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MP222 Corporate Accounting and Reporting

Question 1 (approximately 1500 words):

The Enron scandal is now 20 years old. The lessons from Enron is still far reaching with changes to laws following the disaster. Critically evaluate:

  • the role of consolidated financial statements
  • the need for elimination
  • the primary criterion for determining whether to consolidate (concept of control)

In your evaluation, refer to Enron and the improper way their financial statements were presented.

Question 2 (approximately 1000-1500 words):
Webjet acquired Trip Ninja at the end of 2021.

Research and write a brief summary of Webjet. What do they do? Brief history and so on..

Research about the Webjet’s acquisition of Trip Ninja. Why would Webjet want to acquire Trip ninja? Discuss.

The acquisition price was not disclosed but Trip Ninja announced that the business will “shut- down” before the acquisition. Do you think the acquisition would result in goodwill or a bargain purchase? Explain.

Hypothetically, assume Webjet acquired only 80% of Trip Ninja, how would the accounting differ from 100% acquisitions? Demonstrate by presenting the financial statement with an NCI.

Present the two questions as two separate parts.

Solution

Question 1

The role of consolidated financial statements

There have been substantial shifts in regulations and laws as a result of the Enron crisis, which happened 20 years ago. The importance of consolidated financial statements as well as the idea of control as the major factor for deciding whether to consolidate is two crucial issues to examine while assessing the lessons from Enron (Petra & Spieler, 2020). Despite the fact that a parent company along with its subsidiaries need to everyone compile their own independent financial statements, IAS standards require the parent company to present the fiscal health of the group as if it had been a single entity because of the close relationship between and control by the common management team. The ultimate goal is to offer investors an accurate depiction of the company’s financial standing as of the end of the fiscal year.

The primary audience for consolidated financial statements is the parent company’s management and board of directors (if the parent owns 50% or more of the subsidiary). A company’s financial health can only be fully understood by the consolidation of its subsidiary and controlled entity financial statements, which is where consolidated financial statements come in (Fridson and Alvarez, 2022). Because they don’t contribute to their bottom line, employees at the subsidiary firms won’t care as much about them. Moreover, accounting for a collection of enterprises as one company allows investors and also regulators to evaluate their obligations, assets, cash flows, as well as success more accurately.

Consolidated financial statements must be prepared whenever one company controls another by virtue of owning over fifty per cent of the exceptional common voting stock of the other organisation, unless such control is temporary or not in the ownership of the majority owner (such as when the organisation or organisations are in administration). Consolidating financial statements gives investors a more complete picture of the company’s financial health since it more accurately represents the economic content of its activities. Associated businesses such as subsidiaries, JVs, and affiliates are counted here. The notes-receivable assets along with shareholder equity reported by Enron in its audited financial statements for 2000 were inflated by $172 million. And by $828 million, Enron’s unaudited 2001 filings overestimated them. With little exclusion, all related firms must be rolled into the consolidation if shareholders are considered to have joint control or perhaps considerable influence (Blythe, 2020).

Yet, as the Enron incident showed, consolidated financial statements may be misused and manipulated to significantly mislead a company’s real financial status. These dubious procedures allowed Enron to mislead investors and other stakeholders into thinking the company was in a better financial situation than it really was. Special purpose organisations (SPEs) and other complicated accounting practises were used by Enron to conceal debt and exaggerate earnings.

The need for elimination

Consolidated financial statements of related entities may be made more straightforward via the use of elimination entries. To eliminate double counting of ownership, inter-company costs, inter-company debt, and inter-company income in situations where two or more firms are related, elimination entries are utilised. Special purpose vehicles (SPVs), were created by Fastow along with others at Enron to conceal the company’s massive debt and hazardous assets from creditors and shareholders (Ksu, n.d.). In order to compile reliable consolidated financial statements, intercompany balances, operations, as well as unrealized profits & losses between affiliated companies must be eliminated.

When analysing what may be learned from Enron, it is also important to think about the need of removal. By removing them, the financial statements will more accurately reflect the group’s financial condition by focusing only on the balances and transactions with external partners. Enron’s financial statements were skewed in large part due to the incorrect removal of intercompany transactions. Due to the failure to declare or remove these transactions, a false picture of Enron’s financial health was painted (Kabeyi, 2020). In order to accomplish its financial goals, including concealing debt and inflating earnings, Enron employed convoluted arrangements employing SPEs to undertake transactions that were legally eliminations.

