Chapter 11

Consolidation
Theories,
Push-Down
Accounting,
and Corporate
Joint Ventures
Theories, Push-Down Accounting,
and Joint Ventures: Objectives
1. Compare and contrast the elements of
consolidation approaches under traditional,
parent-company, 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.

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 Consolidation Theories, Push-Down Accounting, and
Corporate Joint Ventures

1: CONSOLIDATION
THEORIES

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Three Theories

Parent-company theory
– Viewpoint of parent company shareholders

Contemporary/entity theory
– Takes the viewpoint of the total consolidated
entity

Traditional theory
– Viewpoint of the parent’s shareholders and
creditors
– Statements are from the viewpoint of the total
consolidated entity
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Income Reporting

Consolidated net income:

• Parent-company theory and traditional

theory
– Income to the parent company shareholders
• Contemporary/entity theory
– Income to be shared between the controlling and
noncontrolling interests

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Asset Valuation

Parent-company theory and traditional theory

– Subsidiary assets and liabilities are adjusted to
fair value only to the extent (tingkat) of the
parent's 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 [$50 + 70%(80-50)] if the parent
owned 70%
Contemporary/entity theory
– Subsidiary assets and liabilities are consolidated
at fair value
• Land would be consolidated at $80 regardless (tanpa
memperhatikan) of ownership percentage.

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Unrealized Gains and Losses

Parent-company theory
– Eliminate unrealized gains and losses attributable
to the subsidiary based on parent's ownership
• 80% of the $10 unrealized gains on upstream
sales would be eliminated if the parent owned
80% of the subsidiary
Contemporary/entity theory and traditional theory
– Unrealized gains and losses are eliminated
• Eliminate 100% of unrealized gains on
upstream sales regardless of parent’s share

All theories eliminate downstream gains and losses

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Constructive Gains and Losses

Parent-company theory
– Recognize constructive gains and losses
attributable to the subsidiary based on parent's
ownership
Contemporary/entity theory and traditional
theory
– Recognize constructive gains and losses
• Include 100% of constructive gains and losses
regardless of parent’s share
All theories recognize 100% of constructive
gains and losses attributable to the parent
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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.

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Other Ideas on Consolidation

– Use footnote disclosure for CI and NCI shares of

consolidated income
• Consolidated net income is on the income statement
with the distribution between CI and NCI in the notes
• Total consolidated equity is on the balance sheet with CI
and NCI equity components in the notes
– Use proportional consolidation, excluding NCI
from the statements

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 Consolidation Theories, Push-Down Accounting, and
Corporate Joint Ventures

2: PUSH-DOWN
ACCOUNTING

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SEC Requires Push-Down

SEC requires push-down accounting for SEC

filings when the subsidiary:
– Is substantially wholly owned (usually 90%), and
– Has substantially no publicly-held 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
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Push-Down Procedure

Assets and liabilities are revalued

Goodwill, if any, is recorded
Retained earnings (prior to acquisition) are
eliminated
Push-down capital
– Is an additional paid-in capital account
– Includes old retained earnings
– Any adjustments to assets and liabilities,
including goodwill
A new retained earnings account is used
subsequent to the business combination
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Push-Down Example
Ped buys 90% of Sad. Sad's book and fair values are:

BV FV BV FV
Cash $5 $5 Liabilities $25 $25
Accounts rec. 30 35
Inventory 40 50 Capital stock 100
Other current 10 10 Retained earnings 20
Plant assets 60 80
Goodwill 0 65
Total $145 $245 Total $145

If Sad applies push-down accounting, it would

revalue its accounts receivable, inventory, and plant
assets, and record goodwill.

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Sad Uses Parent Company Theory

Sad revalues assets and liabilities only to the

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

Accounts receivable (+A) 4.5

Inventory (+A) 9.0
Plant assets (+A) 18.0
Goodwill (+A) 58.5
Retained earnings (-SE) 20.0
Push-down capital (+SE) 110.0

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Sad Uses Contemporary/Entity
Theory

Sad fully revalues assets and liabilities. 100%

of the increases/decreases are recorded.

Accounts receivable (+A) 5

Inventory (+A) 10
Plant assets (+A) 20
Goodwill (+A) 65
Retained earnings (-SE) 20
Push-down capital (+SE) 120

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Push-Down Differences

The example used 90% ownership by the

parent.

SEC requires push-down accounting when the

firm is substantially owned
– May be applied in other instances
Leveraged Buyouts with a change in
controlling interest
– Changing accounting basis may be appropriate

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 Consolidation Theories, Push-Down Accounting, and
Corporate Joint Ventures

3: JOINT VENTURES

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Joint Ventures (def.)

It is a business entity that is owned, operated

and jointly controlled by a small group of
investors for a specific business undertaking
that provides mutual benefit for each of the
venturers.

Forms
– Incorporated
– General or limited partnerships
– Domestic or foreign
– Undivided interest
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Corporate Joint Ventures

Investors who participate in the overall

management of the joint venture
– Use equity method (one-line consolidation) 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

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Unincorporated Joint Ventures

Application of the equity method to

unincorporated joint ventures is appropriate

Industry-specific practice
– Pro rata (proportionate) consolidation in oil & gas
– SEC recommends against proportionate
consolidation for undivided interests in real
estate ventures under joint control

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 Consolidation Theories, Push-Down Accounting, and
Corporate Joint Ventures

4: IDENTIFY VARIABLE
INTEREST ENTITIES

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Variable Interest Entities (def.)

"Variable interests are contractual, ownership,

or other pecuniary interests in a legal entity
that change with changes in the fair value of
the legal entity's net assets exclusive of
variable interests.” [FASB ASC 810-10-15-14]

The primary beneficiary of the variable

interest entity (VIE) must consolidate the VIE.

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Primary Beneficiary

The primary beneficiary

– Has power to direct the VIE activities that most
directly impact its economic performance
– Has an obligation to absorb losses and/or a right
to receive significant benefits from the VIE

The primary beneficiary may be an equity

holder and/or creditor of the VIE

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VIE Example

Get Rich Quick is a VIE with equity contributed

equally by 10 parties, including Corinne. The VIE
will borrow additional amounts equal to twice the
equity. The bank is the major creditor/investor.
Corinne agrees to absorb 75% of the losses and
will take 28% of the profits. The other nine
investors will share equally.

– Corinne is the primary beneficiary and

consolidates the VIE.
– All 10 equity investors will have to make detailed
disclosures about their interests in this VIE.

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 Consolidation Theories, Push-Down Accounting, and
Corporate Joint Ventures

5: CONSOLIDATE
VARIABLE INTEREST
ENTITIES

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Special Consolidation Considerations

VIEs are consolidated like other subsidiaries

– If the primary beneficiary transferred assets to
the VIE, these assets are carried at book value
– Otherwise, the initial valuation is consistent with
the acquisition method
– The primary beneficiary uses voting interests to
allocate future performance to controlling and
noncontrolling interests
– All intercompany transactions and accounts are
eliminated

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