Chapter 12

Knowledge Check – Page 663

Identify and explain the three levels of influence that an investor corporation can have over an investee corporation

1.Control. If an investor controls an investee, it can make all the important decisions of the investee. Control exists when an investing company owns more than 50% of the voting shares of a subsidiary.

2.Significant influence. If the investor does not control an investee, but can affect its important decisions, the investor corporation is said to have significant influence and, according to GAAP, should use the equity method of accounting.

3.Passive investment. If the investor has no influence over the decision making of the investee (or at least no more influence than any other small investor), the investment is called a passive investment and it is accounted for at cost or fair value, depending on the type of investment.

What are consolidated financial statements and under what circumstances are they prepared?

Consolidated financial statements aggregate the accounting information of a parent corporation and all of its subsidiaries into a single set of financial statements. This means that each line in a set of consolidated financial statements reflects the assets, liabilities, revenues, expenses, and cash flows of the parent and all its subsidiaries. Consolidated financial statements are prepared when an investor corporation controls an investee corporation.

In consolidated financial statements, what is the basis of valuing a subsidiary’s assets and liabilities?

In the consolidated balance sheet the assets and liabilities of a subsidiary are recorded at the amount the parent paid for them. That is, the consolidated balance sheet reports the subsidiary’s assets and liabilities at their cost to the parent on the date the subsidiary was purchased by the parent.

Knowledge Check – Page 666

What is goodwill and how is it calculated?

Goodwill is the amount that the purchaser pays for another entity over and above the fair value of the purchased entity’s identifiable assets and liabilities on the date the entity is purchased. It is not possible to say exactly what goodwill is because it is calculated indirectly (it’s what’s leftover or a residual). Goodwill is calculated as:

Goodwill = Purchase price – Fair value of identifiable assets and liabilities purchased

What is non-controlling interest and why does it appear in some entity’s consolidated financial statements?

The non-controlling interest on the balance sheet represents the non-controlling (the shareholders other than the parent) shareholders’ share of assets and liabilities that are reported in the consolidated balance sheet and the non-controlling interest on the income statement represent the non-controlling shareholders’ share of revenues and expenses reported on the consolidated income statement. Non-controlling Interest accounts appear because of how the CICA Handbook requires parent corporations to account for subsidiaries that are less than 100% owned. The CICA Handbook requires that the consolidated balance sheet include 100% of the book values of the subsidiary’s assets and liabilities, even if the parent owns less than 100% of those assets and liabilities. The CICA Handbook also requires that the consolidated income statement report 100% of the revenues and expenses of a subsidiary even if the subsidiary isn’t 100% owned.

Knowledge Check – Page 675

What are the three categories of passive investments and what are the characteristics of each?

Category / Characteristics
Hold-to-maturity / An investment with a maturity date, fixed or determinable payments (like interest payments), and the intent and ability of management to hold the investment to maturity.
Trading / Any investments that management designates as a trading investment. Investments in this category are actively bought and sold for profit making.
Available-for-sale / This is the default category. Any investment that does not give control or significant influence to the investing corporation, or that doesn’t meet the criteria for classification as a held-to-maturity or trading investment, is considered an available-for-sale investment.

What is the basis of valuation on the balance sheet of each category of investment?

Category / Valuation basis
Hold-to-maturity / Cost
Trading / Market
Available-for-sale / Market

For each category of passive investment explain how unrealized gains and losses are accounted for.

Category / Treatment of Unrealized Gains and Losses
Hold-to-maturity / Normally ignored. Unrealized losses would be included in the calculation of net income if the decline in value is permanent.
Trading / Included in the calculation of net income
Available-for-sale / Included in the calculation of comprehensive income and classified as other comprehensive income.