FINANCIAL

ACCOUNTING
THEORY AND
ANALYSIS:
TEXT AND CASES
11TH EDITION

RICHARD G.
SCHROEDER
MYRTLE W. CLARK

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
Wyatts 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
2001: SFAS 141 (FASB ASC
805) abolished further use

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
2007: Revised standard
SFAS No. 141(R) (FASB ASC 805)

The Acquisition Method

SFAS No. 141(R): broadened scope of purchases
Changed name to acquisition method
When a business combination is created by an
exchange of stock, requires that the following
pertinent facts and circumstances be taken into
consideration (FASB ASC 805-10-55-12) :

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

Steps in The Acquisition

Method
Identify acquiring entity
Determine cost of acquisition

Historical cost prior to SFAS No. 141

Revised standard: acquirer must recognize all

assets acquired, liabilities assumed, and any
noncontrolling interest at fair value (exit value)

Business Combinations II

FASB IASB project on business combinations

Phase 1- Valuation of intangibles (IFRS No. 3 and

SFAS No. 141)
Phase 2 Develop a common set of principles
intended to improve the completeness, relevance and
comparability of financial information about business
combinations.

2007: FASB determined business combinations

should be recorded at fair value as defined is
SFAS ASC 820

Now used under guidelines in FASB ASC 805

Consolidation

When one business organization has control over

another they should report as a unified whole
Now required by FASB ASC 810-10-25
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 subsidiarys outstanding common
stock
Has the ability to dominate the subsidiarys 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 entitys purpose?

3.

4.

(Use SFAS No 140 see FASB ASC 860 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

Doesnt 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
(See FASB ASC 840)
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

Special Purpose Entities

FIN No. 46, 2003, Consolidation of Certain Special
Purpose Entities

Later amended by FIN 46R

Company may have controlling financial interest

but no voting interest

Variable interest entities (VIEs)

Intent: require consolidation only if VIE did not effectively

disperse risks and benefits
SFAS No. 167, Dec. 2009, Amendments fo FASB
Interpretation No. 46(R)

Required analysis of controlling financial interest in VIE

Assess whether a company has implicit financial responsibility

Segmental Reporting

Required under SFAS No. 131 (FASB ASC 280)

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 (1976, since

superseded) 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(FASB ASC 280-10-5020 to 25)

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

FASB ASC 280

Goal: use enterprises internal organization so

reportable operating segments will be readily
evident
Definition of operating segment
Major problems:

Determination of reportable segments

Allocation of joint costs
Transfer pricing

Reportable Segments

Meet any of following quantitative thresholds

1.
2.
3.

Reported revenue is >= 10% of combined revenue

Reported profit (loss) >= 10% of combined profit (loss)
Assets >= 10% of combined assets

Some segments can be aggregated

FASB ASC 280-10-50 requires
specific disclosures

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 Rate Method
Temporal Method

FASB and Foreign Currency

Translation

SFAS No. 8 (since superseded)

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 (FASB ASC 830)

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
(Revised)
ted
Consolida
Financial
and
s
t
n
e
m
e
t
a
St
for
g
n
i
t
n
u
o
c
Ac
ts in
n
e
m
t
s
e
v
In
ies
Subsidiar

IAS No 2
1
(revised
)
The Effe
cts of
Changes
in
Foreign
Exchang
e
Rates

IFRS No 3
Business
ons
Combinati
(replaces
)
IAS No. 22

IFRS N
o

Operat
ing
Segme
nts
(Repla
ce
IA S N o s
. 14)

Revised IAS No. 27 (2008):

Consolidated Financial Statements
and Accounting for Investments in
Subsidiaries

More in line with U. S. GAAP

Standard to be applied
1.
2.

For group of entities under control of a parent, and

Accounting for investments when entity presents separate financial
statements

Consolidation required
.
.
.
.

