolling interest’s claim on net assets is an
element of equity, not a liability.
3-24
Noncontrolling Interest
 Computation of income to the
noncontrolling interest

In uncomplicated situations, it is a simple
proportionate share of the subsidiary’s net
income.
 Presentation

ASC 810-10-50 requires that


the term “consolidated net income” be applied to the
income available to all stockholders,
with the allocation of that income between the
controlling and noncontrolling stockholders shown.
3-25
Practice Quiz Question #6
The noncontrolling interest in a
corporation can best be describe as
a. a group of disinterested shareholders
who rarely vote on company issues.
b. all employees below the manager level.
c. all shareholders other than the parent
company.
d. a group of investors who plan to sell
their stock within the next twelve
months .
e. none of the above.
3-26
Learning Objective 3-4
Make calculations and
prepare basic elimination
entries for the consolidation
of a less-than-wholly-owned
subsidiary.
3-27
Summary of differences in consolidation
Wholly Owned
Subsidiary
Partially Owned
Subsidiary
Investment =
Book Value
Chapter 2
Chapter 3
No
Differential
Investment >
Book Value
Chapter 4
Chapter 5
Differential
No NCI
Shareholders
NCI
Shareholders
3-28
Consolidation of Less-than-wholly-owned Subs
 The entity theory requires that the entity’s
entire income and value be reported.



The subsidiary’s income is divided between the parent
(controlling interest) and the NCI shareholders.
The subsidiary’s net assets are divided between the
parent (controlling interest) and the NCI shareholders.
Basic elimination entry is modified to split both:
Sub Equity Accounts
100%
Income from Sub
XXX
NCI in Net Income of Sub
XXX
Dividends Declared by Sub
100%
Investment in Sub
XXX
NCI in Net Assets of Sub
XXX
3-29
Practice Quiz Question #8
The primary difference in
consolidating a less than wholly
owned subsidiary relative to a wholly
owned subsidiary is:
a. income and net assets of the subsidiary
must be divided between the parent and
the NCI shareholders.
b. the title of the worksheet must specify
“Less than wholly owned.”
c. You only consolidate the parent’s %
ownership.
d. There is no difference.
3-30
Group Exercise 1: Basic Elimination Entry
The following information is given:
1)
Photo owns 70% of Snap
2)
Snap’s net income for 20X4 is $160,000
3)
Photo’s net income for 20X4 from its own separate operations is
$500,000.
4)
Snap’s declares dividends of $12,000 during 20X4.
5)
Snap has 10,000 shares of $4 par stock outstanding that were
originally issued at $14 per share.
6)
Snap’s beginning balance in Retained Earnings for 20X4 is $120,000.
Photo
70%
Snap
Book Value Calculations
Investment
Additional
Account = Common
Paid-in
NCI (30%) (70%)
Stock
Capital
Retained
Earnings
Beginning Balance
+ Net Income
 Dividends
Ending Balance
3-31
Group Exercise 1: Basic Elimination Entry
Book Value Calculations
Investment
Additional
Account = Common
Paid-in
NCI (30%) (70%)
Stock
Capital
Retained
Earnings
Beginning Balance
+ Net Income
Dividends
Ending Balance
Basic Elimination Entry
Investment in Snap
Common Stock
Add PIC – CS
Retained Earnings, BB
Income from Snap
NCI in Net Income
Dividends Declared
Investment in Snap
NCI in Net Assets
3-32
Learning Objective 3-5
Prepare a consolidation
worksheet for a less-thanwholly-owned
consolidation.
3-33
Consolidation of < Wholly Owned Subs
 The worksheet is modified when the parent
owns less than 100% of the subsidiary.

The total “Net Income” is divided between:


