FAR SEC 14

Question 1

What is a business combination?

Answer 1

A business combination (hereafter called a combination) is “a transaction or other event in which an acquirer obtains control of one or more businesses.”

Question 2

As it relates to business combinations, what is control?

Answer 2

Control is a controlling financial interest. It is the direct or indirect ability to determine the direction of management and policies of the investee. This usually means one entity’s direct or indirect ownership of more than 50% of the outstanding voting interests of another entity.

Question 3

What is a parent?

Answer 3

A parent is an entity that has a controlling financial interest in one or more subsidiaries.

Question 4

What is a business? (4 elements)

Answer 4

1) A business consists of an integrated set of activities and assets that can be conducted to provide a return of economic benefits directly to investors or others.
2) The three elements of a business are inputs, processes, and outputs.
i) Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business.
ii) To qualify as a business, the set must include an input and a substantive process that together significantly contribute to the ability to create output.
3) When substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set acquired does not constitute a business. This transaction is a regular asset acquisition.
4) The table below presents the differences between the accounting for (a) asset acquisitions and (b) business combinations.

Question 5

What is shown on the table for differences between accounting for asset acquisitions and business combinations?

Answer 5

Question 6

What are the three elements of a business?

Answer 6

The three elements of a business are inputs, processes, and outputs.

Question 7

Are outputs required for an entity to qualify as a business?

Answer 7

No. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business.

Question 8

What is the minimum requirement for an entity to qualify as a business?

Answer 8

To qualify as a business, the set must include an input and a substantive process that together significantly contribute to the ability to create output.

Question 9

What is the accounting treatment for direct acquisition costs for business combinations?

Answer 9

Expensed as incurred

Question 10

What is the accounting treatment for goodwill for business combinations?

Answer 10

May be recognized

Question 11

What is the accounting treatment for Initial recognition of assets acquired for business combinations?

Answer 11

Acquisition date fair value

Question 12

What is the accounting treatment for direct acquisition costs for asset acquisitions?

Answer 12

Capitalized to assets’ cost

Question 13

What is the accounting treatment for goodwill for asset acquisitions?

Answer 13

Never recognized

Question 14

What is the accounting treatment for Initial recognition of assets acquired for asset acquisitions?

Answer 14

Allocation of cost based on relative fair values

Question 15

What are the attributes of consolidated reporting? (5 elements)

Answer 15

1) When one entity controls another, consolidated financial statements must be issued by a parent company regardless of the percentage of ownership.
2) Consolidated statements present amounts for the parent and subsidiary(ies) as if they were a single economic entity.
-Separate parent and subsidiary statements may be used for internal purposes, but they are not in conformity with GAAP.
3) Consolidated reporting is required even when majority ownership is indirect, i.e., when a subsidiary holds a majority interest in another subsidiary.
4) A parent and subsidiary may exist separately for an indefinite period, but consolidated financial statements must be issued that report them as a single entity.
5) Required consolidated reporting is an example of substance over form. Even if the two entities remain legally separate, the financial statements are more meaningful to users if they see the effects of control by one over the other.

Question 16

What are consolidated statements?

Answer 16

Consolidated statements present amounts for the parent and subsidiary(ies) as if they were a single economic entity.
-Separate parent and subsidiary statements may be used for internal purposes, but they are not in conformity with GAAP.

Question 17

When are consolidated statements required?

Answer 17

When one entity controls another, consolidated financial statements must be issued by a parent company regardless of the percentage of ownership. Consolidated reporting is required even when majority ownership is indirect, i.e., when a subsidiary holds a majority interest in another subsidiary.

Question 18

How is required consolidated reporting an example of substance over form?

Answer 18

Required consolidated reporting is an example of substance over form. Even if the two entities remain legally separate, the financial statements are more meaningful to users if they see the effects of control by one over the other.

Question 19

Although parent and subsidiary are separate entities, must they be reported on consolidated statements?

Answer 19

Yes. A parent and subsidiary may exist separately for an indefinite period, but consolidated financial statements must be issued that report them as a single entity.

