Chapter 9 Indirect and Mutual Holdings by Jeanne

Chapter 9: Indirect and Mutual Holdings by Jeanne M. David, Ph. D. , Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn © Pearson Education, Inc. publishing as Prentice Hall 9 -1

Indirect and Mutual Holdings: Objectives 1. Prepare consolidated statements when the parent company controls through indirect holdings. 2. Apply consolidation procedures of indirect holdings to the special case of mutual holdings. © Pearson Education, Inc. publishing as Prentice Hall 9 -2

Indirect and Mutual Holdings 1: Indirect Holdings © Pearson Education, Inc. publishing as Prentice Hall 9 -3

Types of Indirect Holdings Father-Son-Grandson Connecting Affiliates Parent 80% Subsidiary A 70% Subsidiary B Parent owns 80% of A, and through A, 56% of B (80% x 70%). © Pearson Education, Inc. publishing as Prentice Hall 80% 20% Subsidiary A Subsidiary B 40% Parent owns 80% of A, 20% of B, and through A an additional 32% of B (80% x 40%). Parent owns a total of 52% of B. 9 -4

Equity Method for Father-Son. Grandson Holdings • Son applies equity method for Investment in Grandson • Father applies equity method for Investment in Son • Controlling interest share of consolidated income includes – Share for direct holding of son – Share for indirect holding of grandson (by father through son) © Pearson Education, Inc. publishing as Prentice Hall 9 -5

Example: Father-Son-Grandson On 1/1/09 Poe acquires 80% of Shaw. On 1/1/10 Shaw acquires 70% of Turk. Earnings and dividends for 2010 are below: Separate earnings Dividends © Pearson Education, Inc. publishing as Prentice Hall Poe Shaw Turk 100 50 40 60 30 20 9 -6

Equity Method Entries Shaw applies equity method (70%): Cash Investment in Turk for dividends 14 Investment in Turk Income from Turk for income 28 Poe applies equity method (80%): Cash Investment in Shaw for dividends 28 24 Investment in Shaw Income from Shaw for income 80%(50+28) © Pearson Education, Inc. publishing as Prentice Hall 14 24 62. 4 9 -7

Allocations to CI and NCI Poe Shaw Turk Separate income 100. 0 50. 0 40. 0 Allocate: Turk ==> 70% Shaw: 30% NCI 28. 0 (40. 0) Shaw ==> 80% Poe: 20% NCI 62. 4 (78. 0) Poe's ==> CI (162. 4) Total consolidated income CI NCI Total 190. 0 12. 0 15. 6 162. 4 27. 6 190. 0 This allocation may look like the "stepdown method" allocation presented in cost accounting texts. Mathematically it is! © Pearson Education, Inc. publishing as Prentice Hall 9 -8

Allocation Results Poe Shaw Turk CI Separate income 100. 0 50. 0 40. 0 Allocate: Turk ==> 28. 0 (40. 0) 70% Shaw: 30% NCI Shaw ==> 62. 4 (78. 0) 80% Poe: 20% NCI Poe ==> CI (162. 4) 162. 4 Total consolidated income 162. 4 On separate income statements: • Poe's net income = $162. 4 • Shaw's "Income from Turk" = $28. 0 • Poe's "Income from Shaw" = $62. 4 For consolidated statements: • Noncontrolling interest share = 12. 0 + 15. 6 = $27. 6 © Pearson Education, Inc. publishing as Prentice Hall NCI Total 190. 0 12. 0 15. 6 27. 6 190. 0 9 -9

Indirect Holdings with Connecting Affiliates Indirect holdings with connecting affiliates – Handle similar to Father-Son-Grandson, but – Father has direct holdings in both Son and Grandson Example: Pet holds 70% of Sal and 60% of Ty. Sal holds an additional 20% of Ty. Pet Sal Separate income 70 35 Dividends 40 20 Intercompany profit transactions: Ty 20 10 – Downstream: Pet sold Sal land with a gain of $10. This will be fully attributed to Pet. – Upstream: Sal sold $15 inventory to Pet, and Pet holds ending inventory with unrealized profit of $5. This will be allocated between Pet and NCI. © Pearson Education, Inc. publishing as Prentice Hall 9 -10

