SM Modern Advanced Accounting in Canada 7 Hilton

SM Modern Advanced Accounting in Canada 7 Hilton

Chapter 9

Other Consolidation
Reporting Issues

A brief description of the major points covered in each case and problem.

CASES
Case 9-1
In this case, the student must determine how to report two investments. One investment is subject to joint control and should be accounted for as a joint venture. The other investment is subject to control through means other than voting shares and should be accounted for as a variable-interest entity.

Case 9-2
In this case, the company plans to set up a variable-interest entity (VIE) to renovate its manufacturing plant and record a gain on the transfer to the VIE. The student is asked to discuss the accounting issues for the proposed transactions.

Case 9-3
This case requires the downloading of the year-end financial statements of any two of four Canadian public corporations and, for each, to write a report describing the extent of involvement with VIEs and SPEs and the effect that the VIEs and SPEs have on their financial statements.

Case 9-4

This case, adapted from a CA exam, involves a joint venture. Parties to a joint venture are disputing charges by other venturers to the joint venture and accounting policies for the joint venture. The CA, as arbitrator, must resolve the issues.

Case 9-5

This case involves a discussion of the factors to be used in determining whether a particular country is material and should be disclosed separately.

Case 9-6
This case, adapted from a CA exam, involves an unincorporated joint venture in the computer graphics and animation industry. You are asked to prepare a report regarding accounting issues for financial statements that involve special accounting policies, which are not in accordance with GAAP. The accounting issues include valuation of all assets and liabilities at fair value, revenue recognition, related party transaction and consideration received for option to buy additional shares in the entity.

PROBLEMS

Problem 9-1 (25 min.)
This problem involves the preparation of a consolidated balance sheet at the date of acquisition for a VIE under 3 different values attributed to the non-controlling interest.

Problem 9-2 (20 min.)
This problem requires the calculation of amounts for the statement of financial position to be used to consolidate a 100% owned subsidiary where the purchase has just occurred and there are deferred tax complications.

Problem 9-3 (30 min.)
This problem requires the determination of a VIE’s balance sheet amounts to be used for consolidation by the primary beneficiary and the calculation of goodwill and non-controlling interest under the parent company extension theory.

Problem 9-4 (35 min.)
This problem requires the calculation of the acquisition differential (AD) and subsequent amortization for an 80%-owned subsidiary when there is an unrecognized loss carry-forward and deferred income taxes on temporary differences. It also requires a calculation of non-controlling interest along with an explanation as to why the AD gives rise to a deferred income tax liability.

Problem 9-5 (40 min.)
The student is asked to prepare a consolidated balance sheet immediately after acquisition for a parent and its 100%-owned subsidiary where there are deferred tax complications and to prepare an acquisition differential amortization and impairment schedule involving deferred taxes.

Problem 9-6 (50 min.)
This problem is the same as Problem 5 except the subsidiary is 60%-owned. A consolidated balance sheet is required immediately after acquisition, and there are deferred tax complications. The problem also requires the calculation of goodwill and non-controlling interest under the parent company extension theory and an explanation as to how the definition of a liability supports the recognition of a deferred tax liability.

Problem 9-7 (60 min.)
This is a complex problem involving the preparation of a consolidated statement of financial position for a primary beneficiary and a VIE five years after the date of acquisition. It involves negative goodwill and amortization of the acquisition differential. It also requires an explanation of how the definition of a liability supports the inclusion of the VIE’s liability on the consolidated balance sheet.

Problem 9-8 (20 min.)
The student is asked to identify which segments should be reported from a list. The revenue test, operating profit test, and asset test must be performed.

Problem 9-9 (50 min.)
A consolidated balance sheet is required for an investor and its two investees under two scenarios – 1) where the equity method is used to account for a joint venture and 2) where proportionate consolidation is used to account for the joint venture.. Preferred shares and unrealized profits in inventory are also involved.

Problem 9-10 (25 min.)
This problem requires the preparation of a company’s income statement under the assumption that its 40% investment in another company is either (a) a joint venture or (b) a significant influence investment.

Problem 9-11 (25 min.)
A year’s equity method journal entries involving unrealized profits in opening and closing inventory and equipment profits are required under the assumption that the investee is (a) a subsidiary, and (b) a joint venture.

Problem 9-12 (30 min.)
This problem involves the journal entries required for an investment of nonmonetary assets in the formation of a joint venture. The investor receives an equity interest plus cash.

Problem 9-13 (25 min.)
This problem requires an income statement under the equity method if the investee is a joint venture and unrealized gains are involved. A second part requires the calculation of consolidated net income assuming the investee is a subsidiary.

Problem 9-14 (35 min.)
This problem requires the preparation of journal entries under the equity method for a venturer who has contributed assets at a gain for an interest in a joint venture. Finally equity method entries are required for the case where the venturer receives cash back from the assets contributed for an interest in a joint venture.

Problem 9-15 (60 min.)
This problem requires the preparation of a balance sheet for a company with a 40% interest in another company under three assumptions: (a) control exists, (b) the investment is a joint venture, and (c) it is a significantly influenced investment. It also involves a calculation and interpretation of the debt to equity ratio under the three assumptions. The date is five years after acquisition and there are intercompany profits and balances.

