Auditing Special Purpose Frameworks--Business Combinations, Consolidation

Continuing to lay a foundation for developing audit strategies and audit plans, this article presents more comparisons of significant requirements in U.S. GAAP and the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). http://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/PCFR/Pages/Financial-Reporting-Framework.aspx  

This article presents comparisons of these topics:

·      Stock-Based Compensation Plans

·      Consolidation and Subsidiaries

·      Business Combinations

·      Push-Down Accounting

Stock-Based Compensation Plans

U.S. GAAP:

This form of compensation may be accounted for as either a liability or equity amount, depending on management’s intentions, at fair values.   Fair value will be determined based on this hierarchy: 1) a fair value accounting method when it can be reasonably determined, 2) calculated-value method if it can be reasonably estimated or 3) intrinsic value method when neither of these methods can be used.

FRF for SMEs:

This framework requires only footnote disclosures for such plans.  The disclosures include:

·      The terms of awards under the plan.

·      Vesting requirements.

·      The maximum terms of options granted.

·      Separate disclosures for multiple plans.

Consolidation and Subsidiaries

U.S. GAAP:

An entity having a controlling financial interest (normally more than 50% ownership) in another entity is required to consolidate the subsidiary. When the entity cannot maintain significant influence over the operation of the subsidiary, such as in the case of external events like bankruptcy, the subsidiary would not be consolidated.  For investments in variable interest entities, investors that have the power to significantly influence the operations of such entities will usually be deemed “primary beneficiaries.”  In such circumstances, primary beneficiaries are required to consolidate variable interest entities. Either the equity method or cost method would be used otherwise.

FRF for SMEs:

Management can elect to consolidate more than 50%-owned subsidiaries or account for them using the equity method (if it exercises significant influence over the entity).  When significant influence is not exercised over the subsidiary, the cost method should be used to report the investment.  Equity and debt securities that are available for sale, however, should be recognized at market values with changes in such values included in periodic net income.  General disclosures include:

·        Consolidation policy.

·        When consolidated, the names of all subsidiaries, income from each and the percentage of ownership.

·        Descriptions of the periods for subsidiaries’ financial statements that don’t coincide with the parent’s reporting date, along with any significant events or transactions in the intervening periods.

·        When financial statements are not consolidated, method of accounting for its subsidiaries, descriptions, names, carrying amounts, income and percentage of ownership for each.

Business Combinations

U.S. GAAP:

The acquisition method of accounting is required.  The acquisition-date fair values of assets, liabilities, goodwill and non-controlling interests in an acquired entity are used for measurement in financial reporting.

FRF for SMEs:

This framework essentially requires the acquisition method of accounting using acquisition-date market values.  It permits, however, management to elect to account for an intangible asset either separately or as a part of goodwill. General disclosures similar to U.S. GAAP are required for material and immaterial business combinations. 

Push-Down (New Basis) Accounting

U.S. GAAP:

There is no requirement to permit new-basis accounting for acquired entities.

FRF for SMEs:

When an acquirer gains more than 50% control of an entity, the assets and liabilities of the acquired entity may be comprehensively revalued in its financial statements, assuming the new values are reasonably determinable.  This results in similar values being used in the acquired entity’s financial statements and the acquirer’s consolidated statements.  General disclosures include:

·        First applications:

o       Date push-down accounting was first applied and the date of the related purchase transaction.

o       Description of the situation resulting in push-down accounting and the amounts of changes to major classes of assets, liabilities and equity.

·        In addition for the following fiscal period:

o       Amount of the revaluation adjustment and the equity account in which it was recorded.

o       Amount of reclassified retained earnings and the equity account in which it was recorded.

The next article in this series will begin a step-by-step approach to performing small audits of special purpose frameworks, focusing primarily on the FRF for SMEs.