Kế toán, kiểm toán - Chapter six: Variable interest entities, intra-Entity debt, consolidated cash flows, and other issues

Chapter SixVariable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other IssuesCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Learning Objective 6-1Describe a variable interest entity,a primary beneficiary, andthe factors used to decide whena variable interest entity is subjectto consolidation.6-2Variable Interest Entities (VIE’s)Known as Special Purpose Entities (SPE)Established as a separate business structureTrustJoint VenturePartnershipCorporationFrequently has neither independent management nor employeesTypical purposeshelp finance their operations at favorable ratesTransfers of financial assetsLeasingHedging financial instrumentsResearch and developmentOff-balance sheet financing 6-3Variable Interest Entities (VIE’s)Examples of Variable Interests6-4Variable Interest EntitiesCharacteristics of VIEs:Most established for legitimate business purposesSome created to avoid consolidated disclosureGenerally have assets, liabilities, and investors with equity interestsRole of equity investors can be minor if VIE’s activities are strictly limitedEquity investors may serve simply to allow the VIE to function as a legal entity6-5Variable Interest EntitiesCharacteristics continued. . . VIEs bear relatively low economic risk, therefore equity investors are provided a small rate of return. Another party (often the sponsoring firm that benefits from the VIE’s activities) contributes substantial resources – loans and/or guarantees – to enable a VIE to secure financing needed to accomplish its purpose. The sponsoring firm may guarantee the VIE’s debt, assuming the risk of default. 6-6Variable Interest EntitiesCharacteristics continued. . . Contractual arrangements limit returns to equity holders yet participation rights provide increased profit potential and risks to sponsor. Risks and rewards are not distributed according to stock ownership but by other variable interests. Sponsor’s economic interest vary depending on the VIE’s success – Hence the term variable interest entity. 6-7Variable Interest Entities FASB standard FIN 46R3 requires the primary beneficiary (regardless of their ownership) to consolidate the VIE.Who is the “primary beneficiary”? The firm that has the:Power to direct the activities of the VIE that significantly impact the entity’s economic performance.Obligation to absorb significant losses of the entity. Right to receive significant benefits of the entity.6-8Benefit of VIE’sA business sponsors a VIE to purchase and finance asset acquisition.The VIE leases the asset to the sponsor.VIE is often eligible for lower interest rate.The VIE has limited assets. This “asset isolation” and limited activity separates the VIE’s creditor(s) from the overall risk of the sponsor.6-9Variable Interest Entity - ExampleAssume Twin Peaks, a power company, seeks to acquire an electric generating plant for $400 million to expand its market share. It expects to sell the electricity generated by the plant acquisition at a profit to its owners. To take advantage of lower interest rates, Twin Peaks creates Power Finance Co. The sole purpose of Power Finance is to purchase the Ace electric generating plant, provide equity and debt financing, and lease the plant to Twin Peaks.6-10Variable Interest Entity - ExampleAn outside investor provides $16 million in exchange for a 100% nonvoting equity interest in Power Finance.Power Finance will issue debt in exchange for $384 million. Because the $16 million equity investment by itself is insufficient to attract low-interest debt financing, Twin Peaks will guarantee the debt. Twin Peaks will lease the electric generating plant from Power Finance in exchange for payments of $12 million per year based on a 3 percent fixed interest rate for both the debt and equity investors for an initial lease term of five years.6-11Variable Interest Entity - ExampleAt the end of the five-year lease term (or any extension), Twin Peaks must do one of the following:Renew the lease for five years subject to the approval of the equity investor.Purchase the electric generating plant for $400 million. Sell the electric generating plant to an independent third party. If the proceeds of the sale are insufficient to repay the equity investor, Twin Peaks must make a payment of $16 million to the equity investor.6-12Consolidation of VIE’sWhen a VIE’s total business fair value is less than its assessed net asset value, a GAIN is recognized.When a VIE’s total business fair value is greater than its assessed net asset value, Goodwill is reported.Similar to other combinations, valuation of assets, liabilities, and noncontrolling interest should be based on Fair Value.6-13Disclosure Requirements – In Footnotes of ALL VIE InterestsNature, purpose, size, & activities of the VIESignificant judgments made in determining the need to consolidate a VIE or disclose any involvementNature of restrictions on assets and settlement of liabilities, and the related carrying valueNature of risks, and how a VIE affects the financial position, performance and cash flows of a Primary Beneficiary6-14VIE’s and International StandardsThe standards include a new definition of control designed to encompass all possible ways (votingpower, contractual power, decision making rights, etc.) in which one entity can exercise power over another.In May 2011, the International Accounting Standards Board issued IFRS 10 - ConsolidatedFinancial Statements and IFRS 12 - Disclosure of Interests in Other Entities.6-15Learning Objective 6-2Demonstrate the consolidationprocedures to eliminate all intra-entity debt accounts and recognize any associated gain or loss created whenever one company acquires an affiliate’s debt instrument from an outside party.6-16Intra-Entity Debt TransactionsIntra-entity investments in debt securities and related debt accounts must be eliminated in consolidation despite their differing balances.Corresponding receivable and payable and revenue and interest from the consolidated financial statements must be eliminated.Gain/loss on effective retirement of the debt must be recognized in the consolidated statements.A company CANNOT lend money to itself.6-17Intra-Entity Debt Transactions - ExampleAssume Alpha owns 80% of Omega.On 