The primary criterion for determining whether to consolidate (concept of control)

One of the most important considerations in deciding whether or not to merge organisations is the idea of control. The largest voting interest standard is used to determine who has control of a business, although other factors, such as formal agreements or substantial influence, may also be taken into account (Sekerez, 2020). The power in order to direct the management and daily operations of another organisation in order to reap its economic advantages is what it means when talking about “control.” In case a holding company holds over fifty percent of a different business’s stock, then the financial statements of both companies must be consolidated in order to comply with GAAP. Consolidation of financial statements sometimes leads to the use of terms like “parent company,” “holding company,” as well as “conglomerate” interchangeably.

The instance of Enron exemplified the way in which power may be twisted and abused. Many SPEs were created by Enron with little or no equity involvement so that the company could engage in activities that would not affect its consolidated financial statements. Control was misused by Enron in order to mislead stakeholders and investors about the company’s true financial performance (Liu et al., 2021). Although Enron retained ownership of these firms via contractual structures and other ways, they were utilised to conceal debt and exaggerate earnings. Significant modifications were made to address the concerns with consolidated financial statements as well as the choice of control as a result of the Enron affair imposed by regulatory agencies and also standard-setting groups. Financial reporting openness was improved, while internal controls were bolstered, all thanks to the Sarbanes-Oxley Act (SOX). The United States government passed SOX in order to improve company transparency, accountability, and the impartiality of its auditors.

Additional clarification and direction on consolidation principles, requirements for disclosure, along with the identification of control has been added to generally accept accounting principles (GAAP) as well as International Financial Reporting Standards (IFRS). These changes are made to guarantee that the idea of control is implemented correctly and openly, and to avoid the abuse of consolidated financial statements.

If any of the following apply to an entity, CPAs may want to consider consolidating it.

Either the reporting entity or its affiliated parties had a substantial role in creating or altering the entity and this entity was formed with the reporting entity also its affiliates in mind, and all of its operations would directly or indirectly benefit these groups. If the company is a franchisee or operational joint venture controlled by the reporting company with one or more unrelated parties, then this requirement does not apply (Bhaskar & Flower, 2019). Assessment of the fair values of the holdings in the reporting company indicates that the reporting entity, its connected parties, or both contribute over fifty percent of the total equity, subordinated debt, or other kinds of subordinated financial assistance.

Securitizations, other asset-backed financings, and single-lessee leasing agreements make up the bulk of the company’s business.

Here are three considerations for making the decision to merge.

Step 1:

  • First, it requires knowing whether the property is “housed” in a legal body. If the answered “no,” then consolidation is not necessary.
  • Real estate owned by the proprietors of a company outside of a legal organisation need not be consolidated into the company’s financial accounts.
  • Companies, partnerships, and grantor as well as different trusts may all fall within the purview of this law (Greve & Man Zhang, 2017).

Step 2:

  • The second step is to ensure there is enough equity in danger for the VIE to function independently.
  • Is that organisation a VIE if the first question is answered yes? If that’s the case, you don’t have to do any kind of merger.
  • Investors’ equity stakes should reflect the features of a controlling financial interest.
  • No additional collateral is required.
  • Lease payments and administrative costs must not be excessive.
  • No other parties or owners should provide any kind of assurances.
  • No equity investors or connected parties should lend money to other equity investors.
  • No subordinated debt should be in place.

Step 3:

  • If the previous step was answered in the affirmative, the next stage is to determine who, if anybody, is the VIE’s principal beneficiary. There is no need for consolidation if there is no principal beneficiary entity.
  • The major benefactor need not undergo a rigorous quantitative study before a qualitative determination may be made.
  • One main beneficiary is permitted per VIE.
  • Most gains and losses are concentrated in the hands of the principal recipient (Greve & Man Zhang, 2017).
  • The principal beneficiary is the primary source of funding for the VIE.

One investor is the principal benefactor if they get the bulk of the projected gains while another investor takes on the most of the predicted losses. If done properly, consolidated financial statements provide investors a clear picture of a company’s financial health and performance. Due in large part to the Enron incident, consolidated financial statements including the definition of control are now subject to stricter scrutiny. However, due to Enron’s manipulation of elimination underlying the idea of control, the company’s financial health was misrepresented in consolidated financial statements.

