Advanced Accounting PPT (3)

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Financial Effects of Consolidation
Manufacturing Company acquires Finance Corp. for $10 million cash. Balance sheets prior to the acquisition:
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Financial Effects of Equity Method
Suppose the equity method is used instead. Balance sheets prior to the acquisition:
Manufacturing Co. Finance Corp.
Manufacturing Co. Finance Corp.
Total assets Total liabilities Stockholders' equity Total liabilities and equity
$220,000,000 $110,000,000 $115,000,000 $100,000,000 105,000,000 10,000,000 $220,000,000 $110,000,000
Total Liabilities/ Total Equity = 1.10
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Learning Objective 3
Apply the concept of control to equity investments.
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Leasing
SPE created to purchase long-term assets Funding for purchases obtained through loans SPE leases assets to the company SPE uses lease payments to pay interest and principal on the debt
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Balance sheet of Manufacturing Company using equity method Other assets $210,000,000 Investment in Finance Corp. 10,000,000 Total assets $220,000,000 Total liabilities Stockholders' equity Total liabilities and equity $115,000,000 105,000,000 $220,000,000
Total assets
$220,000,000 $110,000,000
Total liabilities Stockholders' equity Total liabilities and equity
$115,000,000 $100,000,000 105,000,000 10,000,000 $220,000,000 $110,00Ronald J. Huefner
James A. Largay
Chapter 3:
Consolidated Financial Statements: Date of Acquisition
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Reporting Business Combinations
Each entity accounts for its operations separately throughout the year
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Learning Objective 1
Explain the purpose of consolidated financial statements and how the concept of control determines when to consolidate.
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Manufacturing Co.’s entry to record acquisition:
Total assets Total liabilities Cash
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110,000,000 100,000,000 10,000,000
Consolidated financial statements are more meaningful than separate statements when one entity in the consolidated group directly or indirectly has a controlling financial interest in the other entity.
Parent
Acquirer
Subsidiary
Acquired company
Year-end reporting
Consolidated Entity
This chapter is limited to wholly-owned subsidiaries.
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Learning Objective 2
Describe the motivations for off-balance-sheet financing.
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Entry to record acquisition:
Investment in Finance Corp. Cash
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10,000,000 10,000,000
Comparing Consolidation and Equity Method Leverage
Motivations for Off-Balance Sheet Entities
Choice: equity method investment or consolidate?
Equity method omits liabilities of the subsidiary from the parent’s balance sheet Consolidation may therefore negatively affect leverage Investors and banks view higher leverage as risky.
Consolidated balance sheet of Manufacturing Company and Subsidiary Total assets $320,000,000 Total liabilities Stockholders' equity Total liabilities and equity $215,000,000 105,000,000 $320,000,000
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Special Purpose Entities (SPEs)
Legal structures formed for specific business activities Control may be obtained with little or no equity investment Frequently have no separate management or employees Often obtain financing from debt Often have a small outside equity interest that obtains a secure return with little or no risk
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Control Through Equity Ownership
Usually control is obtained through ownership, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity Exceptions:
As a consolidated entity Total Liabilities/ Total Assets = 67% Total Liabilities/ Total Equity = 2.05 Using equity method accounting Total Liabilities/ Total Assets = 52%
Purpose of Consolidated Financial Statements To present results of operations and the financial position of a parent and all the entities it controls, as if the consolidated group were a single economic entity Primarily for the benefit of owners and creditors of the parent
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Securitizations
Set up by a financial services company to buy loans or customer receivables from clients
SPE uses the money to buy the receivables SPE issues debt securities backed by the receivables
Allows clients to obtain immediate cash for receivables
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SPE uses the collection proceeds to pay principal and interest
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Examples of SPEs
Securitizations Provide the opportunity to hide debt and losses from investors
Leasing
Joint ventures
Control is temporary, or Control is not present
Control may exist with less than majority ownership of outstanding voting shares The key concept is control.
Lease terms usually allow lessee to report the lease as an operating lease.
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Learning Objective 4
Apply the concept of control to non-equity investments (variable interest entities).
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