the noncontrolling interest (NCI shareholders) and
the controlling interest (the parent company)
Income Statement
Sales
Less: COGS
Less: Depreciation Expense
Less: Other Expenses
Income from Smith, Inc.
Net Income
NCI in Net Income
CI In Net Income
Pinkett, Inc.
Smith, Inc.
$
$
$
840,000
(516,000)
(12,000)
(192,000)
32,400
152,400
$
36,000
$
152,400
$
36,000
Elimination Entries
DR
CR
Consolidated
300,000
(156,000)
(10,000)
(98,000)
32,400
32,400
3,600
36,000
3-34
Practice Quiz Question #9
The primary difference in the
worksheet when consolidating a less
than wholly owned subsidiary is
a. only the parent’s % is consolidated.
b. extra columns are added to split the
subsidiary into two or more pieces.
c. extra rows are added to divide the net
income and net assets of the sub
between the parent and NCI
shareholders.
d. There is no difference.
3-35
Group Exercise 2: Consolidation < 100%
Pinkett, Inc.
Income Statement
Sales
Less: COGS
Less: Depreciation expense
Less: Other Expenses
Income from Smith, Inc.
Net Income
NCI in Net Income
CI in Net Income
Statement of Retained Earnings
Balances, 1/1/X8
Add: Net Income
Less: Dividends
Balances, 12/31/X8
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Sub
Property & Equipment
Accumulated Depreciation
Total Assets
Payables & Accruals
Long-term Debt
Common Stock
Retained Earnings
NCI in Net Assets
Total Liabilities & Equity
$
Smith, Inc.
$
300,000
(156,000)
(10,000)
(98,000)
$
840,000
(516,000)
(12,000)
(192,000)
32,400
152,400
$
36,000
$
152,400
$
36,000
$
124,800
152,400
(108,000)
169,200
$
72,000
36,000
(12,000)
96,000
58,800
114,000
204,000
140,400
336,000
(144,000)
709,200
$
$
$
$
$
$
48,000
66,000
90,000
210,000
(30,000)
384,000
$
168,000
360,000
12,000
169,200
84,000
144,000
60,000
96,000
$
709,200
384,000
Elimination Entries
DR
CR
Consolidated
Assume Pinkett only purchases
90% of Smith.
REQUIRED
• Prepare an analysis of the
investment for 20X8.
• Prepare all consolidation
entries as of 12/31/X8.
• Prepare a consolidation
worksheet at 12/31/X8.
3-36
Group Exercise 2: Solution
Book Value Calculations
Balances, 1/1/X8
+ Net Income
 Dividends
Parent’s
=
NCI
Investment
(10%) Account (90%)
NCI (10%)
(90%)
Subsidiary’s Equity Accounts
Common
Retained
Stock
Earnings
Stock
Earnings
Balances, 12/31/X8
Basic Elimination Entry
Common Stock
Retained Earnings, BB
Income from Smith
NCI in Net Income
Dividends Declared
Investment in Smith
NCI in Net Assets
3-37
Group Exercise 2: Solution
Don’t forget the accumulated depreciation elimination entry:
Accumulated Depreciation
Buildings and Equipment
Property, Plant & Equipment
Accumulated Depreciation
3-38
Group Exercise 2: Solution
Pinkett, Inc.
Income Statement
Sales
Less: COGS
Less: Depreciation expense
Less: Other Expenses
Income from Smith, Inc.
Net Income
NCI in Net Income
CI in Net Income
Statement of Retained Earnings
Balances, 1/1/X8
Add: Net Income
Less: Dividends
Balances, 12/31/X8
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Sub
Property & Equipment
Accumulated Depreciation
Total Assets
Payables & Accruals
Long-term Debt
Common Stock
Retained Earnings
NCI in Net Assets
Total Liabilities & Equity
$
Smith, Inc.
$
300,000
(156,000)
(10,000)
(98,000)
$
840,000
(516,000)
(12,000)
(192,000)
32,400
152,400
$
36,000
$
152,400
$
36,000
$
124,800
152,400
(108,000)
169,200
$
72,000
36,000
(12,000)
96,000
58,800
114,000
204,000
140,400
336,000
(144,000)
709,200
$
$
$
$
$
$
Elimination Entries
DR
CR
Consolidated
48,000
66,000
90,000
210,000
(30,000)
384,000
$
168,000
360,000
12,000
169,200
84,000
144,000
60,000
96,000
$
709,200
384,000
3-39
Learning Objective 3-6
Understand and explain the
purpose of combined
financial statements and
how they differ from
consolidated financial
statements.
3-40
Combined Financial Statements
 Combined financial statements are sometimes
prepared for a group of companies when no
one company in the group owns a majority of
the common stock of any other company in
the group, such as when



an individual, not a corporation, owns or controls
multiple companies.
a parent company prepares financial statement
that only include its subsidiaries, and not itself.
a parent company prepares financial statements
for its subsidiaries by operating group.
3-41
Combined Financial Statements
 The procedures used to prepare combined
financial statements are essentially the same
as those used in preparing consolidated
financial statements:


