CHAPTER 9:

Other Consolidation Reporting

Issues

Prepared by Garabedian & Butler

© 2019 McGraw-Hill Education

 Special-Purpose Entities
 A Special-Purpose Entity (“SPE”) is an entity created to accomplish a
very specific business activity.

 Using assets transferred to them by their sponsors, SPE’s can often secure
lower cost debt financing for the sponsor because
 credit risk is limited to the SPE’s assets (not the broader assets of the sponsor)
&
 the business activity of the SPE is restricted.

 With the debt proceeds, the SPE can then pay the sponsor for the
transferred assets.

The sponsor is therefore “monetizing” previously illiquid assets, by turning

them into cash using the SPE.

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 Exhibit 9.1-Variable Interests in
SPEs
The following are some examples of variable interests in SPEs and the related potential for losses or
returns accruing to the sponsor:
Variable Interests Potential Losses or Returns
•Guarantees of debt •If an SPE cannot repay liabilities, sponsor will pay and incur a loss.
•Subordinated debt •If an SPE cannot repay its senior debt, the sponsor, as
instruments subordinated debt holder, may be required to absorb the loss.
•Variable-rate liability •Sponsor as holder of debt may participate in returns of SPE.
•Lease residual •If the value of a leased asset declines below the residual value
guarantee guarantee, the sponsor, as lessee, will make up the shortfall.
•Non-voting equity •Sponsor as holder of debt or equity may participate in residual
instruments profits.
•Sponsor, as the service provider, receives a portion of residual
•Services
profits.

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 Special-Purpose Entities

 The primary risks and rewards of ownership of an SPE may

not be based on equity ownership but rather on the variable
interests conveyed by contractual arrangements.

 The equity investors typically receive a guaranteed rate of

return as a reward for providing the sponsor, or other primary
beneficiary with contractual control of the SPE.

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 Special-Purpose Entities

 Under IFRS 10 Consolidated Financial Statements, an entity

must consolidate the entities that it controls regardless of the
means of obtaining control.
 Many SPEs are created to conduct activities that are part of the
reporting entity’s ongoing activities.
 Control of an SPE is usually based on who directs the key
activities of the SPE.

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 Special-Purpose Entities

 Since the primary beneficiary controls the resources of the SPE

and will obtain future returns from these resources, these
resources meet the definition of an asset and should be
included on the consolidated balance sheet of the primary
beneficiary.
 3

 Since the primary beneficiary usually bears the risk of absorbing

the majority of the expected losses of the SPE, it is effectively
assuming responsibility for the liabilities of the SPE and
therefore these liabilities should be included on the consolidated
balance sheet of the primary beneficiary.

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Example of SPE: The Cuiaba Power Plant is an asset that Enron used for
both contrived sales and for the misuse of mark-to-market accounting via
transactions with SPE LJM1. (Non-examinable)

• Contrived Sales: Enron owned 65 percent of a Brazilian company called

Empressa Productura de Enerain Ltd. (EPE). EPE was building the Cuiaba Power
Plant in Brazil and the project was experiencing setbacks. Enron wanted to decrease
its ownership in the project but could not find anyone to buy a portion of its
ownership at a profit or even at cost. Enron used its SPE named LJM1 to buy a 13%
stake in Cuiaba EPE for $11.3 million, a price that represented a good profit for
Enron. This was a contrived sale because Enron was really selling a portion of its
investment in EPE to itself.
• Misuse of Mark-to-Market Accounting: Enron went on to use the Cuiaba/EPE
asset and the contrived sale to LJM1 as a reference point for a further overstatement
of profit via revaluing its remaining share in Cuiaba/EPE to “market” value. Enron
reasoned that if the 13% stake sold to LJM1 was worth $11.3 million, then its
remaining share in Cuiaba/EPE should be written up by $34 million to state the asset
at market value. It later revalued the same investment by another $31 million in the
fourth quarter of 1999. In 2001, Enron purchased LJM1’s stake back from LMJ1 for
$14 million, even though the problems with the plant had worsened.
From Jackson – Detecting Accounting Fraud & Ethics
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 Joint Arrangements

 Joint arrangements is a contractual arrangement whereby two or

more parties undertake an activity together and jointly control
that activity.

 Joint arrangements are established for a variety of purposes and

can be established using different structures and legal forms.

 In a joint arrangement, participants contribute resources to carry

out a specific undertaking.

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 Joint Arrangements

 Joint arrangements are classified into two types: joint operations

and joint ventures.

