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Chapter 13: Problem 12

Respond to the following remarks: I just read in the financial pages that Whale company owns 60 percent of Minnow Inc.'s shares. Whale Company includes all of Minnow's assets and liabilities and all of Minnow's revenues and expenses in its consolidated financial statements. It seems to me that this is a misrepresentation. If Whale owns 60 percent of Minnow, then it should only reflect 60 percent of Minnow in its financial statements.

Short Answer

Expert verified
Including 100% of Minnow's financials in Whale's consolidated financial statements is not a misrepresentation, but a standard accounting practice. However, Whale Company also needs to disclose the portion attributable to non-controlling interests separately.

Step by step solution

01

Understanding Consolidation Principles

According to Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), the consolidation of financial statements occurs when a company owns more than 50% of another company's voting stock. This gives the parent company, in this case, Whale Company, control over the subsidiary, Minnow Inc. The consolidation process involves summing all the parent and subsidiary companies' assets, liabilities, revenues, and expenses.
02

Explaining 100% Inclusion

When consolidating, even though the parent company does not own 100%, it still includes 100% of the subsidiary's assets, liabilities, revenues, and expenses in its consolidated financial statements. This is done to reflect the total economic resources and obligations controlled and earned by the parent company and the flows affecting those resources.
03

Addressing the Misrepresentation Part

As per the consolidation rules, it is not a misrepresentation. However, the parent also needs to disclose the share of the equity and profit or loss attributable to non-controlling interests (the remaining 40% Minnow Inc. share) separately in the consolidated financial statements. This ensures that financial statement users can see both the total amounts and those specifically attributable to the parent company.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Consolidation Principles
Consolidation principles are essential in understanding how companies integrate the financials of their subsidiaries. When a parent company holds more than 50% of another company's voting stock, the parent must prepare consolidated financial statements. This means combining the assets, liabilities, revenues, and expenses of both companies into one document. The justification for consolidation is that control over a subsidiary implies economic benefit and risk, so the financial statements should reflect the entire economic reality. The idea is to provide a comprehensive view of the financial standing and performance of the entire group of companies, not just isolated portions.
Non-controlling Interest
Even though Whale Company owns 60% of Minnow Inc., it doesn't mean the remaining 40% ownership is ignored. This portion is known as non-controlling interest. Non-controlling interest represents investors who do not have controlling stakes but still own a share of the subsidiary. In consolidated financial statements, non-controlling interests are separately disclosed. Whale Company must show not only its entire control over Minnow Inc. but also acknowledge these shareholders' stakes. Thus, users of financial statements can distinguish between amounts attributable to Whale and those to other investors.
Generally Accepted Accounting Principles (GAAP)
GAAP plays a crucial role in how companies prepare their consolidated financial statements in the United States. These principles ensure consistency, transparency, and fairness across financial reporting. Under GAAP, once a parent holds more than 50% of a subsidiary鈥檚 voting stock, it must consolidate 100% of the subsidiary鈥檚 financial results. This approach aims to reflect the complete control exercised by the parent company, even if it doesn't own all of the subsidiary's shares. GAAP ensures stakeholders see a clear picture of the parent company's economic position and performance, providing valuable insights into its comprehensive financial situation.
International Financial Reporting Standards (IFRS)
IFRS is a global framework for financial reporting adopted by many countries worldwide. Like GAAP, IFRS mandates that once a company holds control over another, it must consolidate that subsidiary's financials entirely. IFRS provides guidelines similar to GAAP but often with different details in application. The primary focus of IFRS is on clarity, comparability, and global harmonization of financial statements. With IFRS, entities provide a consistent and transparent view of financial information, which aids international investors in understanding the company鈥檚 performance and position. By following IFRS consolidation principles, companies align with a standard that promotes trust and efficiency in the global financial market.

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Most popular questions from this chapter

