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Chapter 18: Intercorporate Equity Investments
Relevant circumstancesConsolidation
Pooling of interestsPurchase methodNew entity approachPro rata
Equity methodFair value method
Reporting on Intercorporate Equity Investments
1. Consolidated reporting as if the two separate legal entities are one accounting entity using either the purchase or pooling method (as appropriate)
2. Nonconsolidation using the equity method of accounting
3. Nonconsolidation using the fair (market) value approaches
Finite Uniformity for Intercorporate Investments
Ownership of Voting Stock
Accounting Method
>50%Consolidate per ARB 51,
APB Opinion No. 16, APB Opinion No. 17
20% to 50% Equity Accounting per APB Opinion No. 18
>20%Fair (market) value for both trading
securities and available-for-sale securities...
Relevant Circumstances
The relevant circumstances that justify differential accounting for intercorporate equity investments depend on the level of influence held by the investor
Three Levels of Control
Majority owned company: owner has effective control Majority owned company: control is only temporary or the majority owner does not have effective control Less-than-majority-owned companies: relevant circumstance is whether the investor can exercise significant influence over operating and financial policies
Consolidation
A technique in which two or more entities are reported as if they are one common accounting entity
Also called a business combination
Consolidation Terms
Combined enterprise
Constituent companies
Combinor
Combinee
Consolidation
Central accounting issue is the valuation of the assets and liabilities of the separate entities being combined for reporting purposes
FASB (1976) outlined three possible methods of accounting
1. pooling of interests accounting
2. purchase accounting
3. new entity approach
Divestitures
Sell-off
Spin-off
Split-off
Split-up
Pooling of Interests
Based on the premise that no substantive transaction occurs between the constituent companies Is argued to be simply the formal unification of two previously separate ownership groups Desirability of pooling is to avoid certain ramifications of purchase accounting
Purchase Method
Assumption is that the combinor is a parent company that purchases the combinee (subsidiary) and must account for the purchase as it would for the acquisition of any asset
The asset, investment in the combinee company, is recorded by the combinor at the latter’s cost determined as of the date the combination is consummated
New Entity Approach
Regard the combined enterprise as an entirely new entityResults in the use of current values for the assets and liabilities of all the separate entities as of the date the combination is consummated
Pro Rata Consolidation ( 4th method)
Consolidation of assets and liabilities occurs only to the extent of the stock acquired by the parent
An arbitrary distinction at the 50 % point where control is assumed does not exist
Equity Method
Used whenever the investor has the ability to exercise significant influence over the investee
A one-line consolidation takes place
The investment account simply mirrors the net change in investee book value
Fair Value Method
Market value applies where no significant influence exists and market values are readily determinable for investments of approximately 20 percent or less
Increases or decreases in market value may or may not go through income depending upon management’s intention to sell them in the near term
SFAS No. 94
Asserts, rather than demonstrates, that consolidated reporting (and the fictional accounting entity thus created) is more relevant to investors than are separate entity statements in which the reporting entity is the legal entity
Chapter 18: Intercorporate Equity Investments
Relevant circumstancesConsolidation
Pooling of interestsPurchase methodNew entity approachPro rata
Equity methodFair value method