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1. Consolidation Theories
Parent-company theory
– Viewpoint of parent company shareholders
Contemporary/entity theory
– Takes the viewpoint of the total consolidated entity
Traditional theory
– Viewpoint of the parent’s shareholders and creditors
– Statements are from the viewpoint of the total consolidated entity
Income Reporting
Consolidated net income:
• Parent-company theory and traditional theory
– Income to the parent company shareholders
• Contemporary/entity theory
– Income to be shared between the controlling and noncontrolling interests
Asset Valuation
Parent-company theory and traditional theory
– Subsidiary assets and liabilities are adjusted to fair value only to the extent of the
parent's 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 [$50 + 70%(80-50)] if the parent
owned 70%
Contemporary/entity theory
– Subsidiary 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
– Eliminate unrealized gains and losses attributable to the subsidiary based on parent's
ownership
• 80% of the $10 unrealized gains on upstream sales would be eliminated if the
parent owned 80% of the subsidiary
Contemporary/entity theory and traditional theory
– Unrealized gains and losses are eliminated
• Eliminate 100% of unrealized gains on upstream sales regardless of parent’s
share
All theories eliminate downstream gains and losses
Constructive Gains and Losses
Parent-company theory
– Recognize constructive gains and losses attributable to the subsidiary based on parent's
ownership
Contemporary/entity theory and traditional theory
– Recognize constructive gains and losses
• Include 100% of constructive gains and losses regardless of parent’s share
All theories recognize 100% of constructive gains and losses attributable to the parent
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.
2: Push-Down Accounting
Push-Down Procedure
Assets and liabilities are revalued
Goodwill, if any, is recorded
Retained earnings (prior to acquisition) are eliminated
Push-down capital
– Is an additional paid-in capital account
– Includes old retained earnings
– Any adjustments to assets and liabilities, including goodwill
A new retained earnings account is used subsequent to the business combination
3: Joint Ventures
It is a business entity that is owned, operated and jointly controlled by a small group of
investors for a specific business undertaking that provides mutual benefit for each of the
venturers.
– Incorporated
– General or limited partnerships
– Domestic or foreign
– Undivided interest
Investors who participate in the overall management of the joint venture
– Use equity method (one-line consolidation) 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
Application of the equity method to unincorporated joint ventures is appropriate
Industry-specific practice
– Pro rata (proportionate) consolidation in oil & gas
– SEC recommends against proportionate consolidation for undivided interests in
real estate ventures under joint control
4: Identify Variable Interest Entities
"Variable interests are contractual, ownership, or other pecuniary interests in a legal entity that
change with changes in the fair value of the legal entity's net assets exclusive of variable
interests.” [FASB ASC 810-10-15-14]
The primary beneficiary of the variable interest entity (VIE) must consolidate the VIE.
The primary beneficiary
– Has power to direct the VIE activities that most directly impact its economic
performance
– Has an obligation to absorb losses and/or a right to receive significant benefits
from the VIE
The primary beneficiary may be an equity holder and/or creditor of the VIE