1/1/12, Omega issued $1 million in 10-year bonds at 9%. Omega issued the bonds at $938,555, with effective interest at 10%. On 1/1/14, Alpha purchased the bonds for $1,057,466, with effective interest at 8%.6-18Intra-Entity Debt Transactions - ExampleBook value of Omega Company’s bonds as of December 31, 2013, the date immediately before the day Alpha Company acquired the bonds6-19Intra-Entity Debt Transactions - ExampleOmega Company’s bonds have been effectively retired. The difference between the $1,057,466 payment and the January 1, 2014, carrying value of the liability must be recognized in the consolidated statements as a gain or loss. Because Alpha paid $110,815 in excess of the recorded liability ($1,057,466 - $946,651), the consolidated entity must recognize a loss of this amount. Then, the bond is retired and no further reporting is necessary by the business combination after January 1, 2014.6-20Intra-Entity Debt Transactions - ExampleOmega retains the $1 million debt balance within its separate financial records and amortizes the remaining discount each year. Annual cash interest payments of $90,000 (9 percent) continue to be made. At the same time, Alpha records the investment at the historical cost of $1,057,466, an amount that also requires periodic amortization. Alpha receives the $90,000 interest payments made by Omega. To organize the accountant’s approach to this consolidation, the subsequent financial recording made by each company is analyzed.6-21Intra-Entity Debt Transactions - ExampleOmega records only two journal entries during 2014 assuming interest is paid each December 31to record the interest expense cash payment and discount on bonds payable.6-22Intra-Entity Debt Transactions - ExampleIn 2014, Alpha records its investment inOmega’s bonds and the interest income.6-23To convert information from the individual companies to the perspective of a single economic entity, we extinguish the debt (it is no longer owed to a third-party). Any gains/losses are attributed to the parent, thus, there is no effect on Noncontrolling Interest.Intra-Entity Debt Transactions - Example6-24Intra-Entity Debt Transactions - ExampleSubsequent Years - Initial Value or Partial Equity Method Adjust the BV’s of the Bonds Payable and the Investment in Bonds to reflect amortization with Entry *B. Also, the loss is now reflected in R/E, which must be adjusted for the difference in interest amounts.6-25Intra-Entity Debt Transactions - ExampleSubsequent Years –Equity MethodWhen the parent applies the equity method, no adjustment to Retained Earnings is needed. In this one case, the $100,747 debit in Entry *B is made to the Investment in Omega Company (instead of Retained Earnings) because the loss has become a component of that account.6-26Learning Objective 6-3Understand that subsidiarypreferred stocks not owned bythe parent are a componentof the noncontrolling interestand are initially measured atacquisition-date fair value.6-27Preferred stock, usually nonvoting, possess certain “preferences” over common shares such as cumulative dividends, participation rights, and sometimes limited voting rights. Preferred shares are part of the sub’s stockholders’ equity, treated in consolidation similarly to common. The existence of subsidiary preferred shares does not complicate the consolidation process. The acquisition method values all business acquisitions (whether 100 percent or less acquired) at their full fair values.Subsidiary Preferred Stock6-28Subsidiary Preferred Stock - Example -The consolidation entry made in the year of acquisition is shown below:6-29Learning Objective 6-4Prepare a consolidatedstatement of cash flows.6-30Consolidated Statement of Cash FlowsCurrent accounting standards require that companies include a statement of cash flows among their consolidated financial reports. The main purpose of the statement of cash flows is to provide information about the entity’s cash receipts and cash payments during a period.The consolidated statement of cash flows is based on the consolidated balance sheet and the consolidated income statement.6-31Consolidated Statement of Cash Flows Intra-entity TransactionsIntra-entity cash flows should not be included on the statement of cash flows. The intra-entity cash flows are already eliminated from the balance sheet, so no additional effects appear on the statement of cash flows.6-32Consolidated Statement of Cash FlowsIn the year of acquisition:The net cash outflow to acquire the subsidiary is reported (cash paid less subsidiary cash acquired).Any amounts acquired are not included in the increase or decrease of balance sheet accounts.In all years: Add back the noncontrolling interest’s share of the sub’s net income.Deduct dividends paid to the outside owners as cash outflow.6-33Learning Objective 6-5Compute basic and dilutedearnings per share for abusiness combination.6-34Consolidated Earnings Per ShareThe computation of EPS for a business combination follows the general rules.Consolidated net income attributable to the parent company owners along with the number of outstanding parent shares provides the basis for calculating basic EPS. Any convertibles, warrants, or options for the parent’s stock that can possibly dilute the reported figure must be included in diluted EPS.6-35Consolidated Earnings Per Share If potentially dilutive items exist on the sub’s individual statements, then the portion of the sub’s net income included in consolidated net income may not be appropriate for the computation of consolidated earnings per share.6-36Consolidated Earnings Per ShareCompute the sub’s own diluted EPS.The earnings used in the computation are used in the determination of consolidated EPS.The portion assigned to the computation is based on the percent of the subsidiary owned by the parent.6-37Learning Objective 6-6Demonstrate the accounting effects of subsidiary stock transactions on parent’s financial records and consolidated financial statements.6-38Subsidiary Stock TransactionsA parent’s ownership percentage may be affected by a subsidiary’s transactions in its own stock (additional issuances, or the purchase or treasury stock).The effects on the consolidated entity are recorded by the parent as an adjustment to APIC and the investment account.Not reported as a gain or loss of the consolidated entity.6-39