Consolidation Theories, Push-Down Accounting, and Corporate Joint Ventures
1. Compare the traditional, parent-company, and entity theories of consolidated financial statements.
Parent company theory views consolidated financial statements from the viewpoint of the parent and entity theory views consolidated financial statements from the viewpoint of the business entity under which all resources are controlled by a single management team. By contrast, traditional theory sometimes reflects the parent viewpoint and at other times it reflects the viewpoint of the business entity. A detailed comparison of these theories is presented in Exhibit 11–1 of the text.
2. Which, if any, of the consolidation theories would be changed by FASB pronouncements? (E.g., assume that a new FASB statement requires noncontrolling interest share to be computed as the noncontrolling interest share of subsidiary dividends declared.)
Only contemporary theory is changed by current pronouncements of the Financial Accounting Standards Board. While such pronouncements can and do change the current accounting and reporting practices, they do not change the logic or the consistency of either parent company or entity theory.
3. Under the entity theory, a total valuation of the subsidiary is imputed on the basis of the price paid by the parent company for its controlling interest. Do you see any practical or conceptual problems with this approach?
The valuation of subsidiary assets on the basis of the price paid for the controlling interest seems justified conceptually when substantially all of the subsidiary stock is acquired by the parent. But the conceptual support for this approach is less when only a slim majority of subsidiary stock is acquired. In addition, the valuation of the noncontrolling interest based on the price paid by the parent has practical limitations because noncontrolling interest does not represent equity ownership in the usual sense. The ability of noncontrolling stockholders to participate in management is limited and noncontrolling shares do not possess the usual marketability of equity securities.
4. Assume that Pat Corporation acquires 60 percent of the voting common stock of Sir Corporation for $6,000,000 and that a consolidated balance sheet is prepared immediately after the acquisition. Would total consolidated assets be equal to their fair values if the parent-company theory were applied? If the entity theory were applied?
Consolidated assets are equal to their fair values under entity theory only when the book values of parent assets are equal to their fair values. Otherwise, consolidated assets are not equal to their fair values under either parent company or entity theories.
5. Why might the traditional practice of valuing the equity of noncontrolling shareholders at book value overstate the value of the noncontrolling interest?
The valuation of the noncontrolling interest at book value might overstate the equity of noncontrolling shareholders because of the limited marketability of shares held by noncontrolling stockholders and because of the limited ability of noncontrolling stockholders to share in management through their voting rights. Valuation of the noncontrolling interest at book value also overstates or understates the noncontrolling interest unless the subsidiary assets are recorded at fair values.
6. Cite the conditions under which consolidated net income under parent-company theory would equal income to controlling stockholders under entity theory.
Consolidated net income under parent company theory and income to the controlling stockholders under entity theory should be the same. This is illustrated in Exhibit 11–5, which shows different income statement amounts for cost of sales, operating expenses, and income allocated to noncontrolling stockholders, but the same income to controlling stockholders. Note that consolidated net income under parent company and traditional theories reflects income to controlling stockholders.
7. If income from a subsidiary is measured under the equity method and the statements are consolidated under entity theory, will consolidated net income equal parent net income?
Income to the parent stockholders under the equity method of accounting is the same as income to the controlling stockholders under entity theory. But income to controlling stockholders is not identified as consolidated net income as it would be under parent company or traditional theories.
8. Why are the income statement amounts under entity theory and traditional theory the same if the subsidiary investment is made at book value? (Do not consider the different income statement presentations of controlling and noncontrolling interests in responding to this question.)
Consolidated income statement amounts under entity theory are the same as under traditional theory when subsidiary investments are made at book value because traditional theory follows entity theory in eliminating the effects of intercompany transactions from consolidated financial statements.
9. Does traditional theory correspond to parent-company or entity theory in matters related to unrealized and constructive gains and losses on intercompany transactions?
Traditional theory corresponds to entity theory in matters relating to unrealized and constructive gains and losses from intercompany transactions. In other words, unrealized and constructive gains and losses are allocated between controlling and noncontrolling interests in the same manner under these two theories.
10. To what extent does push-down accounting facilitate the consolidation process?
Push-down accounting simplifies the consolidation process. The push-down adjustments are recorded in the subsidiary’s separate books at the time of the business combination; thus, it is not necessary to allocate the unamortized fair values in the consolidation working papers.
11. What is a joint venture and how are joint ventures organized?
A joint venture is an entity that is owned, operated, and jointly controlled by a small group of investor-venturers to operate a business for the mutual benefit of the venturers. Some joint ventures are organized as corporations, while others are organized as partnerships or undivided interests. Each venturer typically participates in important decisions of a joint venture irrespective of ownership percentage.
12. What accounting and reporting methods are used by investor-venturers in accounting for their joint venture investments?
Investors in corporate joint ventures use the equity method of accounting and reporting for their investment earnings and investment balances as required by GAAP. The cost method would be used only if the investor could not exercise significant influence over the corporate joint venture. Alternatively, investors in unincorporated joint ventures use the equity method of accounting and reporting or proportional consolidation for undivided interests specified as a special industry practice.
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