Question 20

What is the recognition principle for business combinations? (5 invoices)

Answer 20

1) The acquirer must recognize the identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree.
2) The assets and liabilities recognized must be part of the exchange and not the result of separate transactions.
3) The acquirer must recognize only the consideration transferred for the acquiree.
4) The acquirer also must identify amounts not part of the exchange and account for them according to their nature and relevant GAAP.
5) A precombination transaction that primarily benefits the acquirer is most likely to be accounted for separately from the exchange.

Question 21

What is the accounting for the costs associated with business combinations? (3 elements)

Answer 21

1) Acquisition-related costs, such as finder’s fees, professional and consulting fees, and general administrative costs, are expensed as incurred.
Issue costs for securities are accounted for as follows:
2) Direct issue costs of equity (underwriting, legal, accounting, tax, registration, etc.) reduce additional paid-in capital.
-Indirect costs of issue, records maintenance, and ownership transfers (e.g., a stock transfer agent’s fees) are expensed.
3) Debt issue costs are reported in the balance sheet as a direct deduction from the carrying amount of the debt.

Question 22

How to contingencies relate to the accounting for business combinations? (3 elements)

Answer 22

1) Assets and liabilities arising from contingencies are recognized and measured at acquisition-date fair values.
2) The asset (liability) is derecognized when the contingency is resolved.
3) The acquirer recognizes an indemnification asset when the seller contracts to pay for the result of a contingency or uncertainty related to an asset or liability.

Question 23

What method is used to account for business combinations?

Answer 23

The acquisition method. A business combination must be accounted for using the acquisition method.

Question 24

What are the functions of the acquisition method for accounting for business combinations? (4 elements)

Answer 24

1) A business combination must be accounted for using the acquisition method. It
2) Determines the acquirer and the acquisition date.
3) Recognizes and measures at acquisition-date fair value the
i) Identifiable assets acquired,
ii) Liabilities assumed, and
iii) Any noncontrolling interest in the acquiree.
4) Recognizes goodwill or a gain from a bargain purchase and measures it using the goodwill equation.

Question 25

What are the three items recognized by the acquisition method, and how are they recognized? (4 elements)

Answer 25

1) Recognizes and measures at acquisition-date fair value the
2) Identifiable assets acquired,
3) Liabilities assumed, and
4) Any noncontrolling interest in the acquiree.

Question 26

How must the consideration transferred in a business combination be measured?

Answer 26

The consideration transferred in a business combination must be measured at acquisition-date fair value.

Question 27

What are the components of the consideration transferred in a business combination, and how are they measured? (4 elements)

Answer 27

1) The consideration transferred in a business combination must be measured at acquisition-date fair value. It includes the
2) Fair value of the assets transferred by the acquirer,
3) Fair value of liabilities incurred by the acquirer to former owners of the acquiree (e.g., a liability for contingent consideration), and
4) Fair value of equity interests (e.g., shares of common stock) issued by the acquirer.

Question 28

For business combinations, what are the attributes of contingent consideration? (3 elements)

Answer 28

1) Contingent consideration is an obligation of the acquirer to transfer additional assets or equity securities to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met.
-For example, on the business combination date, the acquirer promises to pay the former shareholders of the acquiree an additional $100,000 next year if the current-year consolidated net income is greater than $500,000.
2) On the business combination date, contingent consideration must be recognized at its acquisition-date fair value.
i) The acquisition-date fair value of contingent consideration must be included in the total fair value of the consideration transferred and included in the calculation of goodwill.
ii) Future settlement of the contingent consideration has no effect on the amount of goodwill that was recognized on the business combination date.
3) The classification of contingent consideration as a liability or as equity is based on the way it is settled (discussed in Study Unit 11, Subunit 6).
i) Contingent consideration that is classified as a liability must be remeasured to fair value at each balance sheet date until it is settled.
-Changes in the fair value are recognized in the income statement.
ii) Contingent consideration that is classified as equity is not remeasured to fair value.

Question 29

For business combinations, what is contingent consideration?

Answer 29

Contingent consideration is an obligation of the acquirer to transfer additional assets or equity securities to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met.
-For example, on the business combination date, the acquirer promises to pay the former shareholders of the acquiree an additional $100,000 next year if the current-year consolidated net income is greater than $500,000.

