ADVANCED

ACCOUNTING II
CHAPTER 11
CONSOLIDATION THEORIES, PUSH-DOWN ACCOUNTING, AND
CORPORATE 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

ADVANCED ACCOUNTING II 2
1. Consolidation Theories –
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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1. Consolidation Theories –
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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1. Consolidation Theories –
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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1. Consolidation Theories –
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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1. Consolidation Theories –
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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1. Consolidation Theories –
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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2. Push-Down Accounting –
SEC Requires Push-Down
 Securities and Exchange Commission (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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2. Push-Down Accounting –
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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2. Push-Down Accounting –
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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2. Push-Down Accounting –
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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2. Push-Down Accounting –
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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2. Push-Down Accounting –
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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3. Joint Ventures –
Joint Ventures (definition)
 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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3. Joint Ventures –
Corporate Joint Ventures
 Investors who participate in the overall management of the joint
venture
• 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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3. Joint Ventures –
Unincorporated Joint Ventures
 Although not specifically addressed, 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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4. Identify Variable Interest Entities –
Variable Interest (definition)
 "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."
 The primary beneficiary of the variable interest entity
(VIE) must consolidate the VIE.

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4. Identify Variable Interest Entities –
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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4. Identify Variable Interest Entities –
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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5. Consolidate Variable Interest Entities –
Special Consolidation Considerations
 VIEs are consolidated like other subsidiaries
 Exception
• Goodwill can only be recorded if the VIE is a "business"
• 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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