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CONSOLIDATION THEORIES AND PUSH-DOWN ACCOUNTING


CONSOLIDATION THEORIES AND PUSH-DOWN ACCOUNTING

Consolidation theories and push-down accounting are related concepts in accounting that address the methods and practices used to consolidate the financial statements of a parent company with those of its subsidiaries.

Consolidation Theories

Consolidation theories refer to the different approaches used to consolidate the financial statements of a parent company with those of its subsidiaries. There are three primary theories:

  • Parent Company Theory: This theory views consolidated financial statements from the perspective of the parent company, focusing on the interests of the parent company shareholders.
  • Entity Theory: This theory considers consolidated financial statements from the viewpoint of the business entity, emphasizing the interests of all stakeholders, including creditors, non-controlling interests, and parent company shareholders.
  • Traditional Theory: This theory is a hybrid of the parent company and entity theories, focusing on both the parent company and the business entity.

Push-Down Accounting

Push-down accounting is a method used to document the acquisition of another company by adjusting the acquired company's assets and liabilities to reflect the purchase price. This method involves recording the acquisition in the subsidiary's financial statements rather than the parent company's financial statements. Key points include:

  • Adjusting Assets and Liabilities: The acquired company's assets and liabilities are adjusted to reflect the purchase price.
  • Recording Expenses: Expenses related to the acquisition are recorded in the acquired company's separate financial statements.
  • Goodwill Recognition: If the purchase price exceeds the fair value, the surplus is recognized as goodwill, an intangible asset.
  • Simplification: Push-down accounting simplifies the consolidation process by recording the purchase price in the subsidiary's books, eliminating the need for complex working paper adjustments.

Practical Applications

  • FAS 141R and FAS 160: These standards require complex measurements and disclosures related to the reporting of non-controlling interests in business combinations, aligning with the entity theory.
  • SEC Regulations: The Securities and Exchange Commission (SEC) requires push-down accounting for SEC filings when a subsidiary is substantially wholly owned (approximately 97% or more ownership) with no publicly held debt or preferred stock outstanding.

 

 

Variable Interest Entities (VIEs)

“A variable interest is a contractual, ownership, or other financial interest in an entity that changes with changes in the fair value of the entity's net assets, excluding variable interests." [FASB ASC 810-10-15-14]

  • Known as special purpose entities
  • Most VIEs are established for legitimate business purposes

Formed as a separate business structure:

  • Trust
  • Joint venture
  • Partnership
  • Corporation

The choice of this structure may be influenced by the specific objectives and needs of the entity.

Summary

Consolidation theories provide the framework for consolidating financial statements, while push-down accounting is a specific method used to document acquisitions by adjusting the acquired company's financial records to reflect the purchase price. Both concepts are crucial in ensuring accurate and transparent financial reporting.

Common examples of VIE activities:

  • transfer of financial assets
  • leasing
  • hedging of financial instruments
  • research and development

Benefits of VIEs:

  • often qualify for lower interest rates
  • low-cost asset financing

Governing agreement limits activities and decision-making

VIEs Primary Beneficiary

  • GAAP provides two characteristics that must be met, namely the concept of economic power and legal liability.
  • The company creating the VIE must not own any voting shares
  • Prior to current consolidation requirements, companies left VIEs unconsolidated in their financial statements
  • The ultimate beneficiary typically exercises its financial control through governance documents or contractual agreements that grant decision-making authority over the VIE
  • The ultimate beneficiary must consolidate in its financial statements the assets, liabilities, revenues, expenses, and non-controlling interests of the VIE

Consolidate a Variable Interest Entities

VIEs are consolidated like other subsidiaries

  • If the ultimate beneficiary transfers assets to the VIE, the assets are recorded at book value
  1. Otherwise, the initial valuation is consistent with the acquisition method
  2. The ultimate beneficiary uses voting rights to allocate future performance to controlling and noncontrolling interests
  3. All intercompany transactions and accounts are eliminated

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