Question 30

For business combinations, how must contingent consideration be recognized? (3 elements)

Answer 30

1) On the business combination date, contingent consideration must be recognized at its acquisition-date fair value.
2) The acquisition-date fair value of contingent consideration must be included in the total fair value of the consideration transferred and included in the calculation of goodwill.
3) Future settlement of the contingent consideration has no effect on the amount of goodwill that was recognized on the business combination date.

Question 31

For business combinations, how must contingent consideration be classified? (3 elements)

Answer 31

1) The classification of contingent consideration as a liability or as equity is based on the way it is settled (discussed in Study Unit 11, Subunit 6).
2) Contingent consideration that is classified as a liability must be remeasured to fair value at each balance sheet date until it is settled.
-Changes in the fair value are recognized in the income statement.
3) Contingent consideration that is classified as equity is not remeasured to fair value.

Question 32

What is goodwill in the context of business combinations?

Answer 32

Goodwill is an intangible asset reflecting the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

Question 33

For business combinations, what is the goodwill equation?

Answer 33

Fair value of the consideration transferred
+
Fair value of any noncontrolling interest in the acquiree
+
Fair value of any previously held equity interest in the acquiree
–
Fair value of identifiable net assets acquired
Positive outcome = Goodwill; Negative outcome = Gain from a bargain purchase

Question 34

For business combinations, how is goodwill recognized? (9 elements)

Answer 34

1) Goodwill is an intangible asset reflecting the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.
2) At the acquisition date, the acquirer recognizes and measures goodwill or a gain from a bargain purchase using the goodwill equation.
3) A positive outcome of the equation results in recognition of goodwill in the consolidated balance sheet.
4) A negative outcome of the equation results in recognition of a gain from a bargain purchase in the consolidated income statement.
5) All components of the goodwill equation are measured at acquisition-date fair value.
6) The identifiable net assets acquired equal the identifiable assets acquired minus liabilities assumed.
7) Below is the goodwill equation:
Fair value of the consideration transferred
+
Fair value of any noncontrolling interest in the acquiree
+
Fair value of any previously held equity interest in the acquiree
–
Fair value of identifiable net assets acquired
Positive outcome = Goodwill; Negative outcome = Gain from a bargain purchase
8) A noncontrolling interest exists when less than 100% of the acquiree was acquired.
9) A previously held equity interest exists when control of the acquiree was achieved in several transactions.

Question 35

For the business combinations, how are the components of the goodwill equation measured?

Answer 35

All components of the goodwill equation are measured at acquisition-date fair value.

Question 36

For business combinations, how are the identifiable net assets acquired calculated?

Answer 36

The identifiable net assets acquired equal the identifiable assets acquired minus liabilities assumed.

Question 37

For business combinations, when does a noncontrolling interest exist?

Answer 37

A noncontrolling interest exists when less than 100% of the acquiree was acquired.

Question 38

For business combinations, when does a previously held equity interest exist?

Answer 38

A previously held equity interest exists when control of the acquiree was achieved in several transactions.

Question 39

For the calculation of goodwill from business combinations, what is the result of a positive outcome of the equation?

Answer 39

A positive outcome of the equation results in recognition of goodwill in the consolidated balance sheet.

Question 40

For the calculation of goodwill from business combinations, what is the result of a negative outcome of the equation?

Answer 40

A negative outcome of the equation results in recognition of a gain from a bargain purchase in the consolidated income statement.

Question 41

For business combinations, what are the basic aspects of the acquisition method? (4 invoices)

Answer 41

1) The acquirer is acquiring assets and assuming liabilities only. The acquiree’s equity accounts are not relevant.
2) Only the acquiree’s identifiable assets acquired and liabilities assumed are recognized.
3) Any goodwill on the books of the acquiree is not an identifiable asset recognized upon acquisition by the acquirer.
4) However, the acquirer may recognize certain intangible assets that did not qualify for recognition by the acquiree.
-For example, on the business combination date, the acquirer may recognize intangible assets, such as a brand name or in-process research and development (IPR&D). These internally developed intangible assets have not been recognized in the financial statements of the acquiree because the costs to develop them (e.g., R&D costs) were expensed as incurred.

