Indirect and Mutual Holdings Answers 1

INDIRECT AND MUTUAL HOLDINGS Answers to Questions 1 An indirect holding of the stock of an affiliate gives the investor an ability to control or significantly influence the decisions of an investee not directly owned through an investee that is directly owned. Two primary types of indirect ownership situations are the father-son-grandson relationship and the connecting affiliates relationship. 2 No. Only 40 percent of T’s stock is held within the affiliation structure and P owns indirectly only 24 percent (60% 40%) of T. T should be included as an equity investment in the consolidated statements of P Company and Subsidiaries. 3 An indirect holding involves the ability of one corporation to control another by virtue of its control over one or more other corporations. An investor has the ability to control or significantly influence an investee that is not directly owned through an investee that is directly owned. A mutual holding affiliation structure is a special type of indirect holding where affiliates indirectly own themselves. In a mutual holding situation, the affiliates hold ownership interests in each other. 4 The parent’s direct and indirect ownership of Subsidiary B is 49 percent (70% 70%). However, consolidation of Subsidiary B is still appropriate because 70 percent of B’s stock is held within the affiliation structure and only 30 percent is held by the noncontrolling stockholders of B. 5 Approach A Pat Sam Stan Combined separate earnings of Pat, Sam, and Stan ($200,000 + $160,000 + $100,000) Less: Noncontrolling interest share computed as follows: Direct noncontrolling interest in Stan’s income ($100,000 30%) Indirect noncontrolling interest in Stan’s income ($100,000 70% 20%) Direct noncontrolling interest in Sam’s income ($160,000 20%) Pat’s net income and controlling share of consolidated net income $384,000 Approach B Separate earnings Allocate Stan’s income to Sam ($100,000 70%) Allocate Sam’s income to Pat ($230,000 80%) Controlling share Noncontrolling interest share $200,000 Pat +184,000 $384,000 $460,000 (30,000) (14,000) (32,000) Sam $160,000 Stan $100,000 + 70,000 -70,000 -184,000 $ 46,000 0 $30,000 9-2 6 7 Indirect and Mutual Holdings When the schedule approach for allocating income is used, investment income from the lowest subsidiary must be added to the separate income of the next subsidiary to determine that subsidiary’s net income before it can be allocated to the next subsidiary, and so on. P Separate earnings Deduct: Unrealized profit Separate realized earnings Allocate S2’s income Allocate S1’s income P’s net income Noncontrolling int. share $20,000 20,000 S1 80% $10,000 - 1,000 9,000 S2 70% $5,000 5,000 + 3,500 -10,000 +10,000 $30,000 $ 2,500 -3,500 0 $1,500 S1’s investment in S2 account was not adjusted for the unrealized profits because this would create a disparity between S1’s investment in S2 account and S1’s share of S2’s equity. 8 A mutual holding situation exists because two affiliates hold ownership interests in each other. The parent is mutually owned. 9 The treasury stock approach considers parent stock held by a subsidiary to be treasury stock of the consolidated entity. Accordingly, the subsidiary investment account is maintained on a cost basis and is deducted at cost from stockholders’ equity in the consolidated balance sheet. 10 In situations in which a subsidiary holds stock in the parent, both the conventional and treasury stock approaches are acceptable, but they do not result in equivalent consolidated financial statements. The consolidated retained earnings and noncontrolling interest amounts will usually be different because of different amounts of investment income. The treasury stock approach is not applicable when the mutually held stock involves subsidiaries holding the stock of each other. 