Ownership of > 50% of voting rights

Ability to govern
Ability to appoint or remove majority of board of directors
Ability to cast majority votes at board of directors meetings

IAS No. 27: Consolidated Financial

Statements and Accounting for
Investments in Subsidiaries

Parent companies should present

consolidated financial statements
When it has the ability to control its subsidiaries

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 IFRS

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

New Developments

New pronouncements dealing with multiple entities:

0
IFRS No. 1
ted
Consolida
Financial
s
Statement

IFR S N o

. 11

Joint
Arrange
ments

IFRS No. 1

of
Disclosure
n
Interests i
ies
Other Entit

ISRS No. 10: Consolidated Financial

Statements

Outlines requirements for preparation and presentation of

consolidated financial statements
Requires entities to consolidate entities it controls.
Requires a parent entity (an entity that controls one or more
other entities) to present consolidated financial statements
Objective: Establish principles for presentation and
preparation of consolidated financial statements. It:

Defines the principle of control and establishes control as the

basis for consolidation
Sets out how to apply the principle of control to identify whether
an investor controls an investee and therefore must consolidate
the investee
Sets out the accounting requirements for the preparation of
consolidated financial statements
Defines an investment entity and sets out an exception to
consolidating particular subsidiaries of an investment entity
Contains special accounting requirements for investment
entities.

ISRS No. 10: Consolidated Financial

Statements

An investor determines whether it is a parent by

assessing whether it controls one or more
investees.
An investor controls an investee if the investor has
all of the following elements:

Power over the investeei.e., the investor has existing

rights that give it the ability to direct the relevant activities
(the activities that significantly affect the investees
returns)
Exposure, or rights, to variable returns from its
involvement with the investee
The ability to use its power over the investee to affect the
amount of the investors returns

ISRS No. 10: Consolidated Financial

Statements

However, a parent need not present consolidated financial

statements if it meets all of the following conditions:

It is a wholly owned subsidiary or is a partially owned subsidiary

of another entity, and its other owners, including those not
otherwise entitled to vote, have been informed about, and do not
object to, the parent not presenting consolidated financial
statements.
Its debt or equity instruments are not traded in a public market).
It did not file, nor is it in the process of filing, its financial
statements with a securities commission or other regulatory
organization for the purpose of issuing any class of instruments
in a public market.
Its ultimate or any intermediate parent of the parent produces
consolidated financial statements available for public use that
comply with IFRSs

ISRS No. 10: Consolidated Financial

Statements

The following principles apply when preparing

consolidated financial statements:

Combine like items of assets, liabilities, equity, income,

expenses, and cash flows of the parent with those of its
subsidiaries.
Offset (eliminate) the carrying amount of the parents
investment in each subsidiary and the parents portion of
equity of each subsidiary.
Eliminate in full intragroup assets and liabilities, equity,
income, expenses, and cash flows relating to transactions
between entities of the group (profits or losses resulting
from intragroup transactions that are recognized in
assets, such as inventory and fixed assets, are eliminated
in full).

ISRS No. 10: Consolidated Financial

Statements

A parent presents noncontrolling interests in its consolidated

statement of financial position within equity separately from
the equity of the owners of the parent.
A reporting entity attributes the profit or loss and each
component of other comprehensive income to the owners of
the parent and to the noncontrolling interests.
The proportion allocated to the parent and noncontrolling
interests are determined on the basis of present ownership
interests.
The reporting entity also attributes total comprehensive
income to the owners of the parent and to the noncontrolling
interests even if this results in the noncontrolling interests
having a deficit balance.

ISRS No. 10: Consolidated Financial

Statements

If a parent loses control of a subsidiary, the parent:

Derecognizes the assets and liabilities of the former subsidiary

from the consolidated statement of financial position
Recognizes any investment retained in the former subsidiary at
its fair value when control is lost and subsequently accounts for
it and for any amounts owed by or to the former subsidiary in
accordance with relevant IFRSs.
That fair value is regarded as the fair value on initial recognition
of a financial asset in accordance with IFRS No. 9 or, when
appropriate, the cost on initial recognition of an investment in an
associate or joint venture
Recognizes the gain or loss associated with the loss of control
attributable to the former controlling interest

ISRS No. 10: Consolidated Financial

Statements

IFRS N0. 10 contains special accounting requirements for

investment entities.
Where an entity meets the definition of an investment entity,
it does not consolidate its subsidiaries or apply IFRS No. 3
when it obtains control of another entity.
IFRS No. 10 provides that an investment entity should have
the following typical characteristics:

It has more than one investment.