Question 42

For business combinations, what is the accounting for a noncontrolling interest (NCI)? (2 elements)

Answer 42

1) A noncontrolling interest is a portion of equity (net assets) in a subsidiary not attributable to the parent. NCI is reported separately in the equity section of the parent’s consolidated balance sheet.
2) On the business combination date, the fair value of NCI can be calculated as total shares of common stock not acquired by the parent times the subsidiary’s market price per share.

Question 43

In consolidated financial reporting, what are the 6 steps to prepare an acquisition-date balance sheet?

Answer 43

A balance sheet should be prepared that reports the financial position of the consolidated entity at the acquisition date.
Step 1 – Determine the amount of goodwill or gain from bargain purchase recognized on the business combination.
Step 2 – Prepare the assets section of the consolidated balance sheet. Assets and liabilities are reported at 100% of their fair value even though an NCI exists.
Step 3 – Prepare the liabilities section of the consolidated balance sheet.
Step 4 – Determine the NCI. An NCI is not reported for every asset and liability. The entire NCI is reported as a single component of consolidated equity. (The fair value of the NCI was given in Example 14-10 as $30,000.)
Step 5 – Because a combination is an acquisition of net assets, the subsidiary’s equity accounts are eliminated. Thus, in the absence of a bargain purchase, the equity of the consolidated entity immediately after acquisition is the equity of the parent just prior to acquisition plus the fair value of the noncontrolling interest.
Step 6 – Prepare the acquisition-date balance sheet.
-If the subsidiary holds shares of the common stock of the parent, this reciprocal investment must be eliminated. Subsidiary shareholdings in a parent are treated as treasury stock of the consolidated entity. Because no gain or loss on treasury stock transactions is recognized, reciprocal investments have no effect on the net income or retained earnings of the consolidated entity.

Question 44

For consolidated financial reporting, when does the consolidated entity prepare its first full set of consolidated financial statements?

Answer 44

After the close of the fiscal year in which the combination occurred, the consolidated entity prepares its first full set of consolidated financial statements.

Question 45

For consolidated financial reporting, what items affect year-end consolidated equity? (3 elements)

Answer 45

Year-end consolidated equity is affected by the
1) net income earned,
2) items of other comprehensive income, and
3) the dividends paid by the consolidating entities.

Question 46

For consolidated financial reporting, what are the 8 steps of the consolidation procedures?

Answer 46

Consolidation procedures. The following steps must be performed when preparing consolidated financial statements:
1) All line items of assets, liabilities, revenues, expenses, gains, losses, and OCI of a subsidiary are added item by item to those of the parent. These items are reported at the consolidated amounts.
2) No investment in the subsidiary account is presented in the consolidated financial statements. Consolidated statements report the assets and liabilities of the subsidiary and the parent as if they are a single economic entity.
3) All the equity of the subsidiary is eliminated (not presented in the consolidated financial statements).
4) The periodic net income or loss and OCI of a consolidated subsidiary attributable to NCIs are presented separately from the periodic net income or loss and OCI attributable to the shareholders of the parent.
5) Goodwill from the acquisition of a subsidiary is presented separately in noncurrent assets.
6) Intraentity balances, transactions, income, and expenses must be eliminated in full (discussed in Subunit 14.5).
7) NCI is reported separately in one line item in the equity section. The NCI must be adjusted for its proportionate share of
i) The subsidiary’s net income (an increase) or net loss (a decrease),
ii) Dividends declared by the subsidiary (a decrease), and
iii) Items of OCI recognized by the subsidiary.
8) Adjustments should be made to report the subsidiary’s assets and liabilities at amounts based on their acquisition-date fair values.

Question 47

The consolidated income statement must present separate amounts for the following: (3 elements)

Answer 47

1) Total consolidated net income
2) Net income attributable to the NCI
3) Net income attributable to the shareholders of the parent

Question 48

For consolidated net income, how are revenues, expenses, gains, losses, and OCI of the subsidiary treated if an acquisition occurs after the first business day of the year?

Answer 48

If an acquisition occurs after the first business day of the year, revenues, expenses, gains, losses, and OCI of the subsidiary are included in the financial statements of the consolidated entity only from the date of the acquisition.