Calculating Investment Balances Sal: Underlying equity Jan 1 Dec 31 Capital stock 200 Retained earnings 50 69 Goodwill 12 12 Unrealized profit in inventory (5) Subtotal (split 70: 30) 276 Unrealized profit on land (10) Total 262 266 Investment in Sal (70%) 183. 4 183. 2 * (70% x 276) - 10 = 183. 2 Noncontrolling interest (30%) 78. 6 82. 8 * 30% x 276 = 82. 8 © Pearson Education, Inc. publishing as Prentice Hall Ty: Underlying equity Jan 1 Dec 31 Capital stock 100 Retained earnings 80 90 Goodwill 12 12 Total 192 202 Investment in Ty (60%) 115. 2 121. 2 Investment in Ty (20%) 38. 4 40. 4 Noncontrolling interest (20%) 38. 4 40. 4 9 -11

Separate income Unrealized $5 profit on inventory (upstream) Unrealized $10 gain on land (downstream) Allocate: Ty ==> 60% Pet: 20% Sal: 20% NCI Sal ==> 70% Pet: 30% NCI Pet ==> CI Total consolidated income Dividend distributions: Ty ==> 60% Pet: 20% Sal: Pet 70. 0 (10) Sal 35. 0 Ty 20. 0 (5) (10) 4. 0 10. 2 95. 8 95. 8 14. 2 110. 0 6 2 (10) 14 (20) Sal's Income from Ty = $4. 0 (40) 40 Pet's Income from Ty = $12. 0 ==> CI Pet's Income from Sal = $23. 8 - $10 unrealized gain = $13. 8 20% NCI Sal ==> 70% Pet: 30% NCI © Pearson Education, Inc. publishing as Prentice Hall NCI Total 125. 0 (5) 12. 0 4. 0 (20. 0) 23. 8 (34. 0) (95. 8) CI 2 6 9 -12

Worksheet Entries Sales Cost of sales Inventory Gain on sale of land Land Income from Ty Dividends Investment in Ty both Sal's and Pet's Noncontrolling interest share (Ty) Dividends Noncontrolling interest (Ty) © Pearson Education, Inc. publishing as Prentice Hall 15. 0 5. 0 10. 0 16. 0 8. 0 4. 0 2. 0 9 -13

Income from Sal Investment in Sal Dividends including 10 unrealized gain on land Noncontrolling interest share (Sal) Dividends Noncontrolling interest (Sal) Capital stock (Ty) Retained earnings (Ty) Goodwill Investment in Ty (Sal & Pet) Noncontrolling interest (Ty) Capital stock (Sal) Retained earnings (Sal) Goodwill Investment in Sal Noncontrolling interest (Sal) © Pearson Education, Inc. publishing as Prentice Hall 13. 8 0. 2 14. 0 10. 2 6. 0 4. 2 100. 0 80. 0 12. 0 153. 6 38. 4 200. 0 50. 0 12. 0 183. 4 78. 6 9 -14

Consolidation Worksheet Income statement: Pet Sal Ty DR CR Consol Sales 200. 0 150. 0 100. 0 15. 0 435. 0 Income from Sal 13. 8 0. 0 Income from Ty 12. 0 4. 0 16. 0 0. 0 Gain on land 10. 0 Cost of sales (100. 0) (80. 0) (50. 0) 5. 0 15. 0 (220. 0) Other expenses (40. 0) (35. 0) (30. 0) (105. 0) Noncontrolling 10. 2 interest share 4. 0 14. 2 Controlling interest share 95. 8 39. 0 20. 0 95. 8 © Pearson Education, Inc. publishing as Prentice Hall 9 -15

Statement of retained earnings: Beginning retained earnings Add net income Deduct dividends Pet Sal Ty DR 80. 0 223. 0 50. 0 80. 0 50. 0 95. 8 39. 0 20. 0 (40. 0) (20. 0) (10. 0) Ending retained earnings Balance sheet: Other assets Inventories Plant assets, net Investment in Sal (70%) Investment in Ty (60%, 20%) Goodwill Total 278. 8 69. 0 90. 0 Pet Sal Ty 50. 6 19. 6 85. 0 50. 0 40. 0 15. 0 400. 0 200. 0 183. 2 121. 2 40. 4 805. 0 © Pearson Education, Inc. publishing as Prentice Hall 300. 0 200. 0 DR CR Consol 223. 0 95. 8 8. 0 2. 0 14. 0 6. 0 (40. 0) CR 0. 2 12. 0 5. 0 10. 0 183. 4 8. 0 153. 6 278. 8 Consol 155. 2 100. 0 690. 0 24. 0 969. 2 9 -16