Eliminate all intercompany receivables, payables,
transactions, unrealized profits and losses,
ownership, and the associated portion of
stockholders’ equity.
The remaining stockholders’ equity is divided into
the portions accruing to the controlling and noncontrolling interests.
3-42
Practice Quiz Question #6
Which of the following statements is
true regarding combined financial
statements:
a. The parent company is always included in
b.
c.
d.
combined financial statements.
Companies included in combined financial
statements simultaneously own a majority of
each others stock.
Combined financial statements combine the
financial statements of a group of companies
that have the same owner.
All intercompany transactions remain in the
accounts of combined financial statements.
3-43
Learning Objective 3-7
Understand and explain the
rules related to the
consolidation of variable
interest entities.
3-44
The Rise and FALL of Enron
Press Release Tuesday, October 16, 2001
ENRON REPORTS NON-RECURRING CHARGES OF $1.01
BILLION AFTER-TAX.
3-45
Special Purpose Entities
 Corporations, trusts, or partnerships created
for a single specified purpose.
 Usually have no substantive operations and
are used only for financing purposes.
 Used for several decades for asset
securitization, risk sharing, and taking
advantage of tax statutes.
3-46
Variable Interest Entities
 A legal structure used for business purposes,
usually a corporation, trust, or partnership,
that either


does not have equity investors that have voting
rights and share in all profits and losses of the
entity, or
has equity investors that do not provide sufficient
financial resources to support the entity’s
activities.
3-47
Enron’s Accounting “Sleight of Hand”
Special Purpose Entities (SPEs)

What is normally the business purpose?


Bundle peripheral activities and have them
done by an independent, but close, friend.
Examples:
 Acquire financing for a project
 Package receivables and sell them to third parties

What was Enron’s purpose?

Move liabilities off the balance sheet

Provide favorable terms for some transactions
3-48
“Raptors”
 Established by Enron CFO to provide a quick
buyer for Enron assets.

Option 1: Find a bona fide third party.


Can’t find anyone?
Option 2: Establish a SPE to take the other side
of the transaction.
 Where does the financing come from?

97% sponsoring institution

3% third party
3-49
Example: The Chewco Raptor
A diagram of the Chewco transaction is set forth below:
3-50
Raptor’s Impact on Earnings
Quarter
Earnings Raptors
Raptor’s
Impact
3Q 2000
$364
$295
$69
4Q 2000
286
(176)
462
1Q 2001
536
281
255
2Q 2001
530
490
40
3Q 2001
(210)
(461)
251
Total
$1,506
$429
$1,077
3-51
Variable Interest Entities (VIEs)
 As a result of the Enron collapse and other notable
scandals related to SPEs, the FASB issued guidance on
VIEs in 2003 (ASC 810-10-25) and updated this
guidance later the same year (ASC 810-10-38C).
 What is a VIE?

An entity that either



does not have equity investors with voting rights and a
percentage of profits and losses, OR
has equity investors that do not provide sufficient
financial resources to support the entity’s activities.
What is a variable interest?

An interest that changes with changes in the VIE’s net assets.
3-52
Variable Interest Entities
 ASC 810-10-25 uses the term “variable interest
entities” to encompass SPEs and other entities
falling within its conditions.
 ASC 810-10-38C defines a variable interest in a
VIE as a contractual, ownership (with or without
voting rights), or other money-related interest in
an entity that changes with changes in the fair
value of the entity’s net assets exclusive of variable
interests.
3-53
Purpose of ASC 810
The main effect of ASC 810-1038C is to capture those
investment relationships in
which a controlling financial
interest is not indicated by
voting rights, but is indicated by
residual interests in risks and
benefits, which is the conceptual
definition of ownership in CON6.
3-54
Example: Variable Interest Entities
Senior Debt
($85k)
Junior Debt
($12k)
Lease Pmts.
ABC Corp.
$100k
Leasing Corp.
Use of Building
Building Owner
Building
Investor ($3k)
How would ABC Corp. typically determine whether to consolidate Leasing Corp.?
 A controlling financial interest through voting rights.
What if ABC Corp. were a related party to Investor?
What if ABC Corp. guaranteed the value of the building at the end of the lease?
What if ABC Corp. received any residual value above $100k when building sold?
3-55
Variable Interest Entities (VIEs)
Variable Interest Relationships


Situations in which an entity receives benefits
and/or is exposed to risks similar to those
received from having a majority ownership
interest.
Results from contractual arrangements.
3-56
VIEs: “Contractual Arrangements”
 Contractual Arrangement Types:

Options

Leases

Guarantees of asset recovery values

Guarantees of debt repayment
 Contractual arrangements may exist
simultaneously with a less than majority
ownership in a VIE.
3-57
VIEs: Potential Variable Interests
 Potential Variable Interests

Subordinated loans to a VIE.