Question 2

Webjet is an online travel agency (OTA) based in Australia that enables users to make reservations for flights, hotels, car rentals, holiday packages, including travel insurance without leaving the convenience of the comfort of your own home. Webjet, which has been in business since 1998, has developed into a significant online travel agency (OTA) within Australia, New Zealand, as well as other countries (Webjetlimited, 2023). Users are able to search for, compare, and book lodgings in a streamlined manner across a wide variety of booking platforms, notably but not restricted to airlines. The organisation does business under a variety of brands, including Webjet, FIT Rums, Lots of Hotels, Online Republic, Sunhotels, JacTravel, and others and these are only some of the names. They have also entered the B2B solutions market, where they provide their travel software as well as travel-related content for sale to other businesses.

Webjet has recently acquired Trip Ninja.

Webjet has an extensive record of being an innovator in the field of new technology. Over the past few years, these businesses have made significant investments in mobile optimisation as well as cutting-edge technology such as AI and Machine Learning in order to provide superior service to their clients and save operating expenses. They were the first to develop the idea of dynamic packaging, enabling customers to customise their own holiday packages by choosing the flights, hotels, and other components that they want (Webjetlimited, 2021).

The acquisition of Trip Ninja by Webjet might be attributed to a variety of different factors, both inside and external to the company. Trip Ninja is a partner online travel agency (OTA) that was established in 2015. The company makes use of existing inventory to identify markup opportunities for multi-city holidays. The proprietary technique developed by Trip Ninja improves the effectiveness of content, enabling OTAs to save time as well as cash while simultaneously achieving their goals in a more expedient manner. Their cutting-edge software enables it easy for tourists to search to find and book tickets, which include flights with a variety of airlines as well as varied times, dates, and stopovers (Webjetlimited, 2021). Trip Ninja is a travel technology company based in Canada that specialises in assisting consumers with the planning of itineraries, which involve many stops and multiple airlines.

Acquisition Outcome

Webjet decided to buy Trip Ninja in order to have access to the innovative software and in-depth understanding of complex flight plans that the latter firm had. It is possible that Webjet may enhance its flight search as well as booking services, providing customers with more flexibility and customised holiday options. This acquisition would be beneficial to Webjet’s present offerings, and the company’s reputation in the competitive online travel business would be strengthened as a direct consequence of the acquisition’s impact (Tatiana, 2021).

A deal is seen as a bargain when the purchase price is substantially lower than the value of both the assets and the liabilities that are being acquired in the transaction. The fact that the price of the transaction is unclear, coupled with the fact that Trip Ninja had previously disclosed that it would be shutting down prior to the sale, increases the potential that the firm will be bought at a discount as opposed to for the value of its goodwill. Webjet may have been able to purchase Trip Ninja’s customer list, intellectual property, including technology at a reduced price as a result of Trip Ninja’s decision to suspend operations. The consequence of this would be a gain resulting from a bargain purchase, which would be reflected in operating income (Webjetlimited, 2021).

Hypothetically, Webjet acquired only 80% of Trip Ninja

However, if Webjet only purchased 80% of Trip Ninja, then the transaction could be taken into account different than it would have been if Webjet had purchased the entire firm. The consolidated financial statements would contain the financial data not just for Webjet but also for Trip Ninja, as they both belong to the same parent company. From the consolidated financial accounts, the remaining 20% is going to be shown as a non-controlling interest (NCI).

The following is a list of the components that would make up the consolidated financial statements:

Statement of Earnings:

  • In the financial filings of the firm, the amount of Trip Ninja’s stock that is not owned by Webjet would be referred to as the non-controlling interest (NCI) for that portion of the shares.
  • The assets and liabilities of Webjet and Trip Ninja would be merged together.
  • To calculate the part of net income (in this case, 20%) that is due to the NCI for the reason of the income statement, divide the net profit as a whole by the percentage of the NCI.
  • The whole revenue and expenditures of Trip Ninja would be included into Webjet’s overall stats.
  • A separate line item would be created in the part of the Statement of Cash Flows that deals with financing operations to account for dividends that were paid to the NCI.
  • The total cash flows, including those through operating, investing, and financing businesses, generated by Webjet and Trip Ninja combined.
  • Any changes made to the proportion of ownership held by the NCI would be detailed on a separate equity statement.
  • The equity would display both Webjet’s and the NCI’s proportionate ownership holdings in the company.

The acquisition of an eighty percent share would, in most cases, lead to the consolidation of Trip Ninja’s financial data with that of Webjet, despite the fact that the NCI would continue to be regarded as a separate organisation (Webjetlimited, 2021). This strategy ensures transparency and delivers an accurate portrayal of the financial position, performance, as well as ownership structure of the consolidated business. On the balance sheet, all of Trip Ninja’s assets and liabilities, as well as all of Trip Ninja’s revenue and expenses, would be shown. The percentage that the NCI would get of Trip Ninja’s net income would be calculated to be equal to twenty percent of Trip Ninja’s net income.