It has more than one investor.
It has investors that are not related parties of the entity.
It has ownership interests in the form of equity or similar
interests.

An investment entity is required to measure an investment in

a subsidiary at fair value in accordance with IFRS No. 9 or
IAS No. 39.

ISRS No. 11: Joint Arrangements

Outlines accounting by entities that

jointly control an arrangement.
Basic principle:

A party to a joint arrangement determines

type of joint arrangement by assessing
rights and obligations.
Party accounts for rights and obligations in
accordance with that type of joint
arrangement.

ISRS No. 11: Joint Arrangements

A joint arrangement is an arrangement of which two or

more parties have joint control. A joint arrangement has
the following characteristics:

The parties are bound by a contractual arrangement.

The contractual arrangement gives two or more of those
parties joint control of the arrangement.

Joint arrangements are either joint operations or joint

ventures:
A joint operation is a joint arrangement whereby the parties
that have joint control of the arrangement have rights to
the assets, and obligations for the liabilities, relating to the
arrangement.
A joint venture is a joint arrangement whereby the parties
that have joint control of the arrangement have rights to
the net assets of the arrangement

ISRS No. 11: Joint Arrangements

A joint operator recognizes in relation to its interest

in a joint operation:

Its assets, including its share of any assets held jointly

Its liabilities, including its share of any liabilities incurred
jointly
Its revenue from the sale of its share of the output of the
joint operation
Its share of the revenue from the sale of the output by the
joint operation
Its expenses, including its share of any expenses incurred
jointly

A joint operator accounts for the assets, liabilities,

revenues and expenses relating to its involvement
in a joint operation in accordance with the relevant
IFRSs.

ISRS No. 11: Joint Arrangements

A joint venturer recognizes its interest in a joint venture as an

investment and shall account for that investment using the equity
method in accordance with IAS No. 28
A party that participates in, but does not have joint control of, a
joint venture usually accounts for its interest in the arrangement
in accordance with IFRS No. 9.
The accounting for joint arrangements in an entitys separate
financial statements depends on the involvement of the entity in
that joint arrangement and the type of the joint arrangement:

If the entity is a joint operator or joint venturer it shall account for its
interest as a joint operation

If the entity is a party that participates in, but does not have joint
control of, a joint arrangement it shall account for its interest:

As a joint operation
As a joint venture in accordance with IFRS No. 9

IFRS No. 12: Disclosure of Interests in

Other Entities

Consolidated disclosure standard

Requires wide range of disclosures about an

entitys interests in subsidiaries and other
entities

Objective: Require disclosure of

information that enables users of
financial statements to evaluate:

Nature of interests in other entities

Effects of interests on financial performance

IFRS No. 12: Disclosure of Interests in

Other Entities

An entity discloses information about

significant judgments and assumptions it
has made in determining:

That it controls another entity

That it has joint control of an arrangement or
significant influence over another entity
The type of joint arrangement when the
arrangement has been structured through a
separate vehicle

IFRS No. 12: Disclosure of Interests in

Other Entities

An entity shall disclose information that enables

users of its consolidated financial statements to:

Understand the composition of the group

Understand the interest that noncontrolling interests have in the
groups activities and cash flows
Evaluate the nature and extent of significant restrictions on its
ability to access or use assets, and settle liabilities, of the group
Evaluate the nature of, and changes in, the risks associated with
its interests in consolidated structured entities
Evaluate the consequences of changes in its ownership interest in
a subsidiary that do not result in a loss of control
Evaluate the consequences of losing control of a subsidiary
during the reporting period

Prepared by Kathryn Yarbrough, MBA

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