22 Mar The financial effects of intercompany transactions
The financial effects of intercompany transactions are eliminated in consolidated financial statements. This helps insure that the statements reflect only assets, liabilities, revenues and expenses arising from transactions with outside parties. Criticisms of Enron’s accounting include (1) gains recognized on asset transfers to controlled special purpose entities (SPEs) that escaped consolidation and, hence, elimination; (2) borrowings by unconsolidated con-ENRONtrolled SPEs; and (3) using SPEs to enable recognition of gains on one’s own stock. To demonstrate these phenomena we consider the following data from Sponsor and Sponsoree, an SPE, before any intercompany transactions. Except as noted, Sponsor has no equity interest in Sponsoree but may qualify as Sponsoree’s primary beneficiary Required For each independent situation below, present the required calculations assuming (1) Sponsor and Sponsoree are not consolidated, and (2) Sponsor and Sponsoree are consolidated. a. Sponsor sells inventory to Sponsoree for $3,000 million and recognizes $500 million profit. The inventory is on hand at year end. Compute Sponsor’s return on assets (ROA) and return on sales (ROS). b. Sponsoree borrows $3,500 million from a bank, uses it to purchase Sponsor’s stock directly from Sponsor, and Sponsor reports stock issued for cash. Compute Sponsor’s total liabilities/total assets. c. Sponsoree’s stock investment in part b was assigned to its trading portfolio. The stock investment’s value is $4,300 million at year end. Compute Sponsor’s ROA. For (1), assume that Sponsor owns 25% of Sponsoree’s stock and that Sponsor’s revenues include the equity accrual, except for the value change in the stock investment made in part b. View Solution: The financial effects of intercompany transactions are eliminated in consolidated
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