References

Bhaskar, K., & Flower, J. (2019). Financial failures and scandals: From Enron to Carillion. Routledge. https://books.google.co.in/books?hl=en&lr=&id=BNCSDwAAQBAJ&oi=fnd&pg=PT7&dq=Financial+failures+and+scandals:+From+Enron+to+Carillion.+Routledge&ots=qnhBaY8lge&sig=FsBvKDb-F_xsnvaWP-K6daw9qt8&redir_esc=y#v=onepage&q=Financial%20failures%20and%20scandals%3A%20From%20Enron%20to%20Carillion.%20Routledge&f=false

Blythe, S.E. (2020). Financial statement fraud: Lessons learned from selected US legal cases in the past twenty years. Journal of Modern Accounting and Auditing16(1), pp.1-18. https://www.researchgate.net/profile/Stephen-Blythe-2/publication/338865738_Financial_Statement_Fraud_Lessons_Learned_from_Selected_US_Legal_Cases_in_the_past_Twenty_Years/links/5f356f1792851cd302f21172/Financial-Statement-Fraud-Lessons-Learned-from-Selected-US-Legal-Cases-in-the-past-Twenty-Years.pdf

Fridson, M.S., & Alvarez, F. (2022). Financial statement analysis: a practitioner’s guide. John Wiley & Sons. https://books.google.co.in/books?hl=en&lr=&id=2cl6EAAAQBAJ&oi=fnd&pg=PA25&dq=Financial+statement+analysis:+a+practitioner%27s+guide.+&ots=5XPyRs3ED1&sig=zkAI2jCIsWHOMwzr6Z2RZNNX83E&redir_esc=y#v=onepage&q=Financial%20statement%20analysis%3A%20a%20practitioner’s%20guide.&f=false

Greve, H. R., & Man Zhang, C. (2017). Institutional logics and power sources: Merger and acquisition decisions. Academy of Management Journal60(2), 671-694. https://doi.org/10.5465/amj.2015.0698

Kabeyi, M. J. B. (2020). Corporate governance in manufacturing and management with analysis of governance failures at Enron and Volkswagen Corporations. Am J Oper Manage Inform Syst4(4), 109-123. https://www.researchgate.net/profile/Moses-Kabeyi/publication/338489019_Corporate_Governance_in_Manufacturing_and_Management_with_Analysis_of_Governance_Failures_at_Enron_and_Volkswagen_Corporations/links/5e414f7292851c7f7f2c5b2b/Corporate-Governance-in-Manufacturing-and-Management-with-Analysis-of-Governance-Failures-at-Enron-and-Volkswagen-Corporations.pdf?_sg%5B0%5D=started_experiment_milestone&origin=journalDetail

Ksu, n.d. Enron Scandal: The Fall of a Wall Street Darling. Retrieved from: https://faculty.ksu.edu.sa/sites/default/files/enron_scandal_the_fall_of_a_wall_street_darling.pdf

Liu, S., Lu, L., & Wu, Y. (2021, September). The Role of SPEs in the Enron Scandal and Its Implications for China. In 2021 International Conference on Financial Management and Economic Transition (FMET 2021) (pp. 1-6). Atlantis Press. https://www.atlantis-press.com/proceedings/fmet-21/125961025

Petra, S., & Spieler, A. C. (2020). Accounting scandals: Enron, Worldcom, and global crossing. In Corporate fraud exposed. Emerald Publishing Limited. https://doi.org/10.1108/978-1-78973-417-120201022

Sekerez, V. (2020). Informational scopes and the area of application of the equity method. Facta Universitatis, Series: Economics and Organization, 173-186. https://doi.org/10.22190/FUEO191021013S

Tatiana, R. (2021). Webjet Limited acquires Trip Ninja. Retrieved from: https://www.traveldailynews.com/post/webjet-limited-acquires-trip-ninja

Webjetlimited, (2021). Acquisition of Trip Ninja. Retrieved from: https://cmsmedia.webjetlimited.com/webjetltd-uploads/2021/11/WebjetLimited_Trip-Ninja-Release-24-Nov-2021-Final.pdf

Webjetlimited, (2023). About. Retrieved from: https://www.webjetlimited.com/

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