Feature By Mark Crowley, DBA, CPA, and MaryBeth Tobin, MSF, MST, CPA
Overstating Sales –
Creating Revenue Through the Consolidation Process If a company grows through acquisitions by buying companies with an equity interest of more than 50 percent but less than 100 percent, is there evidence of revenue creation through the consolidation process? According to the consolidation procedures of the United States Generally Accepted Accounting Principles (U.S. GAAP), companies report 100 percent of sales from the parent company, as well as 100 percent of sales from its subsidiaries, even if the parent does not have total ownership of these affiliates. on the parent company’s consolidated income statement in a line item labeled “non-controlling income.” This line item reports the amount of net income to which the parent company is not entitled. U.S. GAAP does not require a footnote disclosure to identify the non-controlling sales revenue associated with this noncontrolling income.
This article covers a study of 694 public companies with non-controlling income of at least $2 million. An estimate of overstated sales was obtained by dividing the non-controlling income by the consolidated company’s percentage of net income before non-controlling income. It can be inferred that these companies are taking advantage of the consolidation process and are overstating consolidated sales. CREATING REVENUE THROUGH CONSOLIDATION According to U.S. GAAP consolidation procedures, all sales from controlled 32
affiliates, whether wholly-owned (100 percent) or partially-owned (greater than 50 percent, but less than 100 percent), are added together with the parent company sales and reported as consolidated sales. During the consolidation process, the sales revenue from the entity that has a non-controlling interest (50 percent ownership or less) is not reported by that entity at all. Therefore, the parent company reports 100 percent of the sales from all subsidiaries in which it has a majority ownership interest. In doing so, the parent company picks up additional sales above the percentage it owns. The net income generated by these non-controlling sales is reported
METHODOLOGY To determine the extent of overstated sales revenue by consolidated companies, a COMPUSTAT report was run to identify a population of 3,000 consolidated companies that had noncontrolling interests reported in their 2011 fiscal year financial statements. Companies in this population with consolidated losses and/or noncontrolling income of under $2 million were eliminated from the analysis. The remaining sample consisted of 694 consolidated companies with at least $2 million in non-controlling income. The parent company’s consolidated sales, non-controlling income, and consolidated net income were obtained from the database. The percentage of net income before non-controlling income was calculated by adding non-controlling income back to consolidated net income and dividing the resulting net income before non-controlling income by total consolidated sales. An estimate of overstated sales was obtained by dividing the non-controlling income by the parent’s percentage of net income before non-controlling income. This grossing up process, although not exact, serves as a reasonable estimate of the overstated sales revenue reported by these 694 consolidated companies. Today’sCPA
| MARCH/APRIL 2014