Financial Accounting and Reporting-CPA Practice Exam

Which of the following is NOT considered an arrangement that might qualify a company to consolidate a business entity?

1. The company provides substantial financial support

2. The company has a majority ownership presence

3. The company solely conducts activities on its behalf

4. The company participates in the entity’s design

The correct answer is: The company solely conducts activities on its behalf

The correct answer is that a company solely conducting activities on its behalf does not indicate a consolidation arrangement. In financial accounting, the ability to consolidate a business entity is primarily linked to the level of influence, control, or ownership that one entity has over another. To consolidate, a parent company must have control over a subsidiary, typically assessed through ownership of a majority of the voting shares. When a company provides substantial financial support, it may imply a significant relationship that could lead to influence, but financial support alone does not necessarily equate to control. Similarly, having a majority ownership presence directly gives the parent company control over the subsidiary, making it a fundamental criterion for consolidation. Participating in the entity’s design suggests a level of influence and control over the operations and decision-making processes of the entity, further supporting the case for consolidation. In contrast, if a company is merely conducting activities on its own behalf without influence or ownership over another entity, it does not establish a connection for consolidation purposes. Thus, option C rightly identifies a scenario that does not align with the criteria necessary to consolidate financial statements.