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Chapter 13: Problem 13

Is it necessary for one firm to own more than 50 percent of the voting stock of another firm in order to exert control over the investee firm? If not, how should control be defined for purposes of deciding on the preparation of consolidated financial statements?

Short Answer

Expert verified
No, it's not necessary to own more than 50% of voting stock for control. Control for consolidated financial statements can be defined as the ability to govern the financial and operating policies so as to benefit from its activities, achieved through shareholding, strategic alliances or contractual agreements.

Step by step solution

01

Ownership and Control

Control in a business scenario is not strictly confined to ownership of more than 50% stake. Several factors determine control like shareholding percentage, contractual agreements, board representation etc. The percentage of voting shares gives an immediate understanding of control; however businesses may secure control by other means. Therefore, it is not necessary to own more than 50% shares to exert control over another firm.
02

Defining Control for Financial Statements

For consolidated financial statements, control can be defined as the capacity of a firm to govern the financial and operating policies of another entity so as to benefit from its activities. This entails making strategic decisions and holding the power to influence the firm's direction. The entity needs not own more than 50% of the voting stock to achieve this.
03

Concluding Remarks

Though owning more than 50% of voting stock usually means control, it isn't the only way. Other factors can dictate control, leading to consolidated financial statements even when the firm owns less than 50% voting shares.

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Key Concepts

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

Control in Business
In a business setting, control refers to one entity's ability to influence or manage the operations, policies, and decisions of another entity. This influence allows the controlling entity to reap the benefits from the operations and strategies of the entity it controls. Control in a business context does not necessarily mean owning the majority stake. Instead, it encompasses various aspects that can establish control, even when owning less than 50% of voting stock.
  • Strategic Decisions: A controlling entity often has the power to shape strategic directions.
  • Operational Oversight: Having significant input in the day-to-day operations.
Control is a fundamental factor considered when companies prepare consolidated financial statements. These statements reflect the financial status and operations collectively with the subsidiaries under the control of one parent company. Hence, understanding who controls whom becomes crucial in financial reporting.
Voting Stock
Voting stock is a type of shares that gives the shareholder the right to vote at the company's general meetings and to help decide on important business matters. These matters may include the election of board members, mergers, and other pivotal company decisions. The structure of voting stock can vary, influencing control in different ways.
  • Majority Voting Stock: Having more than 50% typically gives majority control.
  • Significant Influence: A significant percentage, even if under 50%, might still allow one to sway crucial decisions.
A firm doesn't need the majority of voting stock to exert control if it can band together with other shareholders or if it can exert influence in other ways. Voting stock is just one piece of the broader concept of control.
Ownership Percentage
Ownership percentage is the share of equity an investor holds in a company. Traditionally, having more than 50% translates to control, but businesses can often have significant control with less than majority ownership.
  • Influence vs. Ownership: A high ownership percentage usually correlates with significant influence.
  • Collaborative Control: Entities can achieve control through alliances even if no single party has over 50%.
The concept of ownership percentage is vital when determining the necessity for consolidated financial statements. If an entity demonstrates control through ownership, direct or indirect, and benefits economically, it may need to consolidate its financial reports with the involved entities.
Board Representation
Board representation is another critical measure of control within a company. It involves having representatives on a company's board who can influence and guide the company's policies and decisions.
  • Strategic Influence: Board members can advocate for strategic moves that align with the owning entity's interests.
  • Governance: They help steer governance policies, often crucial in guiding company culture and ethics.
Having board representation can often compensate for lower ownership percentages by allowing an entity to exert considerable influence over the company's operations and strategic direction. Even with less than 50% voting stock, having representatives on the board can translate into practical control, fitting into the criteria for consolidating financial statements.

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Most popular questions from this chapter

The balance sheets of foreign firms, prepared in their local currencies, must be in balance (assets equal liabilities plus sharcholders'equity). Yet when such balance sheets are translated to U.S. dollars, they usually require a "translation adjustment" in order to balance. Explain why this is so.

a. Managers of U.S. firms sometimes allege that they are at a disadvantage when selling securities in international markets because U.S. disclosure and measurement standards are more comprehensive, stringent, and costly than are those of most other nations.Assume that these managers are correct and propose a solution to the problem. b. Managers of non-U.S. firms sometimes argue that they are impeded from selling securities in U.S. financial markets because U.S. reporting standards are extensive and costly to implement. Propose a diplomatic solution to the problem, with due consideration to the costs and benefits of foreign and domestic business firms.

Access the EDGAR archives (www.sec.gov/edaux/searches.htm) and locate the Schedule 14 D 1 filing (February 1,1995 ) made by Cadbury Schweppes on the successful acquisition of Dr. Pepper/Seven-Up Companies Inc. Hint: Search on "Cadbury" or "Dr. Pepper." Examine the section that contains the financial statements of the U.K. corporation and locate the information on differences between U.K. GAAP and U.S. GAAP. In this section, the company has provided a GAAP reconciliation. a. What are the primary reasons for the differences in net income and shareholders' equity from U.K. GAAP to U.S.GAAP. b. Explain the treatments of goodwill and trademarks under U.K. GAAP. How do these differ from U.S. GAAP? c. Calculate the return on equity under both U.K. and U.S. GAAP. Explain how the different accounting standards have an impact on the computed ratios.

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?)

Explain whether a U.S. firm would experience a gain or a loss related to its unhedged accounts receivable or payable in each of the following cases: a. A U.S. firm has accounts receivable in British pounds, and the pound strengthens relative to the U.S. dollar b. A U.S. firm has accounts payable in Mexican pesos, and the peso weakens relative to the U.S. dollar. c. A U.S. firm has accounts receivable in French francs, and the franc weakens relative to the U.S. dollar. d. A U.S. firm has accounts payable in Canadian dollars, and the Canadian dollar strengthens relative to the U.S. dollar.
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