11 No. Parent dividends paid to the subsidiary are eliminated. 12 The theory is that parent stock purchased by a subsidiary is, in effect, returned to the parent and constructively retired. By recording the constructive retirement of the parent stock on parent books, parent equity will reflect the equity of stockholders outside the consolidated entity. Also, recording the constructive retirement, by reducing parent stock and retained earnings to reflect amounts applicable to controlling stockholders outside the consolidated entity, will establish consistency between capital stock and retained earnings for the parent’s outside stockholders and parent net income, dividends, and earnings per share which also relate to the outside stockholders of the parent. 13 Controlling share of consolidated net income is computed as follows: P = $50,000 + .8S S = $20,000 + .1P P = $50,000 + .8($20,000 + .1P) P = $71,739 Controlling share of consolidated net income = $71,739 14 90% = $64,565 For eliminating the effect of mutually held parent stock, two generally accepted approaches are used—the treasury stock approach and the conventional approach. But when the mutually held stock involves subsidiaries holding stock of each other, the treasury stock approach is not applicable. Chapter 9 15 9-3 By adding beginning noncontrolling interest and noncontrolling interest share (determined by multiplying the company’s net income by the noncontrolling interest percentage) and subtracting the noncontrolling interest’s percentage of dividends, the noncontrolling interest can be determined without use of simultaneous equations. SOLUTIONS TO EXERCISES Solution E9-1 Pen Separate earnings of the three affiliates (in thousands) Add: Dividend income from Sal’s investment in Win accounted for by the cost method ($200,000 15%) Allocate 60% of Tip’s earnings Allocate 60% of Sal’s earnings Controlling Share of Cons. Income Noncontrolling interest share Solution E9-2 $1,600 762 $2,362 Sal $1,000 $400 30 240 (762) (240) ____ $508 $160 Pub Corporation and Subsidiaries Income Allocation Schedule for the year 2011 (in thousands) Pub $800 Separate earnings or loss Allocate Sam’s income: to Pub ($300,000 60%) to Tim ($300,000 20%) Allocate Tim’s loss: to Pub $(340,000) 80% Controlling Share of Consol. Income Noncontrolling interest share Tip 180 (272) $708 Sam $300 Tim $(400) (180) (60) 60 272 $ 60 $ (68) Solution E9-3 Place Corporation and Subsidiaries Income Allocation Schedule for the year 2011 Place Lake Marsh Separate incomes $200,000 $80,000 $ 70,000 Less: Unrealized profit on land _______ (20,000) ______ Separate realized incomes 200,000 60,000 70,000 Allocate Lake’s income 60% to Place 36,000 (36,000) 20% to Marsh (12,000) 12,000 Allocate Marsh’s income 70% to Place 57,400 _______ (57,400) Controlling Share of Consol. Income $293,400 Noncontrolling interest share $12,000 $ 24,600 9-4 Indirect and Mutual Holdings Solution E9-4 1 2 3 c Income from Son is equal to: 70% of Son’s $160,000 income 70% of Son’s 80% interest in Tan’s $100,000 income Income from Son $112,000 56,000 $168,000 d Noncontrolling interest share is equal to: 30% direct noncontrolling interest in Son’s $160,000 income 20% direct noncontrolling interest in Tan’s $100,000 income 30% 80% indirect noncontrolling interest in Tan’s $100,000 income Total noncontrolling interest share $ 48,000 20,000 24,000 $ 92,000 d Consolidated net income is equal to: Combined separate incomes of $360,000 + $160,000 + $100,000 Less: Noncontrolling interest share Controlling interest share of Consolidated net income $528,000 Alternative computation: Pin’s separate income Add: 70% of Son’s $160,000 income Add: (70% 80%) of Tan’s $100,000 income Controlling interest share of Consolidated net income 92,000 $620,000 $360,000 112,000 56,000 $528,000 Solution E9-5 Separate earnings Less: Unrealized profit Separate realized earnings Allocate Val’s income 70% to Tea Allocate Won’s income 10% to Tea 60% to Sal Allocate Tea’s income 80% to Pal 10% to Sal Allocate Sal’s income 80% to Pal Pal’s net income (or Controlling share of consolidated net income) Noncontrolling interest share $ 50,000 Pal Sal Tea Won $30,000 $35,000 $(20,000) - 5,000 _______ ________ 50,000 30,000 30,000 (20,000) Val $40,000 40,000 +28,000 -12,000 + 44,800 + 18,880 + 5,600 -18,880 - 2,000 - 28,000 + 2,000 + 12,000 -44,800 - 5,600 ________ ________ _________ $113,680 $ 4,720 $ 5,600 $ (6,000) $12,000 Chapter 9 9-5 Solution E9-6 Separate earnings Unrealized profit Separate realized earnings Allocate Oak’s income 20% to Nun 70% to Man Allocate Nun’s income 70% to Pet 10% to Man Allocate Man’s income 90% to Pet Pet’s net income (or Controlling share of NI) Noncontrolling interest share $ 65,000 65,000 Pet Man Nun $18,000 $28,000 $9,000 - 4,000 + 2,000 -4,000 14,000 30,000 5,000 + 1,000 + 3,500 + 21,700 + 18,540 $105,240 $ 2,060 -1,000 -3,500 -21,700 - 3,100 + 3,100 -18,540 Oak ________ $ 6,200 ________ $ 500 Alternative solution Pet Reported + Income $65,000 Adjusted - Adjustments = Income $ 65,000 Consolidated Net Income $ 65,000 Noncontrolling Interest = Share 0 Man 18,000 - $4,000 14,000 a 12,600 $1,400 Nun 28,000 + 2,000 30,000 b 23,700 6,300 Oak 9,000 c 3,940 1,060 - 4,000 5,000 $114,000 a $105,240 $14,000 divided 90% to consolidated net income (CNI) 10% to noncontrolling interest share (NIS) b $30,000 divided 70% + (90% 10%) to CNI and 20% + (10% 10%) to NIS c $5,000 divided (90% 70%) + (70% 20%) + (90% 10% 20%) to CNI [78.8%] and 10% + (10% 10% 20%) + (20% 20%) + (10% 70%) to NIS [21.2%] $8,760 9-6 Indirect and Mutual Holdings Solution E9-7 1 b Separate income of Tar Included in consolidated net income (.9 .7 $400,000) Alternative solution Direct noncontrolling interest (.3 $400,000) Indirect noncontrolling interest (.1 .7 $400,000) 2 a Separate income = net income of Van Noncontrolling interest (direct) 3 c Total separate incomes Less: Controlling share of Consolidated net income Pan $1,240,000 100% Sin $350,000 90% Tar $400,000 90% 70% Win $(100,000) 90% 60% Van $240,000 90% 80% 5 d Net income of Sin Separate income Add: 70% of Tar’s $400,000 Deduct: 60% of Won’s $(100,000) Add: 80% of Van’s $240,000 Net income of Sin Pan’s interest Investment increase Less: Dividends received from Sin ($200,000 Net increase $ 120,000 28,000 $ 148,000 $ 48,000 $2,130,000 $1,240,000 315,000 252,000 (54,000) 172,800 $ 204,200 Alternative solution Sin $350,000 10% Tar $400,000 37% Won $(100,000) 46% Van $240,000 28% Total noncontrolling interest share a [See computations for question 3] $ 148,000 $240,000 20% Total noncontrolling interest share 4 $400,000 (252,000) (1,925,800) $ 35,000 148,000 (46,000) 67,200 $ 204,200 90%) $ 350,000 280,000 (60,000) 192,000 $ 762,000 90% 685,800 (180,000) $ 505,800 Chapter 9 9-7 Solution E9-8 1 2 b Separate income of Sam (net income) Separate income of Ten $40,000 - ($80,000 10%) Separate income of Pat $240,000 - ($40,000 70%) - ($80,000 80%) Total separate income d Separate income Unrealized profit on inventory Unrealized profit on land Separate realized income 3 4 $ 80,000 32,000 148,000 $260,000 Pat Sam Ten $148,000 $80,000 $32,000 (10,000) ________ _______ (15,000) $148,000 $70,000 $17,000 a Pat’s separate income Add: Investment income from Sam ($70,000 80%) Add: Investment income from