Question

7.Temple company has a 19% holding in Tipple corporation. Temple also exchanges management with Tipple on a regular basis. Temple holds 2 of Tipple’s 6 board seats. The remaining seats are held by independent directors. Temple is Tipple’s largest customer, buying 24% of Tipple’s ouput, and accounting for 22% of Tipple’s revenue. The remainder of Tipple’s shareholders own less than 5% of Tipple’s capital, except for one who owns 30%.

Is Tipple an investment of Temple’s or does Temple have significant influence or control? Should Temple consolidate Tipple, equity account it or simply account for it as an investment?

Answer 1

Significant influence

The existence of significant influence by an investor is usually evidenced in one or more of the following ways:

a. representation on the board of directors or equivalent governing body of the investee;

b. participation in policy-making processes, including participation in decisions about dividends or other distributions;

c. material transactions between the investor and the investee;

d. interchange of managerial personnel; or e. provision of essential technical informatio

Since Temple run 1. exchange managment personnel

2. Has 2 represenatation directors to board of Tipple corporation,

3. As it holds 19% of share holding so it participates in the policy making process and in other decisions

4. Since it is having material trnascations being the largest customer

So it can be said that Temple company entity has Significant influence over the Tipple corporation.

Control An entity can control the other entity if it has all the following conditions

a. Power over investee

b. Exposed to variable return

c. Ability to use such power.

Power over investee: An entity can have power over investee it it has ability to direct the relavant activities. This can be done by holding majority of share holding or minority share holding. Since the entity is not major shareholder as another investor is having 30% of the capital so this majority condition is not fulfilled. Further a minority shareholder can control the entiy when the other investors except him has less than the shareholding of that person or such person has potential voting rights which are in favour for the investor. Since in the above question as Temple company is not cannot fulfill the minority holding conditions as their is another investor along with the remaining shareholders who holds 30%. Eventhough the temple company is the largest customer it does not have the right to direct the relavant activities. Eg of relavant activities is sales, deciding purchase price of raw material etc.

So it can be said that the Temple company has no power over investee

Exposed to variability of returns Temple run fulfills this condition as the entity holds 19% of the shareholding so it is exposed to variability of return. Eg decrease in the returns

Ability to use such power Since the enity has no power so it fails to fulfill a condition. This power is the one that the enity cannot deligate to others.

So temple run has no control over Tipple corporation.

As per the GAAP rules if an entity has significant influence over the other enity then it is considered as the associate of that enity and such entities need to be consolidated. So Associate entitiy- Tipple corporation is accounted using equity method and are consolidated in the financials of Temple company.