Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
Education.
CHAPTER 6
VARIABLE INTEREST ENTITIES, INTRA-ENTITY DEBT,
CONSOLIDATED CASH FLOWS, AND OTHER ISSUES
Chapter Outline
I. Variable interest entities (VIEs)
A. VIEs typically take the form of a trust, partnership, joint venture, or corporation. In most
cases a sponsoring firm creates these entities to engage in a limited and well-defined set
of business activities. For example, a business may create a VIE to finance the acquisition
of a large asset. The VIE purchases the asset using debt and equity financing, and then
leases the asset back to the sponsoring firm. If their activities are strictly limited and the
asset is pledged as collateral, VIEs are often viewed by lenders as less risky than their
sponsoring firms. As a result, such arrangements can allow financing at lower interest
rates than would otherwise be available to the sponsor.
B. Control of VIEs, by design, sometimes does not rest with its equity holders. Instead,
control is exercised through contractual arrangements with the sponsoring firm who
becomes the “primary beneficiary” of the entity. These contracts can take the form of
leases, participation rights, guarantees, or other residual interests. Through contracting,
the primary beneficiary bears a majority of the risks and receives a majority of the rewards
of the entity, often without owning any voting shares.
C. An entity whose control rests with a primary beneficiary is addressed by FASB ASC
subtopic 810-10 Variable Interest Entities. The following characteristics indicate a
controlling financial interest in a variable interest entity.
1. The power, through voting rights or similar rights, to direct the activities of an entity that
most significantly impact the entity’s economic performance.
2. The obligation to absorb the expected losses of the entity if they occur,or
3. The right to receive the expected residual returns of the entity if they occur
The primary beneficiary bears the risks and receives the rewards of a variable interest
entity and is considered to have a controlling financial interest.
D. If a reporting entity has a controlling financial interest in a variable interest entity, it should
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
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1. Because the acquisition price will usually differ from the carrying amount of the liability,
2. Because of the amortization of any associated discounts and/or premiums, the interest
income reported by the buyer will not equal the interest expense of the debtor.
1. Although several alternatives exist, this textbook assigns all income effects resulting
2. Any noncontrolling interest is, therefore, not affected by the adjustments utilized to
consolidate intra-entity debt.
1. The change in retained earnings is needed because a gain or loss was created in a
2. The adjustment to retained earnings at any point in time is the original gain or loss
adjusted for the subsequent amortization of discounts or premiums.
III. Subsidiary preferred stock
A. Subsidiary preferred shares not owned by the parent are a part of noncontrolling interest.
the parent shares, their weight must be included in computing diluted EPS but only if
earnings per share is reduced.
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1. The subsidiary’s diluted earnings per share are computed first to arrive at (1) an
earnings figure and (2) a shares figure.
2. The portion of the shares figure belonging to the parent is computed. That percentage
of the subsidiary’s diluted earnings is then added to the parent’s net income in order to
complete the earnings per share computation.
VI. Subsidiary stock transactions
A. If the subsidiary issues new shares of stock or reacquires its own shares as treasury
stock, a change is created in the book value underlying the parent’s investment account.
The increase or decrease should be reflected by the parent as an adjustment to this
balance.
B. The book value of the subsidiary that corresponds to the parent’s ownership is measured
before and after the transaction with any alteration recorded directly to the investment
account. The parent’s additional paid-in capital (or retained earnings) account is normally
adjusted although the recognition of a gain or loss is an alternate accounting treatment.
C. Treasury stock acquired by the subsidiary may also necessitate a similar adjustment to the
parent’s investment account. In addition, any subsidiary treasury stock is eliminated within
the consolidation process.
Answer to Discussion Question: Who Lost this $300,000?
This case is designed to give life to a theoretical accounting issue: If a subsidiary’s debt is retired,
should the resulting gain or loss be assigned to the parent or to the subsidiary? The case
illustrates that there is no clear-cut solution. This lack of an absolute answer makes financial
accounting both intriguing and frustrating.
The assignment decision is only necessary in the presence of a noncontrolling interest.