 Joint operations – each operator contributes the use of assets or

resources to the new activity but retains title and control of these
assets and resources.

 An example would be a case in which one operator manufactures

part of a product, a second operator completes the manufacturing
process, and a third operator handles the marketing of the
product with each operator using its own assets to perform its
work.
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 Joint Arrangements

 Joint venture – is an arrangement whereby the parties that

have joint control of the arrangement have rights to the net
assets of the arrangement.

 An entity is a party to a joint venture when the separate vehicle

has the rights to the assets and responsibility for the liabilities.
 In joint ventures, the venturers contribute assets to a separate
legal entity, which has title to the assets.

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 Joint Arrangements
 Appendix A in IFRS 11 presents the following definitions:
 Joint Control – is the contractually agreed sharing of control of an
arrangement, which exists only when decisions about the relevant
activities require the unanimous consent of the parties sharing control.
 Joint Operator – is a party to a joint operation that has joint control of
that joint operation.
 Joint Venturer – is a party to a joint venture that has joint control of that
joint venture.
 Joint control is the key feature in a joint arrangement. This means
that no one venturer can unilaterally control the venture regardless of
the size of its equity contribution.

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 Accounting for Joint Operations

 According to IFRS 11.20, a joint operator must recognize, in

relation to its interest in a joint operation,
a) Its assets, including its share of any assets held jointly;
b) Its liabilities, including its share of any liabilities incurred jointly;
c) Its revenue from the sale of its share of the output arising from
the joint operations;
d) Its share of the revenue from the sale of the output by the joint
operations; and
e) Its expenses, including its share of any expenses incurred jointly.

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 Accounting for an Interest
in a Joint Venture
 Under IFRS 11 the venturer must use the equity method to report its
investment in a joint venture (IAS 28)
• Venturer recognizes its share of the income earned by the joint
venture as “Income from Joint Venture” as one line on the
income statement and “Investment in Joint Venture” as one
line on the balance sheet.

 The following adjustments are required for its share for:

• Allocation and amortization of acquisition differentials.
• Unrealized profits from intercompany transactions.
• Contributions to the joint venture.

 For a joint venture, the venturer’s share of any intercompany

asset profits is eliminated.
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JV is common in Auto industry
Recent JV,

VW's Traton and Toyota's Hino will develop electric trucks

together

The partnership will shorten development times for vehicles

with battery and fuel cell technology, the statement said.

The joint venture will also develop joint electric platforms

including software and interfaces.

https://europe.autonews.com/automakers/vws-traton-and-
toyotas-hino-will-develop-electric-trucks-together

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Foreign car manufacturers JV
in China
Foreign Auto Manufacturer Joint Ventures (with)

Brilliance Auto (BMW-Brilliance), BAIC (BAIC -

BMW
BMW)

Fiat GAC, BAIC (BAIC FCA Automobile Co. Ltd)

Ford Changan FAW

SAIC, FAW, GAC (GAC Chevrolet Opel Motors

General Motors (GM)
Co.Ltd)

GAC (Guangqi Honda), Dongfeng Motor Group (

Honda
Dongfeng Honda)

BAIC, Great Wall (Great Wall-Hyundai Motors

Hyundai
Co.Ltd)

Jaguar Land Rover Chery (Chery Jaguar Land Rover)

Dongfeng Motor Corporation (Dongfeng Yueda Kia)

Kia
GAC (GAC Hafei Kia Motors Co Ltd.)

Luxgen Dongfeng Motor, Soueast

Mazda FAW, Changan
Mercedes-Benz BAIC (Beijing-Benz), BYD (Denza)
Mitsubishi Soueast, GAC (GAC-Mitsubishi)

Dongfeng Motor Group (Dongfeng Motor Co., Ltd.),

Nissan
BAIC Group (BAIC Nissan)

Dongfeng Motor Group, Great.Wall (Great Wall

Peugeot
Peugeot Citroën Co. Ltd)

Dongfeng Motor Group, FAW (FAW Renault Nissan

Renault
Motors Co. Ltd)

Suzuki Changan, Dongfeng Motor Group

Toyota GAC (GAC-Toyota), FAW
Volkswagen SAIC, FAW, GAC 15
Isuzu JMCG, JIM, GAC
JV also common with First Nations
“Through the joint venture model the Aboriginal partner can
potentially bridge resource gaps and attain other benefits. The
possible benefits include (not necessarily in order of
importance): 1. Obtaining sufficient capital to finance a venture
2. Attaining total or partial control over the pace and conditions
imposed on development 3. Receiving a portion of the venture's
profit stream 4. Achieving greater local employment 5.
Transferring of managerial and technical skill 6. Sharing of
risk”
Source: FORGING ABORIGINAL/NON-ABORIGINAL PARTNERSHIPS: THE JOINT VENTURE MODEL GABRIELE
FERRAZI,

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MUSQUEAM INDIAN BAND
 https://www.musqueam.bc.ca/wp-content/uploads/2019/01/
MIB-2018-Consolidated-FS-1.pdf

 https://milltownmarina.ca/about/
Developer Matthew Coté
$17 million Marpole-area
Milltown Marina and Boatyard.

