Purposes of Consolidated Financial Statements
- These statements are intended to reflect the financial position and results of operations of an economic entity rather than a legal entity.
GAAP
*There are four methods for reporting the results of operations and financial position of a subsidiary (investee) by a parent (investor).
*Consolidation:
All operations under common control are combined, intercompany balances and transactions are eliminated and the effects of minority interests are recorded.
Ownership interest >50%
*Equity Basis
The parent company’s equity in the net assets of the subsidiary is reported in the parent company’s balance sheet as an investment, and the parent’s equity share in the net income of the subsidiary is reported in the parent company’s income statement. As with consolidations, intercompany transactions are eliminated.
Ownership interest 20-50%
Market
The investment is recorded at fair value in accordance with FAS 115.
Ownership interest
Accounting Practice for Consolidation Accounting
Consolidations are prepared by eliminating intercompany balances to form a group result.
The Equity Method
- states that the equity method is applied to corporate joint ventures and to investments in certain less than majority-owned companies in circumstances where
(1) the investment is for the long term (i.e., the investment is not “temporary”)
(2) the investor company has the ability to exercise significant influence over the operating and financial policies of the investee company.
Accounting Practice for the Equity Method
The investor’s net income for the period and its shareholders’ equity at the end of the period are the same whether an investment in common stock of an investee company is reported under the equity method or consolidated.
Parent Company Financial Statements
When preparing parent company financial statements, investments carried under the cost method in the consolidated financial statements also must be accounted for by the cost method in parent company financial statements.
Investments in other entities which are either accounted for under the equity or consolidated method in the consolidated financial statements can be accounted for by either the cost or equity method in parent company financial statements.
GAAP Segment Disclosure
public business enterprise report financial and descriptive information about its reportable operating segments.
- Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
Differences In Fiscal Periods
the subsidiary can prepare statements for consolidation purposes for a period that corresponds with or closely approaches the fiscal period of the parent.
It usually is acceptable to use the subsidiary’s statements if the difference in fiscal periods is not more than 3 months.
Statutory Accounting Principles (SAP)
Admitted investments in SCA entities for the market valuation approach?
The admitted investments in SCA entities are recorded using a market valuation approach or equity method. There are strict requirements for market valuation, which are:
- *Once the insurer elects to use the market valuation approach for a particular subsidiary, the insurer cannot change the valuation method to another method (e.g., equity) without the approval of the domiciliary commissioner;
- The subsidiary must be traded on one of the following three major exchanges: (1) the New York Stock Exchange, (2) the American Stock Exchange, (3) the NASDAQ National exchange, or for Foreign SCAs, the equivalent.
- *The insurer must submit subsidiary information to the Securities Valuation Office (SVO) for their calculation of the subsidiary’s market value. Such calculation could result in further discounts in market value above the established base discounts based on ownership percentages detailed below;
- Ownership percentages for determining the discount rate are measured at the holding company level;
- Investment in an SCA results in an ownership percentage 10% to 50%, a base discount percentage is 0% and 20% on a sliding scale basis;
- Investment in an SCA results in an ownership percentage >50% to 80%, a base discount percentage is 20% and 30% on a sliding scale basis;
- Investment in an SCA results in an ownership percentage >80% to 85%, a minimum base discount is 30%. Further, the SCA must have at least two million shares outstanding, with a total market value of at least $50 million in the public’s control;
- Ownership percentages exceeding 85% will result in the SCA being recorded on an equity method.
Statutory Accounting Principles (SAP)
If an SCA investment does not meet the requirements for the market valuation approach or an insurer elects not to use that approach, investments in SCAs are recorded as follows:
- Investments in an insurance SCA are based on the underlying statutory equity of the respective company’s financial statements, adjusted for unamortized goodwill.
- Investments in a noninsurance SCA that have no significant ongoing operations other than to hold assets that are primarily for the direct or indirect benefit or use of the insurer or its affiliates, are based on the underlying equity of the respective company’s financial statements adjusted to a statutory basis of accounting and the resultant proportionate share of the subsidiary’s adjusted surplus, adjusted for unamortized goodwill.
- Investments in a noninsurance SCA that have significant ongoing operations are based on the audited GAAP equity of the investee.
