electronic presentations in microsoft ® powerpoint ® prepared by peter secord saint mary’s...

Electronic Presentations in Microsoft® PowerPoint®

Prepared by

Peter Secord

Saint Mary’s University

© 2003 McGraw-Hill Ryerson Limited

Chapter 10© 2003 McGraw-Hill Ryerson Limited

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Chapter 10

Other

Consolidation Reporting

Issues


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Other Consolidation Reporting Issues

• Chapter Outline– Joint Ventures and Proportionate Consolidation– Future Income Taxes and Business Combinations– Segmented Disclosures– Examples– International Views


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Joint Ventures


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Joint Ventures• Joint Ventures are a common mechanism

where two or more companies with common interests (but perhaps different geographic or technical scope) arrange to do business together, generally on a project or “venture” basis– Generally, a separate business entity is formed,

which may or may not be incorporated– The venturers continue in their own businesses;

the venture tends to carry on a “new” business under the control of the venturers, such as entering a new market or developing a new oil well


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Joint Ventures and Proportionate Consolidation

• Joint ventures are very common in certain industries, including oil and gas exploration and development and in food, beverages and hospitality


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Joint Ventures• In terms of definitions, the CICA Handbook

notes: – A joint venture is an “economic activity” resulting

from a contractual arrangement whereby two or more venturers jointly control the economic activity

• This activity is typically a business venture– Joint control of an economic activity is the

contractually agreed sharing of the continuing power to determine its strategic operating, investing and financing policies

• The venture tends to be governed by a board of directors appointed by the venturers


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Joint Ventures• The venturers are the parties to the joint

venture, have joint control over that joint venture, have the right and ability to obtain future economic benefits from the resources of the joint venture and are exposed to the related risks

• The combination of the joint right and ability to obtain future economic benefits and exposure to the related risks suggests that neither accounting model, full consolidation or the equity method, is fully appropriate


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Joint Ventures• The venturers are bound by contractual

arrangements which establish that the venturers have joint control over the joint venture, regardless of the difference that may exist in their ownership interest– Although they each have “significant influence”, none

of the individual venturers is in a position to exercise unilateral control over the joint venture

– Decisions in all areas essential to the accomplishment of the joint venture require the consent of the venturers in such manner as defined in the terms of the contractual arrangement


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Joint Ventures• Joint ventures are unique:

– The characteristic of joint control distinguishes interests in joint ventures from investments in other activities where an investor may exercise control or significant influence

• A contract is generally required, but not in all cases:– Activities conducted with no formal contractual

arrangements which are jointly controlled in substance are joint ventures

• The unique aspects of joint ventures require a unique accounting treatment


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Joint Ventures and Proportionate Consolidation

• Proportionate consolidation is the appropriate accounting treatment in Canada for external financial reporting by venturers of their investments in joint ventures

• Proportionate consolidation is an application of the proprietary concept of reporting


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Proportionate Consolidation• The proprietary approach incorporates the

amounts recorded by the subsidiary into the consolidated financial statements at fair value at the date of acquisition, but only to the extent of the proportion acquired

• The basis of the inclusion in this manner is that the investor shares in the risks and rewards of ownership in direct proportion to the shareholding percentage

• With a joint venture, joint control makes this treatment appropriate


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Joint Ventures: International View

• Under US GAAP, proportionate consolidation is not permitted

• Net income will be the same under the equity method, as the venturer’s share of net income of the venture is recognized


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• Proportionate consolidation is often used by companies reporting under International Accounting Standards


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• IAS 31 recommends proportionate consolidation, allows use of the equity method for joint ventures

2000 annual report


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• Exercise Caution: – The term “joint venture” is frequently used in the

“international context” in a manner which is less restrictive than the definitions of the CICA Handbook, and (for some companies) refers to any intercorporate partnership, regardless of the control structure.

– Proportionate consolidation is not necessarily applied in all cases which would qualify for this method in Canada

– Further, proportionate consolidation can be, and often is, applied in cases that would not qualify in Canada


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Future Income Taxes and Business Combinations


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• The liability method is GAAP for tax allocation in Canada, in common with the US and IAS


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• In earlier chapters, we recognized the income tax effects and accounted for future income taxes when we eliminated unrealized profits

• We did this when we had asset and liability values for tax purposes which differed from values for financial reporting purposes– Gains realized for tax purposes were unrealized in

the consolidated financial statements

• There are other intercorporate investment situations where income tax effects, including future income taxes, must be recognized


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• At any point in time, there may be a difference between the tax basis of an asset or liability and its carrying amount

• This difference can occur when the purchase discrepancy is recognized and allocated in a business combination accounted for as a purchase

• The difference in carrying value (new book value in consolidation, as compared to tax basis) gives rise to future income taxes which must be recognized in the financial statements


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• Basic principles– The premise is that an enterprise should recognize

a future income tax liability whenever recovery or settlement of the carrying amount of an asset or liability would result in future income tax outflows

– Similarly, an enterprise should recognize a future income tax asset whenever recovery or settlement of the carrying amount of an asset or liability would generate future income tax reductions