Question 49

For consolidated reporting, what is the accounting treatment for dividends paid? (4 elements)

Answer 49

1) Consolidated dividends are those paid to parties outside the consolidated entity by the parent and the subsidiary.
2) Dividends declared by the parent decreases the amount of consolidated retained earnings.
3) The NCI’s share of the subsidiary’s dividends decreases the balance of the NCI.
4) The parent’s share of a subsidiary’s dividends is not reported in the consolidated financial statements. No cash was paid outside of the consolidated entity.

Question 50

For consolidated reporting, what is the accounting treatment for retained earnings? (2 elements)

Answer 50

1) Retained earnings of the consolidated entity at the acquisition date consist solely of the retained earnings of the parent. Equity amounts of the subsidiary are eliminated.
2) Retained earnings of the consolidated entity at a subsequent reporting date consist of (1) acquisition-date retained earnings, plus (2) the net income (loss) for the subsequent period(s) attributable to the shareholders of the parent, minus (3) dividends paid by the parent to entities outside the consolidated entity.

Question 51

For consolidated reporting, what is the accounting treatment for noncontrolling interest (NCI)?

Answer 51

The NCI must be adjusted for its proportionate share of (1) the net income of the subsidiary included in consolidated net income, (2) items of consolidated other comprehensive income attributable to the subsidiary, and (3) dividends paid by the subsidiary.

Question 52

For consolidated reporting of NCI, what are the adjustments? (3 elements)

Answer 52

The NCI must be adjusted for its proportionate share of (1) the net income of the subsidiary included in consolidated net income, (2) items of consolidated other comprehensive income attributable to the subsidiary, and (3) dividends paid by the subsidiary.

Question 53

For consolidated reporting, what is the consolidated statement of changes in equity?

Answer 53

This statement satisfies the requirement for a presentation of a reconciliation of the beginning and ending balances of (1) total equity, (2) equity attributable to the parent, and (3) equity attributable to the NCI.

Question 54

For intraentity eliminations, what is the accounting treatment of the year-end financial statements? (3 elements)

Answer 54

1) Consolidating entities routinely conduct business with each other. The effects of these intraentity transactions must be eliminated in full during the preparation of the consolidated financial statements.
2) Consolidated financial statements report the financial position, results of operations, and cash flows as if the consolidated entities were a single economic entity.
-Thus, all line items in the consolidated financial statements must be presented at the amounts that would have been reported if the intraentity transactions had never occurred.
3) After adding together all the assets, liabilities, and income statement items of a parent and a subsidiary, eliminating journal entries for intraentity transactions must be recorded for proper presentation of the consolidated financial statements.

Question 55

For intraentity eliminations, what is the accounting treatment of reciprocal balances?

Answer 55

In a consolidated balance sheet, reciprocal balances, such as receivables and payables, between a parent and a subsidiary are eliminated in their entirety, regardless of the portion of the subsidiary’s stock held by the parent.

Question 56

For intraentity eliminations, what is the accounting treatment of intraentity inventory transactions - gross profit? (5 elements)

Answer 56

1) Intraentity transactions that give rise to gross profit require more complex treatment.
2) Profit from the sale of inventory between consolidating entities is a component of the net income of the entity that sold the inventory.
3) However, the consolidated entity recognizes profit on this exchange only in proportion to the inventory that is sold to nonaffiliated parties. Accordingly, the gross profit included in the inventory remaining on the purchaser’s books must be eliminated from consolidated net income.
4) The year-end eliminating journal entry eliminates the gross profit recognized for the inventory remaining on the purchaser’s books and reduces the inventory account to the balance it would have had if the intraentity transactions had never occurred.
i) The sales account is debited (decreased) for the amount recognized by the seller on the intraentity sale.
ii) The inventory account is credited (decreased) for the amount equal to the unrealized intraentity gross profit (Seller’s gross profit percentage × Inventory remaining on purchaser’s books).
iii) The cost of goods sold account is credited (decreased) for the difference between a. and b. The total decrease in both the sales account and cost of goods sold account is exactly equal to the amount of gross profit eliminated.

Gross Profit Eliminated:

Inventory remaining on purchaser’s books × Seller’s gross profit percentage

5) If no inventory from an intraentity transaction remains on the purchaser’s books at the end of the reporting period, no adjustment is necessary for unrealized gross profit in ending inventory. The only adjustment for the intraentity sale is to eliminate (1) the sale recognized by the seller and (2) the cost of goods sold recognized by the purchaser.

