Chapter 11: Consolidation Theories, Push-Down Accounting, and

© Pearson Education, Inc. publishing as Prentice Hall 11-1

Chapter 11: Consolidation Theories, Push-Down Accounting,

and Corporate Joint Venturesby Jeanne M. David, Ph.D., Univ. of Detroit Mercy

to accompanyAdvanced Accounting, 10th editionby Floyd A. Beams, Robin P. Clement,

Joseph H. Anthony, and Suzanne Lowensohn


Theories, Push-Down Accounting, and Joint Ventures: Objectives1. Compare and contrast the elements of

consolidation approaches under traditional theory, parent-company theory, and contemporary entity theory.

2. Adjust subsidiary assets and liabilities to fair values using push-down accounting.

3. Account for corporate and unincorporated joint ventures.

4. Identify variable interest entities.5. Consolidate a variable interest entity.


1: Consolidation Theories1: Consolidation Theories

Consolidation Theories, Push-Down Accounting and Corporate Joint Ventures


Parent Company TheoryConsolidated financial statements are• Extension of parent company statement• Viewpoint of parent company shareholders

Prepare consolidated statements• To benefit parent company shareholders

Noncontrolling interests • Have the separate (subsidiary) statements


Entity TheoryConsolidated financial statements• Viewpoint of the total business entity• All resources of the entity are valued

consistently– Impute the value of the firm from the

acquisition price• Income of noncontrolling interests is a

distribution of the total business income


Income Reporting• Parent company theory and traditional theory

– Consolidated net income is income to the parent company shareholders

• Entity theory– Total consolidated income is to be shared

between the controlling and noncontrolling interests


Asset Valuation• Parent company theory and traditional theory

– Assets and liabilities are adjusted to market value at acquisition, but only to the extent of the parent's ownership share.

• Land with a book value of $50 and fair value of $80 would be consolidated at $80 if the parent owned 100%, but at $71 (including only 70% of the $30 appreciation in value) if the parent owned 70%

• Entity theory– Assets and liabilities are consolidated at fair value

• Land would be consolidated at $80 regardless of ownership percentage.


Unrealized Gains and Losses• Parent company theory

– Unrealized gains and losses attributable to the subsidiary are only eliminated to the extent of the parent's ownership• 80% of the $10 unrealized profits on upstream sales

would be eliminated if the parent owned 80% of the subsidiary

• Entity theory and traditional theory– Unrealized gains and losses are eliminated

• All theories treat downstream gains and losses the same


Consolidated Stockholders' Equity• Contemporary theory

– Noncontrolling interest is a single amount and a part of stockholders' equity

• Entity theory– Noncontrolling interest is also part of

stockholders' equity– It would be decomposed into paid in capital,

retained earnings, etc.• Other ideas being promoted

– Use footnote disclosure for CI and NCI shares of consolidated income

– Use proportional consolidation, excluding NCI from the statements


2: Push-Down Accounting2: Push-Down Accounting



SEC Requires Push-Down• SEC requires push-down accounting for SEC

filings when the subsidiary– Is substantially fully owned (97%), and– Has substantially no public debt or preferred

stock• Establishes a new basis for the assets and liabilities

– Based on acquisition price• Arguments against

– Subsidiary is not party to the acquisition – Subsidiary receives no new funds, sells no assets


Push-Down Procedure• Assets and liabilities are revalued• Goodwill, if any, is recorded• Retained earnings (prior to acquisition) are

eliminated• Push-down capital replaces retained earnings

– Includes old retained earnings– Any adjustments to assets and liabilities,

including goodwill


Push-Down Example• Paly buys 90% of Sim. Sim's book and fair values are:

• If Sim applies push-down accounting, it would revalue its inventories, fixed assets, liabilities, and record goodwill.

BV FV BV FVCash 5 5 Liabilities 25 30Inventory 10 15 Capital stock 100 Plant assets 200 300 Retained earnings 90 Goodwill 0 50 Total 215 Total 215 370


Sim Uses Parent Company Theory• Sim revalues assets and liabilities only to the

extent of Paly's ownership. Only 90% of the increases/decreases are recorded.

Inventory 4.5 Plant assets 90.0 Goodwill 45.0 Retained earnings 90.0

Liabilities 4.5Push-down capital 225.0


Sim Uses Entity Theory• Sim fully revalues assets and liabilities. 100% of

the increases/decreases are recorded.Inventory 5 Plant assets 100 Goodwill 50 Retained earnings 90

Liabilities 5Push-down capital 240


Push-Down Differences• The example used 90% ownership by the parent. • SEC requires push-down accounting when the firm

is substantially owned… 97%– Differences between the methods of application

will be considerably less• Leveraged Buyouts with a change in controlling

interest– Changing accounting basis may be appropriate


3: Joint Ventures3: Joint Ventures



Joint Ventures (def.)• Form

– Partnership or corporate– Domestic or foreign– Temporary or relatively permanent

• It is a business entity that is owned, operated and jointly controlled by a small group of investors for the conduct of a specific business undertaking that provides mutual benefit for each of the venturers.


Corporate Joint Ventures• Investors who participate in the overall management

of the joint venture (APB Opinion No. 18)– Use equity method for the joint venture– If significant influence is not present, use the cost

method

• Investors with more than 50% of the voting stock have a subsidiary, not a joint venture– Consolidate the subsidiary


Unincorporated Joint Ventures• Although not specifically addressed by APB

Opinion No. 18, application of the equity method to unincorporated joint ventures is appropriate

• Industry specific practice– Proportional consolidation in oil & gas and

undivided interests in real estate ventures


4: Identify Variable Interest Entities4: Identify Variable Interest Entities



Variable Interest (def.)"Variable interests in a variable interest entity

are contractual, ownership, or other pecuniary interests in an entity that change with changes in the fair value of the entity's net assets exclusive of variable interests." (FIN 46(R), para.2c)

The primary beneficiary of the variable interest entity (VIE) must consolidate the VIE.


Primary Beneficiary• The entity that will

– Absorb the majority of the expected losses, receive a majority of the expected gains or both

– If separate entities are expected to absorb the profits and losses, the entity expected to absorb the losses is the primary beneficiary

• The primary beneficiary may be an equity holder and/or creditor of the VIE


VIE Example• Get Rich Quick is a VIE with equity contributed equally by

10 parties, including Corrine.• The VIE will borrow additional amounts equal to twice the

equity. The bank is the major creditor/investor!• Corrine agrees to absorb 75% of the losses and will take 28%

of the profits. The other nine investors will share equally.– Corrine is the primary beneficiary and consolidates

the VIE.– All 10 equity investors will have to make detailed

disclosures about their interests in this VIE.


5: Consolidate Variable Interest 5: Consolidate Variable Interest EntitiesEntities



Special Consolidation Considerations• VIEs are consolidated like other subsidiaries

– FASB Statement No. 141• Exception

– Goodwill can only be recorded if the VIE is a "business" FIN 46(R)

– If the VIE is not a "business," the excess paid is an extraordinary loss

• "business""Self-sustaining, integrated set of activities

and assets conducted and managed for providing a return to investors."


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Chapter 11: Consolidation Theories, Push-Down Accounting, and