Liabilities Capital stock Pet Sal 126. 2 31. 0 400. 0 278. 8 69. 0 Retained earnings Noncontrolling interest Total 805. 0 300. 0 © Pearson Education, Inc. publishing as Prentice Hall Ty 10. 0 100. 0 90. 0 DR Consol 167. 2 100. 0 200. 0 CR 278. 8 2. 0 4. 2 38. 4 78. 6 123. 2 969. 2 9 -17

Indirect and Mutual Holdings 2: Mutual Holdings © Pearson Education, Inc. publishing as Prentice Hall 9 -18

Types of Mutual Holdings Parent Mutually Owned Connecting Affiliates Mutually Owned Parent 80% 10% Subsidiary A Parent owns 80% of A, and through A, has 8% (80% x 10%) of its own (treasury) stock. © Pearson Education, Inc. publishing as Prentice Hall 80% Subsidiary A 20% 40% 20% Subsidiary B Parent owns 80% of A, 20% of B, through A an additional 32% (80% x 40%) of B, and through B an additional 4% (20% x 20%) of A. 9 -19

Treasury Stock or Conventional Treasury stock method – Treats parent mutually held stock as treasury stock – Parent has fewer shares outstanding – "Interdependency" assumed eliminated by treasury stock treatment Conventional method for mutual holding – Treats stock as retired – Parent has fewer shares outstanding – Simultaneous set of equations – Fully recognizes interdependencies © Pearson Education, Inc. publishing as Prentice Hall 9 -20

Parent Stock Mutually Held One or more affiliates holds parent company stock • Treasury stock method – Recognize treasury stock at cost of subsidiary's investment in parent – Reduce Investment in subsidiary • Conventional method – Parent treats stock as retired, reducing common stock, and additional paid in capital or retained earnings – Reduce Investment in subsidiary © Pearson Education, Inc. publishing as Prentice Hall 9 -21

Comparison • Both methods reduce – Income from Subsidiary for the – Parent dividends paid to subsidiary • Methods result in different – Equity accounts • Treasury stock • Retired common stock – Consolidated retained earnings – Noncontrolling interest © Pearson Education, Inc. publishing as Prentice Hall 9 -22

Treasury Stock Method - Data Pace owns 90% of Salt acquired at fair value equal to cost, no goodwill. Salt owns 10% of Pace. At the start of 2010: • Investment in Salt, $297 • Noncontrolling interest, $33 • Salt's total stockholders' equity – Common stock $200 – Retained earnings $130 During 2010, • Separate income: Pace $60, Salt $40 • Dividends: Pace $30, Salt $20 © Pearson Education, Inc. publishing as Prentice Hall 9 -23

Pace Uses Treasury Stock Method Allocations of income to CI and NCI: Separate Income Parent dividends Allocate: Salt => 90%: 10% Pace => 100% Totals Pace 60. 0 (3. 0) 38. 7 95. 7 Salt 40. 0 3. 0 (43. 0) CI 95. 7 NCI 4. 3 Total 100. 0 95. 7 4. 3 100. 0 • Controlling interest share $95. 7 • Noncontrolling interest share $4. 3 • Pace's Income from Salt $38. 7 – 3. 0 = $35. 7 © Pearson Education, Inc. publishing as Prentice Hall 9 -24

Pace's Equity Method Entries Cash 18. 0 Investment in Salt 18. 0 for dividends Investment in Salt 38. 7 Income from Salt 38. 7 for income Income from Salt 3. 0 Dividends 3. 0 In place of the last entry, the Pace could record its dividend directly as: for Pace dividends paid to Salt Dividends Income from Salt Cash © Pearson Education, Inc. publishing as Prentice Hall 27. 0 30. 0 9 -25

Worksheet Entries Income from Salt Dividends Investment in Salt Noncontrolling interest share Dividends Noncontrolling interest Common stock Retained earnings Investment in Salt Noncontrolling interests Treasury stock Investment in Pace © Pearson Education, Inc. publishing as Prentice Hall 35. 7 18. 0 17. 7 4. 3 2. 0 2. 3 200. 0 130. 0 297. 0 33. 0 70. 0 9 -26

Parent Mutually Held - Data Pace 2 owns 90% of Salt 2 acquired at fair value equal to cost, no goodwill. Salt owns 10% of Investment and Pace. At the start of 2010: noncontrolling interest • Investment in Salt 2, $226, 154 = 226, 154 + 33, 846 • Noncontrolling interest, $33, 846 • Salt 2's total stockholders' equity equals underlying equity less mutual holding – Common stock $200, 000 – Retained earnings $130, 000 = 200, 000 + 100, 000 – 70, 000. During 2010, • Separate income: Pace 2 $60, 000, Salt 2 $40, 000 • Dividends: Pace 2 $30, 000, Salt 2 $20, 000 © Pearson Education, Inc. publishing as Prentice Hall 9 -27