Question 57

For intraentity inventory transactions - Gross Profit, what are the year-end eliminating journal entries? (4 elements)

Answer 57

1) The year-end eliminating journal entry eliminates the gross profit recognized for the inventory remaining on the purchaser’s books and reduces the inventory account to the balance it would have had if the intraentity transactions had never occurred.
2) The sales account is debited (decreased) for the amount recognized by the seller on the intraentity sale.
3) The inventory account is credited (decreased) for the amount equal to the unrealized intraentity gross profit (Seller’s gross profit percentage × Inventory remaining on purchaser’s books).
4) The cost of goods sold account is credited (decreased) for the difference between a. and b. The total decrease in both the sales account and cost of goods sold account is exactly equal to the amount of gross profit eliminated.

Gross Profit Eliminated:

Inventory remaining on purchaser’s books × Seller’s gross profit percentage

Question 58

For intraentity eliminations, what are the attributes of intraentity noncurrent assets transactions? (2 elements)

Answer 58

1) Transfers of noncurrent assets require elimination of any gain or loss on sale recognized on the intraentity transaction.
2) All the accounts related to the asset transferred must be reported in the consolidated financial statements at the amounts that would have been reported if the intraentity transactions had never occurred.
i) Thus, the depreciation expense recognized in the consolidated financial statements must be the depreciation expense as it would have been recognized in the seller’s separate financial statements.
ii) If the original useful life and the depreciation method remain the same, the depreciation expense eliminated (added) is equal to the amount of gain (loss) on sale of equipment divided by the years of useful life remaining.

Question 59

For intraentity eliminations, what is the accounting treatment of debt? (2 elements)

Answer 59

1) When one entity holds the debt securities of another entity with which it is consolidated, the elimination is treated as an extinguishment of debt, with recognition of any resulting gain or loss.
2) All accounts related to the debt, such as the maturity amount, interest receivable (payable), and interest income (expense), must be eliminated.
3) The premium or discount on the debtor’s and creditor’s books, and any related amortization, is eliminated and recognized as a gain or loss on extinguishment in the period of purchase.

Question 60

For intraentity eliminations, what is the accounting treatment of reciprocal dividends? (3 elements)

Answer 60

1) When consolidated entities hold reciprocal equity stakes, the portion of dividends paid to each other must be eliminated from the consolidated financial statements.
2) The portion of the parent’s dividends paid to outside parties reduces consolidated retained earnings.
3) The portion of the subsidiary’s dividends paid to outside parties reduces any noncontrolling interest.

Dividends & Their Consolidated Treatment

Parent’s dividends to subsidiary => Eliminated
Subsidiary’s dividends to parent => Eliminated
Parent’s dividends to third parties => Reduces retained earnings
Subsidiary’s dividends to third parties => Reduces NCI

Question 61

For intraentity eliminations, what is shown on the table for the consolidated treatment of different dividend types? (4 elements)

Answer 61

Question 62

What is the accounting treatment for deconsolidation? (4 elements)

Answer 62

1) A parent deconsolidates a subsidiary when it no longer has a controlling financial interest.
-Deconsolidation ordinarily occurs when the parent no longer has more than 50% of the outstanding voting interests of the other entity.
2) Upon deconsolidation, the parent recognizes a gain or loss in the income statement. It equals the difference at the deconsolidation date between .
i)The sum of the
a) Fair value of the consideration received
b) Fair value of any retained investment
c) Carrying amount of any NCI
ii) The carrying amount of the subsidiary (including the carrying amount of goodwill).
3) If b.1. is greater than b.2., a gain is recognized for the difference. If b.2. is greater than b.1., a loss is recognized.
4) When control over the subsidiary is lost, the parent must cease to present consolidated financial statements and should perform all of the following at the deconsolidation date:
i) Derecognize all the assets (including goodwill) and liabilities of the subsidiary at their carrying amounts.
ii) Derecognize the NCI in the former subsidiary at its carrying amount.
iii) Recognize the fair value of any consideration received from the transaction that results in deconsolidation.
iv) Recognize any gain or loss from the disposal transaction.
v) Recognize any investment retained in the former subsidiary at its fair value.