Regardless of the ownership level all intra-entity balances are eliminated on the worksheet with a
gain or loss recognized. Not until the consolidated net income is allocated across the controlling
interest and the noncontrolling interest does the assignment decision have an impact.
We assume that financial and operating decisions are made in the best interest of the business
entity as a whole. This debt would not have been retired unless corporate officials believed that
Penston/Swansan would benefit from the decision. Thus, an argument can be made against any
assignment to either separate party.
Students should choose and justify one method. Discussion often centers on the following:
▪ Parent company officials made the actual choice that created the book loss. Therefore,
assigning the $300,000 to the subsidiary directs the impact of their decision to the wrong
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
▪ Both parties were involved in the transaction so that some allocation of the loss is required. If,
at the time of repurchase, a discount existed within the subsidiary’s accounts, this figure would
have been amortized to interest expense (if the debt had not been retired). Thus, the
$300,000 loss was accepted now in place of the later amortization. This reasoning then
assigns this portion of the loss to the subsidiary. Because the parent agreed to pay more than
face value, that remaining portion is assigned to the buyer.
Answers to Questions
1. A variable interest entity (VIE) is a business structure that is designed to accomplish a specific
2. Variable interests are contractual, ownership, or other pecuniary interests in an entity that
change with changes in the entity’s net asset value. Variable interests will absorb portions of a
3. The following characteristics are indicative of an enterprise qualifying as a primary beneficiary
with a controlling financial interest in a VIE.
4. Because the bonds were purchased from an outside party, the acquisition price is likely to
differ from the carrying amount of the debt in the subsidiary’s records. This difference creates
accounting challenges in handling the intra-entity transaction. From a consolidated
5. If the bonds are acquired directly from the affiliate company, all reciprocal accounts will be
equal in amount. The debt and the receivable will be in agreement so that no gain or loss is
6. The gain or loss to be reported is the difference between the price paid and the carrying
amount of the debt on the date of acquisition. For consolidation purposes, this gain or loss
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14. Basic Earnings per Share. The existence of subsidiary convertible securities does not affect
basic EPS. The parent’s basic earnings per share is computed by dividing the parent’s share
15. Several reasons could exist for a subsidiary to issue new shares of stock to outside parties.
First, additional financing is brought into the company by any such sale. Also, stock issuance
16. Because the new stock was issued at a price above the subsidiary’s assigned consolidation
value, the overall valuation for Metcalf’s stock has been increased. Consequently, the
17. A stock dividend does not alter the assigned consolidated subsidiary value and, thus, creates
no effect on Washburn’s investment account or on the consolidated figures. Hence, no entry is
recorded by the parent company in connection with the subsidiary’s stock dividend.
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
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Answers to Problems
1. C
7. D Cash flow from operations:
Net income ……………………………………………………….. $45,000
Depreciation ……………………………………………………… 10,000
Trademark amortization …………………………………….. 15,000
Increase in accounts receivable …………………………. (17,000)
9. C
10. C Post-issue subsidiary valuation ($800,000 + $250,000) $1,050,000
Arcola’s new ownership percentage (40,000 ÷ 50,000) 80%
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14. B 30% of $147,000 subsidiary net income; the intra-entity debt effects are
attributed solely to the parent company. 30% x $147,000 = $44,100
15. A For 2018, the adjustment to beginning retained earnings should recognize
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16. D Consideration transferred for preferred stock ……………………….. $ 424,000
Consideration transferred for common stock ………………………… 3,960,000
Noncontrolling interest fair value for preferred ……………………… 1,696,000
Noncontrolling interest fair value for common ………………………. 440,000
19. B Subsidiary’s unamortized fair value of prior to new share issue
(12,000 × $49) ………………………………………………. $588,000
Parent‘s ownership …………………………………………… 100%
Unamortized subsidiary fair value ……………………. $588,000
Subsidiary unamortized fair value after issuing new
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
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Education.