• These situations arises whenever the values in consolidation differ from the tax values as recorded by the individual companies


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• There are two essential provisions of the Handbook which apply in the context of business combinations:– “Old” future income taxes recorded by the

subsidiary company are not carried forward into the consolidated financial statements

– “New” future income taxes are recognized on any temporary differences arising in consolidation between the reported values (consolidated) and the tax basis of the asset on the books of the individual enterprise (the subsidiary)


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• Example– In a business combination, the carrying amount of a

particular asset is stated at its fair value of $20,000. In the books of the acquired company the asset had a book value of $12,000 and a tax basis of $9,000, which does not change. Assume a tax rate of 40%

– The “old” future tax liability of (12,000 - 9,000) * 40% = $1,200 must be eliminated

– A “new” future tax liability must be reported in the consolidated financial statements in the amount of (20,000 - 9,000) * 40% = $4,400

– Such allocations change the reported goodwill


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• A business combination may increase the likelihood that loss carry forwards or other tax deductible amounts may be claimed– Other previously unrecognized future income tax

assets (of either parent or subsidiary) may be recognized at the time of a business combination, providing that it is more likely than not that the benefits will be realized

– These future income tax assets are identifiable assets in the allocation of the purchase price


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Segmented Reporting


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Segmented Reporting• When consolidated financial statements are

prepared, a significant amount of detail is lost– This lost detail could be very useful for analysts

and other users of the financial statements– Yet, individual financial statements of subsidiaries

may provide so much information as to overload– Managers do not wish competitors to have

confidential or sensitive data

• An efficient method of communicating just enough pertinent detail is necessary

• The mechanism of segmented reporting provides this vehicle


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Segmented Reporting• Segments may be defined in various ways;

there are fundamental issues associated with segment definition:– The CICA Handbook recommends a management

approach, based on the way segments are organized within the enterprise for making operating decisions and assessing performance

– As a result: • Segments are based on defined organizational

structure in a transparent manner• Preparers can provide the required information

in a cost-effective and timely manner.


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Segmented Reporting• To employ the management approach, an

operating segment is defined as a component of an enterprise:– that engages in business activities from which it

may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise)


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– whose operating results are regularly reviewed by the enterprise's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and


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– whose operating results are regularly reviewed by the enterprise's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and

– for which discrete financial information is available


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Segmented Reporting• Separate disclosure is required for segments

when one or more of these thresholds is met:– Reported revenue, both external and intersegment, is

10 percent or more of the combined revenue, internal and external, of all segments


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– The absolute amount of reported profit or loss is 10 percent or more of the greater, in absolute amount, of:

• the combined reported profit of all operating segments that did not report a loss, or

• the combined reported loss of all operating segments that did report a loss.


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– The absolute amount of reported profit or loss is 10 percent or more of the greater, in absolute amount, of:

• the combined reported profit of all operating segments that did not report a loss, or

• the combined reported loss of all operating segments that did report a loss.

– Its assets are 10 percent or more of the combined assets of all operating segments.


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Segmented Reporting• General information is required:

– Factors used to identify the enterprise's reportable segments, including the basis of organization

• whether management has chosen to organize the enterprise around differences in products and services, geographic areas, regulatory environments, or a combination of factors and whether operating segments have been aggregated

– Types of products and services from which each reportable segment derives its revenues

• Note that the prior approach of geographic and industrial segmentation has been superceded


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Segmented Reporting• Segment information is provided for the following

items, until 75% of the total revenue is reached:– A measure of profit or loss and total assets for each

reportable segment, including detail of• Revenues, separating internal and external • Interest revenue and interest expense (separately)• Amortization and other significant non-cash items • Unusual items and extraordinary items (separately)• Equity in the net income of investees • Income tax expense or benefit• Investments subject to significant influence • Expenditure on capital assets and goodwill


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Segmented Reporting• Comprehensive reconciliation to consolidated

amounts is required: – The total of the reportable segments' revenues to

the enterprise's total revenues.– The total of the reportable segments' measures of

profit or loss to the enterprise's corresponding measure of profit or loss

– The total of the reportable segments' assets to the enterprise's total assets.

– For all other significant items, in a like manner

• All significant reconciling items should be separately identified and described


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Segmented Reporting

• Segmented disclosure is generally in the notes, but can also be on the face of the financial statements


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Segmented Reporting

• Segmented disclosure is potentially minimal


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Segmented Reporting

• Segmented disclosure may also be highly detailed, with full explanation, definitions and justification of the approach used and disclosure provided

• Which approach provides more assistance to the user of the financial statements?


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Segmented Reporting


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Segmented Reporting


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International View• Under US GAAP, the management approach

to segment disclosure is also required, and provides similar results

• Under IAS, definitions, thresholds and reporting criteria are similar, but disclosure is provided in a matrix format, with geographic or industry segments defined and identified as primary or secondary– For example, this means that if the geographic

areas are identified as primary segments, secondary segments (industrial) would also be reported


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International View

• Graphical depiction can be very effective


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International View

• These graphs illustrate the two layer (matrix) approach recommended under IAS

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