Ten [$17,000 + ($70,000 10%)] 70% Pat’s income (controlling share of consolidated net income) $220,800 d Total separate realized income Less: Controlling share of consolidated net income Noncontrolling interest share $148,000 56,000 220,800 Alternative solution Direct noncontrolling interest in Sam ($70,000 .1) $ 7,000 Indirect noncontrolling interest in Sam ($70,000 .3 .1) 5,100 Direct noncontrolling interest in Ten ($17,000 .3) Noncontrolling interest share 16,800 $235,000 $ 14,200 2,100 $ 14,200 Solution E9-9 P = Income of Pan on a consolidated basis (including mutual income) S = Income of Sol on a consolidated basis (including mutual income) P = Separate income of $3,000,000 + 80% of S S = Separate income of $1,500,000 + 30% of P P = $3,000,000 + .8($1,500,000 + .3P) = $3,000,000 + $1,200,000 + .24P .76P = $4,200,000 P = $5,526,316 Controlling Share of Consolidated net income = $5,526,316 70% = $3,868,421 9-8 Indirect and Mutual Holdings Solution E9-10 P = Pad’s income on a consolidated basis S = Sad’s income on a consolidated basis T = Two’s income on a consolidated basis P = $200,000 + .7S S = $120,000 + .8T T = $80,000 + .1S Solve for S S = $120,000 + .8($80,000 + .1S) S = $184,000 + .08S S = $200,000 Compute P and T P = $200,000 + .7($200,000) P = $340,000 T = $80,000 + .1($200,000) T = $100,000 Income Allocation Controlling share of consolidated net income (equal to P) Noncontrolling interest share in Sad ($200,000 20%) Noncontrolling interest share in Two ($100,000 20%) Total consolidated income $340,000 40,000 20,000 $400,000 Chapter 9 9-9 Solution E9-11 [AICPA adapted] 1 b 2 b 3 d 4 c Supporting computations A = Pin’s income on a consolidated basis B = Son’s income on a consolidated basis C = Tin’s income on a consolidated basis A = $190,000 + .8B + .7C B = $170,000 + .15C C = $230,000 + .25A Solve for A A = $190,000 + .8[$170,000 + .15($230,000 + .25A)] + .7($230,000 + .25A) A = $190,000 + $136,000 + $27,600 + .03A + $161,000 + .175A A = $514,600 + .205A .795A = $514,600 A = $647,295.59 Determine C C = $230,000 + .25($647,295.59) C = $391,823.89 Determine B B = $170,000 + .15($391,823.90) B = $228,773.58 Allocate income to controlling share of consolidated net income and noncontrolling interest Controlling Share of Consolidated net income ($647,295.59 Noncontrolling interest — Son ($228,773.58 20%) Noncontrolling interest — Tin ($391,823.90 15%) Total consolidated income 75%) $485,471.69 45,754.72 58,773.59 $590,000.00 9-10 Indirect and Mutual Holdings Solution E9-12 1 d Combined separate income Less: Noncontrolling interest share Controlling Share of Consolidated net income Alternatively: Pet’s separate income Add: Sod’s net income of $67,500 90% Less: Dividends received from Pet ($50,000 15%) Controlling interest share of Consolidated net income 2 6,750 $153,250 $160,000 $100,000 60,750 (7,500) $153,250 b P = $100,000 + .9($60,000 + .15P) .865P = $154,000 P = $178,035 S = $60,000 + $26,705 = $86,705 Controlling Share of Consolidated net income = $178,035 .85 = Noncontrolling interest share = $86,705 .10 = Total consolidated income $151,330 8,670 $160,000 Solution E9-13 1 Treasury stock approach Investment in Sat balance December 31, 2011 Investment balance December 31, 2010 Add: Income from Sat Less: Dividends received from Sat Add: Dividends paid to Sat Investment in Sat December 31, 2011 $245,700 26,900 (21,000) 6,000 $257,600 Supporting computations Computation of income from Sat: Sat’s separate income Add: Sat’s dividend income from Pug Sat’s net income Pug’s ownership interest Pug’s equity in Sat’s income Less: Dividends paid to Sat ($60,000 10%) Less: Excess amortization ($9,000 x 70%) Income from Sat $ 50,000 6,000 56,000 70% 39,200 (6,000) (6,300) $ 26,900 2 Conventional approach Pug’s net income and consolidated net income P = ($120,000 + .7S) - $6,300 S = $50,000 + .1P P = $120,000 + .7($50,000 + .1P) - $6,300 P = $120,000 + $35,000 + .07P - $6,300 .93P = $148,700 P = $159,892 Chapter 9 9-11 S = $50,000 + .1($159,892) S = $65,989 Pug’s net income and controlling share ($159,892 90%) Noncontrolling interest share ($65,989 Total income $143,903 30%) Income from Sat Controlling Share of Consolidated net income Less: Pug’s separate income Income from Sat Or alternatively, ($65,989 70%) - ($159,892 10%) - $6,300 excess Investment in Sat December 31, 2011 Investment in Sat December 31, 2010 Add: Income from Sat Less: Dividends from Sat Investment in Sat December 31, 2011 19,797 $163,700 $143,903 120,000 $ 23,903 $ 23,903 $245,700 23,903 (21,000) $248,603 9-12 Indirect and Mutual Holdings SOLUTIONS TO PROBLEMS Solution P9-1 Pad Corporation and Subsidiaries Schedule to Compute Controlling Share of Consolidated Net Income and Noncontrolling Interest Share for the year 2011 Separate income (loss) $500,000 Pad Sal Axe Ban $300,000 $150,000 $(20,000) Less: Unrealized profit Separate realized income (loss) 500,000 Allocate Ban’s loss 70% to Sal (20,000) 300,000 130,000 (20,000) (14,000) Allocate Axe’s income 60% to Sal Patent Allocate Sal’s income 90% to Pad Patent ______ 14,000 78,000 (78,000) (12,000) 352,000 316,800 (40,000) (316,800) Controlling share of net income $776,800 Noncontrolling interest income $ 35,200 $ 52,000 $ (6,000) Check: Income allocated: $776,800 consolidated net income + $35,200 noncontrolling interest share in Sal + $52,000 noncontrolling interest share in Axe - $6,000 noncontrolling interest share (loss) in Ban = $858,000 Income to allocate: $500,000 Pad income + $300,000 Sal income + $130,000 realized income of Axe - $20,000 loss of Ban - $52,000 patent = $858,000 Controlling share of consolidated net income: $500,000 - $40,000 + 90%($300,000 - $12,000) + (90% 60% $130,000) - (90% 70% $776,800 $20,000) = Chapter 9 9-13 Solution P9-2 1 Sea’s books Investment in Toy (70%) 294,000 Cash To record purchase of a 70% interest in Toy Corporation. Cash Investment in Toy (70%) To record dividends received from Toy ($20,000 294,000 14,000 14,000 70%). Investment in Toy (70%) 35,000 Income from Toy 35,000 To record investment income computed as follows: $ 42,000 Share of Toy’s net income ($60,000 70%) Less: Unrealized profit from upstream sale of (7,000) inventory items ($10,000 70%) $ 35,000 Pot’s books Cash Investment in Sea (80%) To record dividends received from Sea ($60,000 48,000 Investment in Sea (80%) 88,000 Income from Sea To record investment income computed as follows: Share of Toy’s net income ($100,000 + $35,000) 80% Less: Unrealized gain on land sold to Toy 48,000 80%). 88,000 $108,000 (20,000) $ 88,000 9-14 Indirect and Mutual Holdings Solution P9-2 (Continued) 2 Schedule of income allocation Separate earnings Less: Unrealized profits Separate realized earnings Allocate Toy’s realized earnings to Sea ($50,000 70%) Sea’s net income Allocate Sea’s net income to Pot ($135,000 80%) Pot’s net income and Controlling share of net income Noncontrolling interest share Check: 3 Pot $300,000 (20,000) 280,000 Sea Toy $100,000 $ 60,000 (10,000) 100,000 50,000 35,000 (35,000) 135,000 108,000 $388,000 (108,000) _______ $ 27,000 $ 15,000 Realized earnings ($280,000 + $100,000 + $50,000) $430,000 Less: Noncontrolling interest share (27,000+15,000) (42,000) Controlling share of net income $388,000 Schedule of assets and equities at December 31, 2012 Pot Assets Investment in Sea (80%) Investment in Toy (70%) Total assets Liabilities Capital stock Retained earnings Total liabilities and