21. C Adjusted acquisition-date sub. fair value at 1/1/18
Consideration transferred ……………………………………………….. $592,000
Noncontrolling interest acquisition-date fair value ……………. 148,000
Increase in Stamford book value ………………………………………. 80,000
Stock issue proceeds ………………………………………………………. 150,000
Subsidiary valuation basis 1/1/18 ………………………………………….. 970,000
23. (10 minutes) (Qualification of Primary Beneficiary of a VIE)
Consolidation of a variable interest entity is required if a firm has a variable
interest that gives the firm
▪ The power, through voting rights or similar rights, to direct the activities
HCO Media internet site above $500,000, Hillsborough should consolidate
HCO Media.
24. (30 minutes) (VIE Qualifications for Consolidation)
a. The purpose of consolidated financial statements is to present the financial
position and results of operations of a group of businesses as if they were a
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24. (continued)
▪ The total equity at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other
parties. In most cases, if equity at risk is less than 10% of total assets, the
risk is deemed insufficient.
▪ The equity investors in the VIE lack any one of the following three
characteristics of a controlling financial interest.
1. The power, through voting rights or similar rights, to direct the
documents or other arrangements with variable interest holders).
Consolidation of a variable interest entity is required if a firm has a variable
interest that gives the firm
▪ The power, through voting rights or similar rights, to direct the activities
c. Risks of the construction project that has TecPC has effectively shifted to
the owners of the VIE:
At the end of the 1st five-year lease term, if the parent opts to sell the facility,
and the proceeds are insufficient to repay the VIE investors, TecPC may be
required to pay up to 85% of the project’s cost. Thus, a potential 15% risk.
Risks that remain with TecPC
▪ Guarantees of return to VIE investors at market rate, if facility does not
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
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24. (continued)
d. TecPC possesses the following characteristics of a primary beneficiary:
25. (10 minutes) (Consolidation of variable interest entity.)
a. Implied valuation and excess allocation for Softplus.
Noncontrolling interest fair value $ 60,000
Consideration transferred by Pantech 20,000
PanTech recognizes the $20,000 excess net asset fair value as a bargain purchase
and records all of SoftPlus’ assets and liabilities at their individual fair values.
Cash $20,000
Marketing software 160,000
Computer equipment 40,000
-0-
b. Implied valuation and excess allocation for Softplus.
Noncontrolling interest fair value 60,000
Consideration transferred by Pantech 20,000
Total business fair value 80,000
Fair value of VIE net identifiable assets 60,000
Goodwill $20,000
When the fair value of a VIE (that is a business) is greater than assessed
asset values, all identifiable assets and liabilities are reported at fair values
(unless a previously held interest) and the difference is treated as goodwill.
27. (35 minutes) (Consolidation of a primary beneficiary and variable interest entity one
year after control is obtained)
Primair and Vista
Consolidation Worksheet
Year Ended December 31, 2018
Primair
Vista
Adj. & Elim.
NCI
Consolidated
Revenues
(839,500)
(188,000)
(1,027,500)
Cost of good sold
612,000
75,000
687,000
Other operating expenses
78,000
25,000
103,000
Interest income
(21,000)
(IE) 21,000
-0-
Interest expense
21,000
(IE) 21,000
-0-
Net Income
(170,500)
(67,000)
Consolidated net income
(237,500)
to noncontrolling interest
(20,000)
20,000
to Primair
(217,500)
Retained earnings 1/1
(1,555,000)
(40,000)
(S) 40,000
(1,555,000)
Net income
(170,500)
(67,000)
(217,500)
Dividends declared
250,000
-0-
250,000
Retained earnings 12/31
(1,475,500)
(107,000)
(1,522,500)
Current assets
460,500
50,000
510,500
Loan receivable from Vista
300,000
(P) 300,000
-0-
Equipment (net)
794,000
525,000
1,319,000
Trademark
0
45,000
(A) 95,000
140,000
Total assets
1,554,500
620,000
1,969,500