Question 63

Upon deconsolidation, the parent recognizes a gain or loss in the income statement. It equals the difference at the deconsolidation date between [A] - [B]. (2 elements)

Answer 63

A) The sum of the
1) Fair value of the consideration received
2) Fair value of any retained investment
3) Carrying amount of any NCI
B) The carrying amount of the subsidiary (including the carrying amount of goodwill).

Question 64

When control over the subsidiary is lost, the parent must cease to present consolidated financial statements and should perform all of the following at the deconsolidation date: (5 elements)

Answer 64

1) Derecognize all the assets (including goodwill) and liabilities of the subsidiary at their carrying amounts.
2) Derecognize the NCI in the former subsidiary at its carrying amount.
3) Recognize the fair value of any consideration received from the transaction that results in deconsolidation.
4) Recognize any gain or loss from the disposal transaction.
5) Recognize any investment retained in the former subsidiary at its fair value.

Question 65

What are the attributes of variable interest entities (VIEs) that relate to the topic of business combinations? (6 invoices)

Answer 65

1) An investor must consolidate an investee in which it has a controlling financial interest.
i) A controlling financial interest is the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.
ii) The usual condition for a controlling financial interest is ownership of a majority voting interest. Thus, ownership by one reporting entity, directly or indirectly, of more than 50% of the outstanding voting shares of another entity generally is a condition for consolidation.
2) Under certain circumstances, the voting interest test is not sufficient to determine which party has a controlling financial interest in the entity. For example,
i) The entity’s (investee’s) equity is not sufficient to finance its activities without incurring additional debt (e.g., an entity’s capital structure consists of 2% equity and 98% debt).
ii) The equity instruments (i.e., shares of common stock) do not have the normal equity characteristics that provide its holders with a potential controlling interest.
3) The variable interest model was developed to determine whether a controlling financial interest exists through arrangements that are not based solely on voting interests. Under this model, the party that has the power to direct the entity’s most significant economic activities and the ability to participate in the entity’s economic risks and rewards must consolidate the entity. This model includes the following steps:
i) Identify the variable interest in the entity.
ii) Determine whether the entity is a variable interest entity (VIE).
iii) Identify the primary beneficiary of the VIE (the party that must consolidate the VIE).
4) Variable interests are investments or other interests that will (1) absorb portions of a variable interest entity’s (VIE’s) expected losses or (2) receive portions of the entity’s expected residual returns. The following are common examples of variable interests:
i) Shares of common stock. The equity investors provide capital to the entity and receive an ownership interest that exposes the investors to potential losses and potential returns of the entity. Thus, they are subject to the entity’s economic risks and receive its rewards.
ii) Guarantees of debt. If the VIE cannot repay its debt, the party liable on the debt guarantee will incur a loss. Thus, this party is subject to the entity’s economic risks.
iii) Subordinated debt issued by the VIE.
5) An entity is a VIE if it meets any of the following criteria:
i) The total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support.
ii) As a group, the holders of the equity investment at risk have one of the following three characteristics:
a) Lack the power, through voting rights, to direct the activities that most significantly affect the entity’s economic performance.
b) Lack the obligation to absorb the entity’s expected losses.
c) Lack the right to receive the entity’s expected residual returns.
iii) The entity is structured so that voting rights do not necessarily reflect the underlying economic reality. This situation occurs when
a) The voting rights of some investors are not proportional to their share in expected losses or expected residual returns of entity and
b) Substantially all of the entity’s activities are on behalf of an investor that has disproportionately few voting rights.
6) The primary beneficiary is the reporting entity that is required to consolidate the VIE. Only one reporting entity (if any) is expected to be identified as the primary beneficiary of a VIE.
i) The primary beneficiary has a controlling financial interest in a VIE if it has
a) The power to direct activities that most significantly affect the economic performance of the VIE and
b) The obligation to absorb losses or the right to receive benefits of the VIE that potentially could be significant to the VIE.