equity Sea Toy $ 1,848,000 $460,000 $540,000 440,000 ___________ 315,000 ________ $ 2,288,000 $775,000 $540,000 $ 300,000 $200,000 $100,000 1,200,000 400,000 300,000 788,000 175,000 140,000 $ 2,288,000 $775,000 $540,000 Note: Pot’s assets other than investments consist of $1,600,000 assets at the beginning of the year, plus separate earnings of $300,000 and dividend income of $48,000, less dividends paid of $100,000. Sea’s assets other than investments consist of $700,000 assets at the beginning of the period, plus separate earnings of $100,000 and dividend income of $14,000, less investment cost of $294,000 and dividends paid of $60,000. Chapter 9 9-15 Solution P9-3 Preliminary computations Check on consolidated net income Net income as stated Less: Investment income Separate income Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Separate realized incomes Allocate Tip’s income 50% to Pen 40% to Sir Sir’s net income Allocate Sir’s income 80% to Pen Less: Depreciation on excess allocated to plant and Equipment Total income of consolidated Entity Controlling share of NI Noncontrolling int. share Pen Sir $184,500 $90,000 (84,500) (10,000) 100,000 80,000 Tip Total $25,000 $299,500 (94,500) 25,000 205,000 8,000 8,000 _______ _______ 108,000 80,000 2,500 65,600 (5,000) (20,000) (20,000) 5,000 193,000 2,000 82,000 (2,500) (2,000) (65,600) ( 1,250) (6,250) ________ ________ _______ $186,750 $171,100 171,100 $ 15,150 $ 500 15,650 Investment in Sir (80%) Implied total fair value of Sir ($420,000 / 80%) Book value of Sir Excess of fair value over book value Excess allocated to equipment with a four year lfe Amortization ($25,000 / 4 yrs) $420,000 $ 525,000 $ 6,250 Investment in Tip (50%) Implied total fair value of Tip ($75,000 / 50%) Book value of Sir Excess of fair value over book value – Goodwill (500,000) $ 25,000 $ 75,000 $ 150,000 $ 30,000 (120,000) $186,750 9-16 Indirect and Mutual Holdings Solution P9-3 (continued) Pen Corporation and Subsidiaries Consolidation Working Papers for the year ended December 31, 2011 Pen Income Statement Sales Sir $500,000 Income from Sir Income from Tip Cost of sales Adjustments and Eliminations Tip $300,000 $100,000 Consolidated Statements h 50,000 $ 850,000 d 72,000 a 22,500 72,000 12,500 10,000 240,000* 150,000* 60,000* i 20,000 70,000* 15,000* f 6,250 c 15,150 g 8,000 412,000* h 50,000 Other expenses 160,000* Noncont.int.share — Sir c Noncont.int.share — Tip Cont.int.shareof NI $184,500 $ 90,000 251,250* 15,150* 500 500* $ 25,000 $ 171,100 Retained Earnings Retained earnings — Pen $115,500 f 12,500 g 8,000 160,000 — Sir Retained earnings — Tip Retained earnings Net income Dividends 45,000 184,500 80,000* $ 95,000 e 160,000 90,000 40,000* b 45,000 171,100 25,000 10,000* a 9,000 c 9,000 d 32,000 Retained earnings December 31 Balance Sheet Cash Accounts receivable Inventories Plant and equipment — net Investment in Sir 80% Investment in Tip 50% Investment in Tip 40% Goodwill $220,000 $210,000 $ 60,000 $ 67,000 $ 36,000 $ 10,000 70,000 110,000 50,000 75,000 140,000 425,000 $ 186,100 $ 113,000 j 10,000 i 20,000 20,000 35,000 115,000 e 25,000 130,000 200,000 f 18,750 74,000 b 30,000 $660,000 30,000 $180,000 Accounts payable Other liabilities Capital stock $ 70,000 100,000 600,000 $ 40,000 10,000 400,000 $ 15,000 5,000 100,000 Retained earnings 220,000 210,000 60,000 $1,159,250 j 10,000 $ 115,000 115,000 b 100,000 600,000 e 400,000 $990,000 $660,000 686,250 d 40,000 e 468,000 a 7,500 b 87,500 a 6,000 b 68,000 508,000 95,000 $990,000 80,000* 186,100 $180,000 Noncontrolling interest — Sir (beginning) e 117,000 Noncontrolling interest — Tip (beginning) Noncontrolling interest December 31 b 19,500 c 6,650 143,150 $1,159,250 * Deduct