Current liabilities
(29,000)
(18,000)
(47,000)
Long-term debt
(180,000)
(180,000)
Loan payable to Primair
(300,000)
(P) 300,000
-0-
Common stock
(50,000)
(15,000)
(S) 15,000
(50,000)
(S) 55,000
Noncontrolling interest
(A) 95,000
(150,000)
(170,000)
Retained earnings 12/31
(1,475,500)
(107,000)
(1,522,500)
Total liabilities and equity
(1,554,500)
(620,000)
471,000
471,000
(1,969,500)
Fair value of Vista on January 1, 2018 $150,000
Book value—date control is obtained 55,000
Excess fair over book value 95,000
To trademark (indefinite life) 95,000
-0-
Consolidated net income distribution:
Consolidated net income $237,500
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
6-6-15
28. (25 Minutes) (Consolidation entry for three consecutive years to report effects
of intra-entity bond acquisition. Straight-line method used. Parent uses equity
method)
a. Carrying Amount of Bonds Payable, January 1, 2016
Carrying amount, January 1, 2014 …………………………………. $1,050,000
Gain on Retirement of Bonds, January 1, 2016
Purchase price ($400,000 × 96%) …………………………………… $384,000
Carrying amount of liability (computed above) ………………. 416,000
Gain on retirement of bonds …………………………………………. $ 32,000
Carrying Amount of Bonds Payable, December 31, 2016
Carrying Amount of Investment in Bonds, December 31, 2016
Investment carrying amount, Jan. 1, 2016 (purchase price) $384,000
Amortization for 2016 ($16,000 discount ÷ 8-yr. rem. life) .. 2,000
Carrying amount of investment, December 31, 2016 ………. $386,000
Intra-entity Interest Balances for 2016
Interest income:
Cash collection ($400,000 × 9%) …………………………..…… $36,000
Amortization of discount for 2016 (above) ………………… 2,000
Intra-entity interest income ………………………………………. $38,000
Education.
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
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Education.
28. (continued)
CONSOLIDATION ENTRY *B (2018)
Bonds Payable ……………………………………………. 400,000
Premium on Bonds Payable …………………………. 10,000
29. (12 Minutes) (Determine consolidated income statement accounts after
acquisition of intra-entity bonds.)
CONSOLIDATED TOTALS
▪ Revenues and Interest Income = $1,051,360 (add the two book values and
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30. (30 Minutes) (Consolidation entry for two years to report effects of intra-
entity bond acquisition. Effective rate method applied.)
a. Loss on Repurchase of Bond
Cost of acquisition ………………………………….. $201,000
Carrying amount ($760,000 × 1/5) …………….. 152,000
Loss on repurchase ………………………………… $ 49,000
Interest Balances for 2016
Interest income:
Investment in Bonds, 12/31/16 ………………….. $198,870
Bonds Payable Balance, December 31, 2016
Carrying amount, 1/1/16 (above) ………………. $152,000
Amortization of discount:
Cash interest ($180,000 × 9%) …………….. $16,200
b. Interest Balances for 2017 followed by 2018
Interest income: $198,870 (Investment in Bonds
balance for the year) × 7% (rounded) ………………….. $13,921
Schaefer, Doupnik, 13e
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30. (continued)
Investment in Bonds Balance, December 31, 2017
Carrying amount, January 1, 2017 (part a) …………. $198,870
Amortization of premium:
Cash interest ($180,000 × 9%) ………………………. $16,200
Interest Balances for 2018
Interest income: $196,591 (Investment in Bonds …. $13,761
balance for the year [above]) × 7% (rounded)
Interest expense: $156,325 (liability balance
for the year [above]) × 12% ………………………….. $18,759
Investment in Bonds Balance, December 31, 2018
Carrying amount, January 1, 2018 (above) …………. $196,591
Chapter 06 – Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues – Hoyle,
Schaefer, Doupnik, 13e
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Education.
30. (continued)
Adjustment Needed to Investment in Zack for Bond Retirement Loss:
Loss on retirement of debt (part a) …………………………………….. $49,000
Amounts recognized in previous years:
Interest income: 2017 $(14,070)
Entry *B—12/31/18
Bonds Payable …………………………………………………. 158,884
Interest Income ………………………………………………… 13,761
Investment in Bonds Amortization Table:
Interest Carrying
Cash Revenue Amortization Amount
201,000
2016 16,200 14,070 2,130 198,870