Equity interests in a VIE (50% or less).



Guarantees to a VIE’s lenders or equity
holders (that reduce the true risk of these
parties).
Written put options on a VIE’s assets held
by a VIE or its lenders or equity holders.
Forward contracts on purchases and sales.
3-58
VIEs: Most are “SPEs”
 Special Purpose Entities


Legally structured entities to serve a specific,
predetermined, limited purpose.
May be a corporation, partnership, trust, or some
other legal entity.

Creator is called the “sponsor.”

Usually thinly capitalized.

Most commonly used for securitizations (of
receivables).
3-59
VIEs: The Primary Beneficiary
 The primary beneficiary of a VIE must consolidate
the VIE.
 The primary beneficiary is the entity that


has the power to direct the activities of a VIE that most
significantly impact the VIE’s economic performance.
will absorb losses of the VIE that could potentially be
significant to the VIE or will receive the benefits from
the VIE that could potentially be significant to the VIE.
 Only one primary beneficiary can exist for a VIE
(by definition).
3-60
Group Exercise 3: To Consolidate (or not)?
Parch Inc. and Rees Urch, Parch’s former head of R&D, formed
Sede Inc., which will perform research and development.
Sede issued 10,000 shares of common stock to Urch, who is
now Sede’s president. Parch lent $800,000 to Sede for initial
working capital in return for a note receivable that can be
converted at will into 100,000 shares of Sede’s common stock.
Parch also granted Sede a line of credit of $1,000,000.
REQUIRED
1. Is consolidation appropriate?
2. What would Parch accomplish with this arrangement?
3. If consolidation were not appropriate, what serious
reporting issue exists regarding Parch’s separate
financial statements?
3-61
Practice Quiz Question #3
On 1/1/X2, Pocahontas, Inc. invested $480,000 in
Smith (80% owned). For 20X2, Smith:
(1) earned $70,000,
(2) declared dividends of $60,000, and
(3) paid dividends of $50,000.
What amounts does Pocahontas report?
Cost
Equity
Investment income for 20X2
Investment in Smith at year-end
Retained earnings increase
3-62
Practice Quiz Question #4
On 1/1/X2, Pocahontas, Inc. invested $480,000 in
Smith (80% owned) and NCI shareholders invested
$120,000. For 20X2, Smith:
(1) earned $70,000,
(2) declared dividends of $60,000, and
(3) paid dividends of $50,000.
What amounts does Pocahontas report for the
following items?
NCI in net income for 20X2
NCI in net assets at 12/31/X2
Parent’s retained earnings increase
3-63
Learning Objective 3-8
Understand and explain
differences in consolidation
rules under U.S. GAAP
and IFRS.
3-64
IFRS Differences Related to VIEs and SPEs
 U.S. GAAP and International Financial
Reporting Standards (IFRS) are rapidly
converging.