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 Contributions to the
Joint Venture
 On the date of formation of a joint venture, instead of
contribution cash, a venturer may contributes non-monetary
assets and receives an interest in the joint venture and that the
assets contributed have a fair value that is greater than their
carrying amount in the records of the venturer.

 IAS 28 deal with if it would be appropriate for the venturer to

record a gain from investing these non-monetary assets in the
joint venture and if so, how much and when it should be
recognized.

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 Contributions to the
Joint Venture
 IAS 28 requirements:
1. The investment should be recorded at the fair value of the non-
monetary assets transferred to the joint venture.

2. If commercial substance: Only the gain represented by interests

of the other nonrelated venturers should be recognized on the date
of the contribution

3. If no commercial substance: then the entire gain is considered to

be unrealized unless the venture receives assets in addition to an
interest in the joint venture.

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 Contributions to the
Joint Venture
 IAS 28 requirements continued:
4. The portion of the gain represented by the venturer’s own interest
should be unrealized until the asset has been sold to unrelated
outsiders by the joint venture.

5. If a loss results from the recording of the investment, the portion of

the loss represented by the interest of the other unrelated venturers
is recognized immediately into income. When it is evident that the
asset contributed to the joint venture is impaired, the entire loss is
immediately recognized.

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 Deferred Income Taxes and
Business Combinations
 The temporary difference in carrying value for book purposes compared
to tax purposes gives rise to deferred income taxes.

 IAS 12 defines 2 types of temporary differences:

• deductible temporary differences give rise to future tax
deductions, i.e. Deferred income tax assets.
• taxable temporary differences give rise to future taxable
income, i.e. deferred income tax liabilities.

 If asset book value < tax value, OR liability book value > tax value,
deferred tax asset arises.
 If asset book value > tax value, OR liability book value < tax value,
deferred tax liability arises.

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 Deferred Income Taxes and
Business Combinations

 These “new” deferred income tax asset or deferred income tax

liability balances reflecting the acquisition date fair values of
the subsidiary’s assets and liabilities replace the “old” future
income taxes recorded by the subsidiary company based on its
historical costs.

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 Deferred Income Taxes and
Business Combinations
 Example (assuming tax rate of 40%)
• In a business combination, the carrying amount of an asset is
reflected at its fair value = $20,000.
In the G/L of the subsidiary, the asset has a book value= $12,000
the subsidiary’s tax return it has a tax basis = $9,000
• The “old” deferred income tax liability of (12,000 – 9,000) x
40% = $1,200 on the subsidiary’s books must be eliminated.
• A “new” deferred tax liability must be reported in the
consolidated financial statements
(20,000 – 9,000) x 40% = $4,400
• The “new” deferred tax liability is included in the acquisition
differential allocation and therefore goodwill increases.

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 Segment Disclosures
 When consolidated financial statements of large and diverse
companies are prepared, a significant amount of detail about the
profitability of different products and services, the geographic
areas in which the consolidated operates, and its customers is
aggregated.
• Separate disclosure could provide useful predictive information
for analysts and other users of the financial statements.
• However, providing individual financial statements of
subsidiaries and consolidated adjustment details may
overwhelm users.
• Managers do not wish competitors to have too much
confidential or sensitive data.
 Segmented reporting is an efficient method of communicating
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enough but not excessive relevant data.
 Segment Disclosures

 IFRS 8 requires separate disclosures for segments when one or

more of these thresholds is met:
1. Reported revenue, both external and intersegment, is 10% or more
of the combined revenue, internal and external, of all segments.
2. The absolute amount of reported profit or loss is 10%
or more of the greater, in absolute amount of:
a. The combined reported profit of all operating segments that did not report a loss, or
b. The combined reported loss of all operating segments that did report a profit.
3. Its assets are 10% or more of the combined assets of all operating
segments.
At least 75% of a company’s external revenues are reported.

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