For WizardKim-DP

2nd Post Discussion:

Respond to the post below from your fellow classmate. Any opinions, or anything you would like to add to discuss about their post. Must be three substantial paragraphs, and three references.

In today’s fast paced and globalized business environment, companies are no longer solely competing in their geographic region, but against companies around the globe (Hoyle et al., 2017). In order to remain competitive and increase their profitability, companies are diversifying their business portfolios. The primary form of diversification is through the investment in companies outside the companies’ respective industry as well as companies that work in tangent with the investing company. We have already learned many companies have been purchasing a controlling interest in smaller companies (Hoyle et al., 2017). This controlling interest often falls in the range of 20 to 50%, requiring the investor to use the equity method to account for their percentage of the investee’s income and expenses (Hoyle et al., 2017).

            However, in the past few years, larger companies have purchased more than 50% of the investee’s voting stock. When purchasing more than 50% of a company’s voting stock, the investor now controls the investee’s business decisions and, in some cases, the company being bought will be completely dissolved into the investing company (Hoyle et al., 2017). Now, controlling more than 50% of an investee’s voting stock, the investor can no longer use the equity method. Instead, they will use the consolidation method to account for their investment (History of IFRS 10, 2012). The consolidation of financial statements is often considered the most complex accounting technique in the entire profession (Hoyle et al., 2017). Consolidated financial statements primary objective is to provide investors the results of operations and the overall financial position of the parent company and their subsidiaries (FASB Original Pronouncements, As Amended, 2020). In order to provide the financial position of not only the parent company but the subsidiaries as well, the accounts treat the parent and the subsidiaries as if they were one single entity. Consolidated financial statements combine and present the assets, liabilities, equity, income, expenses, and cash flows of the parent a subsidiary company into a single financial statement (History of IFRS 10, 2012).

            Many investors have the belief that consolidated financial statements are more meaningful than individual financial statements (FASB Original Pronouncements, As Amended, 2020). This belief is backed by the belief that consolidated financial statements provide a better representation of companies that directly or indirectly control other companies. Investors often believe by consolidating all the accounts into a single statement, they can more accurately get an idea of the overall picture of the parent company (FASB Original Pronouncements, As Amended, 2020). For example, by combining the income statements of the parent company with all of their subsidiaries, the investor can get a better idea of the overall profitability of the company. This being said, some investors are not in favor of consolidated financial statements because of the ability to hide poor performance (MÜLLER, 2011). When companies consolidate financial statements, a subsidiary that is not a strong performer can be masked by a subsidiary that is overachieving (MÜLLER, 2011). For example, let’s say Beatle Juice owns three subsidiaries and two of them are performing amazingly, recording record sales, but the third subsidiary is recording record losses. When the three subsidiaries are combined together, the two strong performers will net out the poor performing company and the investors will be none the wiser (MÜLLER, 2011). In an attempt to relieve investors of this worry, many companies will not only consolidate their financial statements, but provide individual statements as well (MÜLLER, 2011). 

 

References

Deloitte. (2012, June 29). History of IFRS 10. IFRS 10 - Consolidated Financial Statements. https://www.iasplus.com/en/standards/ifrs/ifrs10.

Financial Accounting Standards Board. (2020, January). FASB Original Pronouncements, As Amended. https://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820901468&blobheader=application%2Fpdf.

Hoyle, J. B., Schaefer, T. F., & Doupnik, T. S. (2017). Advanced accounting (13th ed.). Mcgraw-Hill Education.

MÜLLER, V. (2011). Value relevance of consolidated versus parent company financial statements: evidence from the largest three European capital markets. Accounting and Management Information Systems, 10(3), 326-350. https://search.proquest.com/docview/993333255?accountid=35796