WEB-BASED PROBLEMS

Web Problem 9-1
The student answers a series of questions based on the 2012 financial statements of Empire Company Limited, a Canadian company. The questions involve special purpose entities, joint ventures and deferred income taxes.

Web Problem 9-2
The student answers a series of questions based on the 2012 financial statements ofCAE Inc., a Canadian company. The questions involve special purpose entities, joint ventures and deferred income taxes.

Web Problem 9-3
The student answers a series of questions based on the 2011 financial statements of Rogers Communications Inc., a Canadian company. The questions involve analysis and interpretation of segment reporting information disclosed in the company’s financial statements

Web Problem 9-4
The student answers a series of questions based on the 2011 financial statements of Barrick Gold Corporation, a Canadian company. The questions involve analysis and interpretation of segment reporting information disclosed in the company’s financial statements

SOLUTIONS TO REVIEW QUESTIONS

1. Both the subsidiary and the variable-interest entity (VIE) are controlled. The subsidiary is controlled by the parent whereas the VIE is controlled by the primary beneficiary. The main difference is the way in which the VIE is controlled. The parent typically controls the subsidiary by owning the majority of the voting shares of the subsidiary. The primary beneficiary controls the VIE through governing agreements and may even have this control without owning any of the voting shares of the VIE.

2. Assets and liabilities should be presented on a balance sheet if they meet the definition of assets and liabilities. Assets are economic resources controlled by an entity as a result of past transactions or events and from which future economic benefits may be obtained. A primary beneficiary controls a variable-interest entity (VIE), and therefore indirectly controls the economic resources of the VIE and receives the majority of the future economic benefits. Liabilities are obligations of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future. The primary beneficiary indirectly takes responsibility for the majority of the risk related to the obligations of the VIE.

3. For an interest in a joint operation, the venturer should recognize the assets it controls and the liabilities it incurs; the expenses it incurs; and its share of the revenue and expenses from the sale of goods or services by the joint operation.

4. Normally, a 62% interest in the voting shares of a company would be sufficient for control to exist, and therefore Z would be a subsidiary. But, there could be an agreement between Y Company and the investors who hold the other 38% that does not give Y control over Z Company. The agreement could give joint control to Y and one or more of the other shareholders. In this situation, Z would not be a subsidiary; rather, it would be a joint venture. Or, the agreement could give control to another shareholder. In this case, Y may have to report the investment using the equity method if it had significant influence or at fair value if it did not have significant influence. If Y did not have sufficient equity at risk, someone else would control Z and Z would be a VIE.

5. In a parent–subsidiary affiliation, 100% of intercompany inventory profits are eliminated. If the parent was the selling company, the elimination is entirely allocated to the parent. If the subsidiary was the selling company, the elimination is allocated to the parent and the non-controlling interest. In a venturer–joint venture affiliation, only the venturer’s share of the intercompany profit is eliminated, regardless of which party was the selling company. If the joint venture was the selling company, there is no non-controlling interest to make an allocation to. If the venturer was the selling company, the venturer realizes a portion of the profit equal to the interest of the other venturers, provided that they are not related to the venturer.

6. The investment is recorded at the fair value of the nonmonetary assets transferred. The gain is split between the amount represented by the interests of the other nonrelated venturers and the amount represented by the venturer’s own interest. The amount pertaining to the other venturers’ interests is recognized in income immediately if the transaction has commercial substance. If not, the amount is brought into income over the life of the asset. The amount pertaining to the venturer’s own interest is brought into income over the life of the asset if the asset is being used to generate a profit for the venturer.

7. The gain recognition principle states that gains should be recorded when they are realized i.e., when a transaction has occurred with an outside entity and consideration is received. For transactions between a venturer and the joint venture, the portion of the gain equal to the outside interest in the joint venture is considered to be realized because the other parties in the joint venture are not related to the venturer and are considered to be outsiders.

8. The fact that the fair values of Y’s assets exceeded their tax bases on the date that X Company acquired control over Y will have the following impact on the consolidated balance sheet:
a. A deferred tax liability will be determined for the difference between the fair value and the tax bases of Y’s net assets. The difference between this deferred tax liability and the amount already reported on Y’s separate-entity balance sheet would be included in the allocation of the acquisition differential.
b. As a result of (a), goodwill will be different than it would have been if Y’s assets had fair values equal to their tax bases.
c. The deferred tax liability determined in (a) will be disclosed on the consolidated balance sheet and will be reassessed each year.
d. Finally, as a result of (a), the non-controlling interest on the consolidated balance sheet will be different than it would have been if Y’s assets had fair values equal to their tax bases.

9. The parent company may be able to recognize its own unused income tax losses and those of the acquired company at the date of acquisition if it can now meet the “probability” test for these losses. This test may now be met because of synergies created by the combining of the two companies. If this is so, this will result in deferred tax assets appearing on the consolidated statements that were not on the separate-entity statements.

