Chapter 11: Consolidation

Theories, Push-Down Accounting,

and Corporate Joint Ventures
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy

to accompany
Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn

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 Theories, Push-Down Accounting,
and Joint Ventures: Objectives
1. Compare and contrast the elements of
consolidation approaches under traditional
theory, parent-company theory, and
contemporary entity theory.
2. Adjust subsidiary assets and liabilities to fair
values using push-down accounting.
3. Account for corporate and unincorporated joint
ventures.
4. Identify variable interest entities.
5. Consolidate a variable interest entity.
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Consolidation Theories, Push-Down Accounting and
Corporate Joint Ventures
1: Consolidation Theories

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 Parent Company Theory
Consolidated financial statements are
• Extension of parent company statement
• Viewpoint of parent company shareholders

Prepare consolidated statements

• To benefit parent company shareholders

Noncontrolling interests
• Have the separate (subsidiary) statements

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 Entity Theory
Consolidated financial statements
• Viewpoint of the total business entity
• All resources of the entity are valued
consistently
– Impute the value of the firm from the
acquisition price
• Income of noncontrolling interests is a
distribution of the total business income

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 Income Reporting
• Parent company theory and traditional theory
– Consolidated net income is income to the
parent company shareholders
• Entity theory
– Total consolidated income is to be shared
between the controlling and noncontrolling
interests

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 Asset Valuation
• Parent company theory and traditional theory
– Assets and liabilities are adjusted to market
value at acquisition, but only to the extent of
the parent's ownership share.
• Land with a book value of $50 and fair value of $80
would be consolidated at $80 if the parent owned
100%, but at $71 (including only 70% of the $30
appreciation in value) if the parent owned 70%
• Entity theory
– Assets and liabilities are consolidated at fair
value
• Land would be consolidated at $80 regardless of
ownership percentage.
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 Unrealized Gains and Losses
• Parent company theory
– Unrealized gains and losses attributable to
the subsidiary are only eliminated to the
extent of the parent's ownership
• 80% of the $10 unrealized profits on
upstream sales would be eliminated if the
parent owned 80% of the subsidiary
• Entity theory and traditional theory
– Unrealized gains and losses are eliminated
• All theories treat downstream gains and losses
the same
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 Consolidated Stockholders' Equity
• Contemporary theory
– Noncontrolling interest is a single amount
and a part of stockholders' equity
• Entity theory
– Noncontrolling interest is also part of
stockholders' equity
– It would be decomposed into paid in capital,
retained earnings, etc.
• Other ideas being promoted
– Use footnote disclosure for CI and NCI
shares of consolidated income
– Use proportional consolidation, excluding
NCI from the statements
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Consolidation Theories, Push-Down Accounting and
Corporate Joint Ventures
2: Push-Down Accounting

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 SEC Requires Push-Down
• SEC requires push-down accounting for SEC
filings when the subsidiary
– Is substantially fully owned (97%), and
– Has substantially no public debt or preferred
stock
• Establishes a new basis for the assets and
liabilities
– Based on acquisition price
• Arguments against
– Subsidiary is not party to the acquisition
– Subsidiary receives no new funds, sells no
assets
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 Push-Down Procedure
• Assets and liabilities are revalued
• Goodwill, if any, is recorded
• Retained earnings (prior to acquisition) are
eliminated
• Push-down capital replaces retained earnings
– Includes old retained earnings
– Any adjustments to assets and liabilities,
including goodwill

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 Push-Down Example
• Paly buys 90% of Sim. Sim's book and fair
values are:
BV FV BV FV
Cash 5 5 Liabilities 25 30
Inventory 10 15 Capital stock 100
Plant assets 200 300 Retained earnings 90
Goodwill 0 50 Total 215
Total 215 370
• If Sim applies push-down accounting, it would
revalue its inventories, fixed assets, liabilities,
and record goodwill.
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 Sim Uses Parent Company Theory
• Sim revalues assets and liabilities only to the
extent of Paly's ownership. Only 90% of the
increases/decreases are recorded.
Inventory 4.5
Plant assets 90.0
Goodwill 45.0
Retained earnings 90.0
Liabilities 4.5
Push-down capital 225.0

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 Sim Uses Entity Theory
• Sim fully revalues assets and liabilities. 100% of
the increases/decreases are recorded.
Inventory 5
Plant assets 100
Goodwill 50
Retained earnings 90
Liabilities 5
Push-down capital 240

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 Push-Down Differences
• The example used 90% ownership by the
parent.
• SEC requires push-down accounting when the
firm is substantially owned… 97%
– Differences between the methods of
application will be considerably less
• Leveraged Buyouts with a change in controlling
interest
– Changing accounting basis may be
appropriate
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Consolidation Theories, Push-Down Accounting and
Corporate Joint Ventures
3: Joint Ventures

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 Joint Ventures (def.)
• Form
– Partnership or corporate
– Domestic or foreign
– Temporary or relatively permanent
• It is a business entity that is owned, operated
and jointly controlled by a small group of
investors for the conduct of a specific business
undertaking that provides mutual benefit for
each of the venturers.

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 Corporate Joint Ventures
• Investors who participate in the overall
management of the joint venture (APB Opinion
No. 18)
– Use equity method for the joint venture
– If significant influence is not present, use the
cost method

• Investors with more than 50% of the voting

stock have a subsidiary, not a joint venture
– Consolidate the subsidiary
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 Unincorporated Joint Ventures
• Although not specifically addressed by APB
Opinion No. 18, application of the equity
method to unincorporated joint ventures is
appropriate

• Industry specific practice

– Proportional consolidation in oil & gas and
undivided interests in real estate ventures

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Consolidation Theories, Push-Down Accounting and
Corporate Joint Ventures
4: Identify Variable Interest Entities

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 Variable Interest (def.)
"Variable interests in a variable interest entity
are contractual, ownership, or other pecuniary
interests in an entity that change with changes
in the fair value of the entity's net assets
exclusive of variable interests." (FIN 46(R),
para.2c)
The primary beneficiary of the variable interest
entity (VIE) must consolidate the VIE.

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 Primary Beneficiary
• The entity that will
– Absorb the majority of the expected losses,
receive a majority of the expected gains or
both
– If separate entities are expected to absorb the
profits and losses, the entity expected to
absorb the losses is the primary beneficiary
• The primary beneficiary may be an equity
holder and/or creditor of the VIE

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 VIE Example
• Get Rich Quick is a VIE with equity contributed
equally by 10 parties, including Corrine.
• The VIE will borrow additional amounts equal to twice
the equity. The bank is the major creditor/investor!
• Corrine agrees to absorb 75% of the losses and will take
28% of the profits. The other nine investors will share
equally.
– Corrine is the primary beneficiary and
consolidates the VIE.
– All 10 equity investors will have to make detailed
disclosures about their interests in this VIE.

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Consolidation Theories, Push-Down Accounting and
Corporate Joint Ventures
5: Consolidate Variable Interest
Entities

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Special Consolidation Considerations
• VIEs are consolidated like other subsidiaries
– FASB Statement No. 141
• Exception
– Goodwill can only be recorded if the VIE
is a "business" FIN 46(R)
– If the VIE is not a "business," the excess
paid is an extraordinary loss
• "business"
"Self-sustaining, integrated set of activities
and assets conducted and managed for
providing a return to investors."
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