Question 66

For VIEs, what is the accounting treatment for the VIE investor? (3 elements)

Answer 66

1) An investor must consolidate an investee in which it has a controlling financial interest.
2) A controlling financial interest is the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.
3) The usual condition for a controlling financial interest is ownership of a majority voting interest. Thus, ownership by one reporting entity, directly or indirectly, of more than 50% of the outstanding voting shares of another entity generally is a condition for consolidation.

Question 67

For VIEs, under what circumstances does the voting interest test fail to determine which party has a controlling interest in the entity? (3 elements)

Answer 67

1) Under certain circumstances, the voting interest test is not sufficient to determine which party has a controlling financial interest in the entity. For example,
2) The entity’s (investee’s) equity is not sufficient to finance its activities without incurring additional debt (e.g., an entity’s capital structure consists of 2% equity and 98% debt).
3) The equity instruments (i.e., shares of common stock) do not have the normal equity characteristics that provide its holders with a potential controlling interest.

Question 68

For VIEs, what are the attributes of the variable interest model? (4 elements)

Answer 68

1) The variable interest model was developed to determine whether a controlling financial interest exists through arrangements that are not based solely on voting interests.
Under this model, the party that has the power to direct the entity’s most significant economic activities and the ability to participate in the entity’s economic risks and rewards must consolidate the entity. This model includes the following steps:
2)Identify the variable interest in the entity.
3) Determine whether the entity is a variable interest entity (VIE).
4) Identify the primary beneficiary of the VIE (the party that must consolidate the VIE).

Question 69

For VIEs, what are variable interests? What are 3 common examples of variable interests?

Answer 69

1) Variable interests are investments or other interests that will (1) absorb portions of a variable interest entity’s (VIE’s) expected losses or (2) receive portions of the entity’s expected residual returns. The following are common examples of variable interests:
2) Shares of common stock. The equity investors provide capital to the entity and receive an ownership interest that exposes the investors to potential losses and potential returns of the entity. Thus, they are subject to the entity’s economic risks and receive its rewards.
3) Guarantees of debt. If the VIE cannot repay its debt, the party liable on the debt guarantee will incur a loss. Thus, this party is subject to the entity’s economic risks.
4) Subordinated debt issued by the VIE.

Question 70

What are the sufficient conditions for an entity to qualify as a VIE? (3 elements)

Answer 70

An entity is a VIE if it meets any of the following criteria:
1) The total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support.
2) As a group, the holders of the equity investment at risk have one of the following three characteristics:
i) Lack the power, through voting rights, to direct the activities that most significantly affect the entity’s economic performance.
ii) Lack the obligation to absorb the entity’s expected losses.
iii) Lack the right to receive the entity’s expected residual returns.
3) The entity is structured so that voting rights do not necessarily reflect the underlying economic reality. This situation occurs when
i) The voting rights of some investors are not proportional to their share in expected losses or expected residual returns of entity and
ii) Substantially all of the entity’s activities are on behalf of an investor that has disproportionately few voting rights.

Question 71

What is the primary beneficiary of a VIE? (2 elements)

Answer 71

1) The primary beneficiary is the reporting entity that is required to consolidate the VIE. Only one reporting entity (if any) is expected to be identified as the primary beneficiary of a VIE.
2) The primary beneficiary has a controlling financial interest in a VIE if it has
i) The power to direct activities that most significantly affect the economic performance of the VIE and
ii) The obligation to absorb losses or the right to receive benefits of the VIE that potentially could be significant to the VIE.

Question 72

What are the attributes of combined financial statements? (3 elements)

Answer 72

1) Consolidated statements should be prepared only when the controlling financial interest is held by one of the consolidated entities. These financial statements report the financial information of the parent and all its subsidiaries as if they were a single economic entity.
2) When consolidated statements are not prepared, combined financial statements may be more meaningful than the separate financial statements of commonly controlled entities.
-For example, combined statements are useful when one individual owns a controlling financial interest in several entities with related operations. They also may be used to present the statements of entities under common management.
3) Combined statements are prepared in the same way as consolidated statements. However, the financial data of the parent is not reported in these statements.
i) When they are prepared for related entities, e.g., commonly controlled entities, intraentity transactions and gains or losses are eliminated.
ii) Moreover, consolidation procedures are applied to such matters as (a) noncontrolling interests, (b) foreign operations, (c) different fiscal periods, and (d) income taxes.