Construct One Argument Which Provides At Least Two Reasons ✓ Solved

Construct one (1) argument in which you provide at least two

According to the assignment, students are required to construct a single well-reasoned argument that explains the rationale behind the U.S. Generally Accepted Accounting Principles (GAAP) treatment when reporting additional investments in subsidiaries after the parent has established control. Specifically, they need to identify at least two reasons supporting this accounting approach and provide justification for their reasoning.

Furthermore, students should identify the main characteristics of a variable interest entity (VIE) and evaluate how including VIEs in consolidated financial statements benefits investors. The analysis should be supported with logical arguments and relevant accounting principles.

Sample Paper For Above instruction

The treatment of additional investments in subsidiaries under U.S. GAAP, especially after acquiring control, has been a subject of debate among accounting professionals and investors, with some like Warren Buffett suggesting that it undervalues the parent’s investment. This perspective highlights concerns that the current standards may not fully capture the economic realities of such investments. However, the U.S. GAAP approach has underlying rationales that justify its methodology.

One primary reason for the U.S. GAAP treatment is the emphasis on the historical cost basis in consolidations. U.S. GAAP requires that when a parent acquires control of a subsidiary, it consolidates the subsidiary’s assets and liabilities at their acquisition-date fair values. Subsequent investments are then recorded based on the consideration transferred, preserving the original cost basis unless revaluation is necessary. This approach provides consistency and comparability across financial statements, minimizing the influence of market fluctuations or subjective valuation changes that could distort financial reporting. By focusing on actual transactions and considering the initial acquisition cost, GAAP aims to present a conservative and reliable view of the parent’s investment, avoiding potential overstatement resulting from market volatility or unrealized gains.

A second reason stems from the necessity of maintaining accountability and clarity in financial reporting. The GAAP standards are designed to reflect the legal structure of control, which is typically established through majority voting rights or other control mechanisms, rather than market valuation. When a parent company acquires additional interests in a subsidiary, it is fundamentally strengthening its control, which is best represented through consolidation based on the acquisition date fair values of assets and liabilities. This method ensures that financial statements accurately depict the controlling interest along with the noncontrolling interests, maintaining transparency and consistency in reporting ownership interests. It also prevents the inflation of asset values based on market speculation or non-transactional valuation changes, thereby serving the interests of investors and regulators alike.

The characteristics of a Variable Interest Entity (VIE) further underpin the rationale for specific accounting treatments. Unlike traditional subsidiaries controlled via voting rights, VIEs are entities where control is based on contractual arrangements or other factors, with residual equity investors often lacking a controlling interest. The main characteristics include the absence of substantive voting rights, the presence of variable interests that can absorb the entity’s expected losses or receive its expected benefits, and a primary beneficiary that consolidates the VIE’s financials. These entities are often used for specific financing arrangements or to achieve off-balance-sheet financing, hence the motivation to include them in consolidated statements.

Including VIEs in consolidated financial statements increases transparency and provides investors with a more comprehensive view of a company’s risks and exposures. Since VIEs can significantly impact the financial position and performance of the parent, their exclusion might obscure the true economic substance of the entity. By consolidating VIEs, investors gain better insights into the company’s underlying economic activities, risk exposures, and resource commitments. This enhances the decision-making process, allowing investors to assess risk more accurately and to understand the full scope of the parent company's financial commitments and the nature of its interests in various entities.

In conclusion, the U.S. GAAP approach to reporting additional investments post-control emphasizes consistency, transparency, and accountability. It aims to present a true and fair view of the controlling interest by focusing on historical cost and control mechanisms rather than fluctuating market values. The inclusion of VIEs further enhances investor understanding by revealing entities that may influence the financial health of the reporting entity, regardless of formal voting rights. Together, these standards support prudent financial reporting that aligns with the primary goal of providing reliable, comparable, and transparent financial information for stakeholders.

References

• FASB. (2014). Accounting Standards Update No. 2014-07: Consolidation (Topic 810): (Part 1 of 2)—Applying the Variable Interest Model. Financial Accounting Standards Board.
• Hoyle, J., Schaefer, T. F., & Doupnik, T. S. (2019). Advanced Accounting (13th Ed.). McGraw-Hill Education.
• Reinstein, A., Churyk, T., & Berde, S. (2012). Financial Accounting and Reporting. McGraw-Hill Education.
• US GAAP ASC 810-10, Consolidation Guidance.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate Accounting (16th Ed.). Wiley.
• Financial Accounting Standards Advisory Council. (2017). VIE and Consolidation Standards. FASAC.
• Hsu, D., Duh, R. F., & Cheng, W. (2012). Principles of Accounting. Pearson Education.
• International Financial Reporting Standards (IFRS) 10: Consolidated Financial Statements. IFRS Foundation.
• U.S. Securities and Exchange Commission (SEC). (2020). Financial Reporting Manual.
• Healy, P., & Palepu, K. (2012). Business Analysis & Valuation: Using Financial Statements. Cengage Learning.