Statutory Accounting Principles (SAP)
initial acquisition of an SCA is recorded as:
- The initial acquisition of an SCA is recorded as the sum of (a) any cash payment, (b) the fair value of other assets distributed, (c) the fair value of any liabilities assumed, and (d) any direct costs of the acquisition.
After the date of acquisition, the initial investment amount is adjusted for the amortization of goodwill, the reporting entity’s share of statutory basis earnings or losses, and other changes in surplus (including changes in nonadmitted assets) of the investee.
Market Value Accounting
Investments in SCAs accounted for under the market value approach are recorded in accordance with the NAIC Purposes and Procedures of the Securities Valuation Office (SVO), Procedures for Valuing Common Stocks and Stock Warrants.
If fair market value is unavailable from the SVO, management must determine market value based on analytical or pricing mechanisms.
Statutory Impairment
If an impairment loss is recognized, the insurer must disclose:
• A description of the impaired assets and the facts and circumstances leading to the impairment and
• The amount of the impairment and how fair value was determined.
SAP Disclosures
For all investments in SCA entities that exceed 10 percent of the total admitted assets of the insurer, the following disclosures are required:
• *The name of each SCA entity and percentage of ownership of common stock
- The accounting policies of the insurer with respect to investments in SCA entities
- The difference, if any, between the amount at which the investment is carried and the amount of underlying equity in net assets (i.e., goodwill, other nonadmitted assets, market value or discounted market value adjustments) and the accounting treatment of the difference
- For those SCA entities for which a quoted market price is available, the aggregate value of each SCA investment based on the quoted market price and the difference, if any, between the amount at which the investment is carried and the quoted market price;
- Summarized information as to assets, liabilities, and results of operations either individually or in groups
- Conversion of outstanding convertible securities, exercise of outstanding options and warrants and other contingent issuances of an investee that may have a significant effect on an investor’s share of reported earnings or losses. In addition, material effects of possible conversions, exercises or contingent issuances are disclosed in notes to the financial statements of the insurer.
Special Issues
Installment Acquisition of Subsidiary
When ownership of the subsidiary reaches 20% or the parent is otherwise able to exercise influence, APB Opinion No. 18 requires retroactive application of the equity method of accounting. When the parent company attains control of the subsidiary, usually through 50 percent or more ownership, purchase accounting is applied retroactively, and fully consolidated financial statements are prepared for subsequent periods
Special Issues
Parent Company Sale of a Portion of Subsidiary
The difference between the carrying value of the parent’s investment in subsidiary and the amount received is treated as a gain or loss in the parent’s income statement.
gain or loss is not considered to be an extraordinary item for consolidated income statement presentation.
Special Issues
Parent Company Acquisition of Minority Interest
Purchase accounting applies when a parent company acquires all or part of a minority interest.
When the amount paid for the minority interest is > than the carrying value of the minority interest, the excess usually is treated as goodwill.
When the amount paid for the minority interest is less than the minority interest carrying value, the difference is allocated pro rata to the noncurrent assets, other than long term investments in marketable securities.
Authoritative Guidance
Control
The Securities and Exchange Commission (SEC), Regulation S-X, Rule 1-02, extends the definition of control to “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting shares, by contract, or otherwise…”.
Authoritative Guidance
Minority Interests
Acquiring less than 100 percent requires the parent to record on the balance sheet a liability representing minority interests.
- Minority interests represent the ownership interests in the net assets of the subsidiary held by persons outside the controlling entities’ structure.
- Minority interest is reported separately from permanent stockholders’ equity because it represents an outside claim (from the permanent stockholders’ perspective) on the net assets of a subsidiary.
Examples of situations that may indicate temporary control include:
- A parent is under judicial or regulatory order to divest the subsidiary;
- There is pending litigation concerning the acquisition of a subsidiary and it is probable such litigation will result in its divestiture.
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Chapter 251
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Chapter 358
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Chapter 427
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Chapter 521
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Chapter 655
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Chapter 718
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Chapter 823
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Chapter 918
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Chapter 1018
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Chapter 1120
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Chapter 1237
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Chapter 1317
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Chapter 1425
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Chapter 1520
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Chapter 1626
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Chapter 17 - Budget24
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Chapter 18 - Strategic Planning8
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Chapter 19 - Management reports18
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Chapter 20 - Mergers and Acquisitions20
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Chapter 2120
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Chapter 2220
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Chapter 24 - Internal Control22
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Chapter 25 - Reinsurance25
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Chapter 262