10. Temporary differences exist when the carrying amount of an asset or liability is different from its tax base. A deductible temporary difference is one that can be deducted in determining taxable income in the future when an asset or liability is recovered or settled for its carrying amount. Deductible temporary differences exist when the carrying amount of an asset is less than its tax base, or when an amount related to a liability can be deducted for tax purposes. Deductible temporary differences represent a deferred tax asset to the company. A taxable temporary difference will result in a taxable amount in the future when the carrying amount of an asset or liability is recovered or settled and represents a deferred tax liability to the company. A taxable temporary difference arises mainly when the carrying amount of an asset is greater than its tax base.

11. A deferred tax asset would exist on a subsidiary’s balance sheet if the subsidiary carried an asset on its books at less than its tax base. If this same asset had a fair value that was greater than the tax base, a deferred tax liability would be reported on the consolidated balance sheet. The reason for the change is that the carrying amount of the asset on the consolidated balance sheet has changed as a result of the acquisition transaction.

12. Since tax returns are filed for separate legal entities and not the consolidated entity, the fair value excess in a business combination is not considered to be a deductible cost for tax purposes. If the asset acquired in a business combination were subsequently sold at its fair value, a gain would be reported for tax purposes at the subsidiary level and tax would be assessed on that gain even though no gain may be realized from a consolidated point of view. This deferred tax obligation is reported as a deferred tax liability on the consolidated financial statements at the date of acquisition.

13. A company should report information about an operating segment that meets any ONE of the following:
a. The operating segment’s reported revenue (intersegment sales plus transfers, plus external sales) is 10% or more of the combined internal and external revenue of the company.
b. The absolute amount of the segment’s reported profit or loss is 10% or more of the greater of:
i. the combined reported profit of all operating segments that did not report a loss
ii. the combined reported loss of all operating segments that did report a loss.
c. The segment’s assets are 10% or more of the combined assets of the company.

14. The following information must be disclosed for each operating segment:
• factors used to identify the reportable segments
• types of products and services offered by reportable segments
• profit or loss
• total assets
• total liabilities if such amounts are regularly provided to the chief operating decision maker
In addition, the following should also be disclosed if they are included in the measure of profit or loss reviewed by the chief operating decision maker:
• external and intersegment revenue
• interest revenue and expense (separately)
• amortization and other significant noncash items
• unusual items
• equity in income of investees
• income tax expense or benefit
• amount of investment in investees subject to significant influence
• total expenditures for additions to non-current assets and goodwill

15. In addition to segmented information based on operating segments, the financial statements must also disclose segmented information on an enterprise-wide basis. In other words, the financial statements must provide segmented information regardless of whether there are operating segments to report. Unless it is impractical to do so, the financial statements should disclose the following:
• Information about external revenues, property, plant and equipment, and goodwill on the basis of geographic areas.
• Information about external revenues on a product-by-product basis, or by each group of similar products.
• If the company’s revenue to a single external customer is 10% or more of total revenue, the company must disclose this fact, the total amount of the revenue to that customer, and the identity of the operating segment(s) reporting the revenue.

16. The following reconciliations are required for segment reporting:
(a) the total of the reportable segments’ revenues to the entity’s revenue.
(b) the total of the reportable segments’ measures of profit or loss to the entity’s profit or loss
(c) the total of the reportable segments’ assets to the entity’s assets.
(d) the total of the reportable segments’ liabilities to the entity’s liabilities if segment liabilities are reported separately
(e) the total of the reportable segments’ amounts for every other material item of information disclosed to the corresponding amount for the entity.

17. The presentation of a measure of profit, revenue, and assets for each reportable segment
allows a statement user to calculate a measure of return on assets, margin, and turnover, so that the relative contribution of each segment to the overall profitability of the company can be assessed and compared with that of the previous year.

SOLUTIONS TO CASES

Case 9-1
Holdco’s 30% interest in Elgin Company should be reported using the equity method because Elgin Company is a joint venture. Although Ms. Richer owns 70% of the common shares of Elgin, he does not control Elgin. The shareholders’ agreement indicates that the two shareholders must agree on all major operating and financing decisions. Therefore, the two shareholders jointly control Elgin and Elgin should be accounted for as a joint venture. According to IFRS 10, the equity method should be used to report an investment in a joint venture. This accounting treatment will not affect the debt-to-equity ratio.

Metcalfe Inc. should be consolidated with Holdco because Metcalfe is a variable-interest entity and Holdco is the primary beneficiary. Although Holdco only owns 40% of Metcalfe, it controls Metcalfe because Ms. Landman, the sole owner of Holdco, is responsible for all key operating, investing, and financing decisions. Furthermore, Holdco has the obligation to absorb Metcalfe’s expected losses and the right to receive Metcalfe’s expected residual returns if they occur. Debt will increase by $1,500,000 and equity will increase by $300,000, which is the fair value of the non-controlling interest. The incremental transaction has a debt-to-equity ratio of 5:1. Assuming that Holdco’s debt-to-equity ratio is less than 3:1 prior to this transaction, the new acquisition will cause the debt-to-equity ratio to increase.