Foreign companies whose shares are registered on U.S. security exchanges must file a description of significant differences between U.S. and domestic accounting principles with the SEC, as well as a reconciliation of net income and shareholders' equity under domestic and U.S. GAAP Antic Knights, plc, a British firm, included the following information in its SEC filings for 2000 1\. Summary of Differences Between United Kingdom and United States Generally Accepted Accounting Principles: (a) Acquisition cost Under United Kingdom GAAP, certain acquisition-related costs can be immediately charged to retained earnings. Under United States GAAP, these costs are charged to the statement of earnings as incurred. Examples of such items include certain costs related to the closure of facilities and severances of terminated employees. (b) Deferred Taxation United Kingdom GAAP allows for no provision for deferred taxation to be made if there is reasonable evidence that such taxation will not be payable in the foreseeable future. United States GAAP requires provisions for deferred taxation be made for all differences between the tax basis and book basis of assets and liabilities. (c) Goodwill and Otber Intangibles The Company writes off certain intangible assets, including goodwill, covenants not to compete, and favorable lease rights, directly to retained earnings in the year of acquisition. Under U.S. GAAP these intangible assets would be capitalized as assets and amortized over their estimated useful lives. 2\. Reconciliations of Net Income and Shareholders' Equity: a. For each of the indicated differences between U.S. and U.K. GAAP, indicate which method of accounting you consider to be more suitable to the needs of investor analysts. Explain your reasoning. b. Based on the information provided, do you consider U.K. or U.S.GAAP to be more conservative? Explain. c. Based on the explanations of differences between U.K. and U.S. GAAP, explain why each of the individual reconciling items is added (or subtracted) to convert to U.S. GAAP. (For example, why is goodwill subtracted in the income reconciliation and added in the shareholders' equity reconciliation?)

Evaluate the following statements: Accounting for goodwill makes no sense. If a firm generates goodwill internally, the costs are written off as expenses, and no related asset appears on the balance sheet. If, on the other band, a firm purchases goodwill by acquiring another firm, the amount paid for goodwill is reported as an asset. How is an analyst supposed to make comparisons given these rules? Wouldn't it be more sensible to make all firms write off goodwill immediately?

On January \(1,1999,\) Maplegrove Deli, Inc. purchased all of the outstanding stock of Bizno's Sub Shops, Inc. for 4,500,000 dollar. Maplegrove paid 2,000,000 dollar cash and issued 25,000 shares of its common stock, no par value, currently selling for 100 dollar per share. The estimated fair value and carrying value of Bizno's assets (purchased by Maplegrove) and liabilities (assumed by Maplegrove) approximated 6,200,000 dollar and 1,920,000 dollar respectively.The excess of the purchase price over the fair value of the assets is being amortized over 40 years on a straightline basis. During \(1999,\) Bizno's earned a net income of 3,400,000 dollar and paid dividends of 230,000 dollar. a. Use the balance sheet equation to show how Maplegrove's financial statements are affected at the date of acquisition. b. How is Maplegrove affected by Bizno's net income and dividends? c. How much goodwill should Maplegrove amortize? Show the effect on Maplegrove's balance sheet equation. d. What is the net amount Maplegrove earned from owning Bizno's during the year?

Boise Cascade Company is a major producer of paper, building, and office products. The company reported the following items related to foreign exchange gains and losses in its 1993 financial statements (dollars in thousands): Notes Foreign exchange gains and losses reported on the Statements of Income (Loss) arose primarily from activities of the Company's Canadian subsidiaries. On December \(31,1993,\) contracts for the purchase of 50,000,000 Canadian dollars were outstanding. Gains or losses in the market value of the forward contracts were recorded as they were incurred during the year and partially offset gains or losses arising from translation of the Canadian subsidiaries'net liabilities. a. The Note discussion indicates that the firm, through its Canadian subsidiaries, has net liabilities, in Canadian dollars. Explain the meaning of this term. b. From the information provided, are you able to tell whether the U.S. dollar strengthened or weakened against the Canadian dollar during \(1993 ?\) Explain. c. Does Boise Cascade attempt to fully "hedge" its foreign currency transactions? Explain.

Cabot Corporation, a producer of specialty chemicals and materials, reported the following accounting policies for intercorporate investments: Principles of Consolidation:The Consolidated Financial Statements include the accounts of Cabot Corporation and majority-owned and controlled domestic and foreign subsidiaries. Investments in majority-owned affiliates where control is temporary and investments in 20 to 50 percent-owned affiliates are accounted for on the equity method. All significant intercompany transactions have been eliminated. a. Cabot noted only"majority-owned and controlled" subsidiaries are included in the consolidation. Is it possible that majority ownership (greater than 50 percent in a subsidiary would not constitute control? Discuss. b. Why are subsidiaries that are less than 100 percent-owned included in the consolidation? c. Cabot used the equity method to account for investments in 20 - to 50 percentowned affiliates. Explain how consolidation of these affiliates would affect Cabot's reported total assets, total liabilities, shareholders' equity, and net income d. Cabot stated that all significant intercompany transactions were eliminated. Provide several examples of intercompany transactions that require elimination in order to consolidate affiliated firms.
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