The FASB and the IASB are working together to
remove differences in existing standards.
They are also working jointly on all new
standards so that agreed-upon standards can be
adopted.
 Despite convergence efforts, there are still
some differences related to VIEs and SPEs.
 See Figure 3-1 on p. 124 of the text.
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Key Differences between U.S. GAAP and IFRS
Topic
Determination
of Control
U.S. GAAP
 Normally, control is
determined by majority
ownership of voting shares.
 However, majority ownership
may not indicate control of a
VIE.
 Thus, VIE rules must be
evaluated first in all
situations.
 The primary beneficiary must
consolidate a VIE.
 The majority shareholder
consolidates most non-VIEs.
 Control is based on direct or
indirect voting interests.
 An entity with less than 50
percent ownership may have
“effective control” through
other contractual
arrangements.
IFRS
 Normally, control is determined by
majority ownership of voting
shares.
 In addition to voting shares,
convertible instruments and other
contractual rights that could affect
control are considered.
 A parent with less than 50 percent
of the voting shares could have
control through contractual
arrangements allowing control of
votes of the board of directors.
 Control over SPEs is determined
based on judgment and relevant
facts.
 Substance over form considered in
determining whether an SPE
should be consolidated.
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Key Differences between U.S. GAAP and IFRS
Topic
Related Parties
Definitions of
VIEs versus
SPEs
U.S. GAAP
IFRS
 Interests held by related
 There is no specific provision for
parties and “de facto” agents
related parties or de facto agents.
may be considered in
determining control of a VIE.
 SPEs can be VIEs.
 Considers specific indicators of
 Consolidation rules focus on
whether an entity has control of
whether an entity is a VIE
an SPE: (1) whether the SPE
(regardless of whether or
conducts activities for the entity,
not it is an SPE).
(2) whether the entity has
 This guidance applies only to
decision-making power to obtain
legal entities.
majority of benefits from the SPE,
(3) whether the entity has the
right to majority of benefits from
the SPE, and (4) whether the
entity has majority of the SPE’s
residual or risks.
 This guidance applies whether or
not conducted by a legal entity.
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Key Differences between U.S. GAAP and IFRS
Topic
Disclosure
Accounting for
Joint Ventures
U.S. GAAP
 Disclosures required for
determining control of a VIE.
 Entities must disclose
whether or not they are the
primary beneficiary of
related VIEs.
 Owners typically share
control (often with 50-50
ownership).
 If the joint venture is a VIE,
contracts must be
considered to determine
whether consolidation is
required.
 If the joint venture is not a
VIE, venturers use the equity
method.
 Proportional consolidation
generally not permitted.
IFRS
 No SPE-specific disclosure
requirements.
 There are specific disclosure
requirements related to
consolidation in general.
 Joint ventures can be accounted
for using either proportionate
consolidation or the equity
method.
 Proportionate consolidation
reports the venturer’s share of
the assets, liabilities, income, and
expenses on a line-by-line basis
based on the venturer’s financial
statement line items.
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Practice Quiz Question #5
Which of the following differs
between U.S. GAAP and IFRS in the
determination of control?
a. In U.S. GAAP, control is solely based on
ownership but IFRS considers other
factors.
b. U.S. GAAP ignores direct stock
ownership, while IFRS considers it.
c. In U.S. GAAP, rules related to VIEs must
be followed, but IFRS has not specifically
addressed VIEs (only SPEs).
e. The determination of control is identical
under U.S. GAAP and IFRS.
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Appendix 3B
Understand and explain the
differences in theories of
consolidation.
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Different Approaches to Consolidation
 Theories that might serve as a basis for
preparing consolidated financial statements:

Proprietary theory

Parent company theory

Entity theory
 With the issuance of ASC 805, the FASB’s
approach to consolidation now focuses on the
entity theory.
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Proprietary Theory
 Views the firm as an extension of its
owners.
 Assets and liabilities of the firm are
considered to be those of the owners.
 Results in a pro rata consolidation where
the parent consolidates only its
proportionate share of a less-than-wholly
owned subsidiary’s assets, liabilities,
revenues, and expenses.
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Parent Company Theory
 Recognizes that although the parent does not
have direct ownership or responsibility, it
has the ability to exercise effective control
over all of the subsidiary’s assets and
liabilities, not simply a proportionate share.
 Separate recognition is given, in the
consolidated financial statements, to the
noncontrolling interest’s claim on the net
assets and earnings of the subsidiary.
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Entity Theory
 Focuses on the firm as a separate economic
entity rather than on the ownership rights
of the shareholders.
 Emphasis is on the consolidated entity itself,
with the controlling and noncontrolling
shareholders viewed as two separate
groups, each having an equity in the
consolidated entity.
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Recognition of Subsidiary Income
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Entity Theory
 All of the assets, liabilities, revenues, and
expenses of a less-than-wholly owned
subsidiary are included in the consolidated
financial statements, with no special
treatment accorded either the controlling or
noncontrolling interest.
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Reporting Net Assets of the Subsidiary
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Current Practice
 ASC 805-50-30 has significantly changed the
preparation of consolidated financial
statements subsequent to the acquisition of
less-than-wholly owned subsidiaries.


Under ASC 805-50-30, consolidation follows
largely an entity-theory approach.
Accordingly, the full entity fair value increment
and the full amount of goodwill are recognized.
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Current Practice
 Current approach clearly follows the entity
theory with minor modifications aimed at the
practical reality that consolidated financial
statements are used primarily by those
having a long-run interest in the parent
company.
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Practice Quiz Question #7
Current consolidation practice in
the U.S. adopts the:
a.
b.
c.
d.
e.
proprietary theory.
parent company theory.
equity theory.
entity theory.
None of the above.
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Conclusion
The End
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