Pace 2 Uses Conventional Method Allocation information: Pace 2 Separate Income $60, 000 Salt 2's allocation. 90 S Pace 2's allocation Equations: P = $60, 000 +. 9 S S = $40, 000 +. 1 P CI share =. 9 P NCI share =. 1 S Salt 2 CI $40, 000 NCI . 10 S Total $100, 000 . 10 P. 90 P Solved, substituting 2 nd equation into 1 st: P = 105, 495 S = 50, 550 CI share = 94, 945 NCI share = 5, 055 Conventional method is analogous to reciprocal cost allocation method. © Pearson Education, Inc. publishing as Prentice Hall 9 -28

Note on Results: P = 105, 495 S = 50, 550 CI = 94, 945 NCI = 5, 055 • CI + NCI = $100, 000, the total separate income • Pace 2's Income from Salt 2 =. 9 S -. 1 P = $34, 945 90% of Salt's income – 10% mutual holding • CI = Pace 2's separate income + Income from Salt 2 $60, 000 + $34, 945 = $94, 945 (as a check!) © Pearson Education, Inc. publishing as Prentice Hall 9 -29

Pace 2's Equity Method Entries Cash Investment in Salt 2 for dividends Investment in Salt 2 Income from Salt 2 for income Income from Salt 2 18, 0 00 37, 9 45 3, 00 0 3, 00 Dividends 0 for Pace 2 dividends paid to © Pearson Education, Inc. publishing as Prentice Hall Salt 2 9 -30

Worksheet Entries - Conventional Income from Salt 2 Dividends Investment in Salt 2 Noncontrolling interest share Dividends Noncontrolling interest Common stock Retained earnings Investment in Salt 2 Noncontrolling interests Investment in Salt 2 Investment in Pace 2 © Pearson Education, Inc. publishing as Prentice Hall 34, 945 18, 000 15, 945 5, 055 2, 000 3, 055 200, 000 130, 000 296, 154 33, 846 70, 000 9 -31

Subsidiary Stock Mutually Held Subsidiaries hold stock in each other – Use conventional approach – Treasury stock method is not appropriate • It is not parent's stock • Subsidiary stock is eliminated in consolidation © Pearson Education, Inc. publishing as Prentice Hall 9 -32

Subsidiary Mutual Holdings Poly owns 80% of Seth acquired at book value plus $25, 000 goodwill. Seth owns 70% of Uno acquired at book value plus $10, 000 goodwill. Uno owns 10% of Seth, cost method. At the start of 2010: • Investment in Seth (by Poly, 80%), $340, 000 • Investment in Uno (by Seth, 70%), $133, 000 • Investment in Seth (by Uno, 10%), $40, 000 • Noncontrolling interest, $102, 000 For 2010: Separate income Dividends Poly Seth Uno 112, 000 51, 000 40, 000 50, 000 30, 000 20, 000 © Pearson Education, Inc. publishing as Prentice Hall 9 -33

Allocate income to CI and NCI Allocation Info. Poly Seth Uno CI NCI Total Separate income 112, 000 51, 000 40, 000 203, 000 Uno's allocation => . 7 U . 3 U Seth's allocation =>. 8 S . 1 S Poly's allocation => Equations: P = 112, 000 +. 8 S S = 51, 000 +. 7 U U = 40, 000 +. 1 S CI = 1 P NCI =. 3 U +. 1 S Solving, substituting 2 nd equation into 3 rd (or 3 rd into 2 nd): U = 48, 495 S = 84, 946 P = 179, 957 CI share = 179, 957 NCI share = 14, 548 + 8, 495 = 23, 043 © Pearson Education, Inc. publishing as Prentice Hall 1. 0 P 9 -34

A Look at the Results: U = 48, 495 S = 84, 946 P = 179, 957 CI share = 179, 957 NCI share = 14, 548 + 8, 495 = 23, 043 Consolidated income • CI and NCI shares = 203, 000, total separate income. Intercompany income • Poly's Income from Seth =. 8 S = 67, 957 • Seth's Income from Uno =. 7 U = 33, 946 • Uno's Dividend income =. 1(Seth's dividends) = 3, 000 Individual reported income • Poly's separate income + income from Seth = 179, 957 • Seth's separate income + income from Uno = 84, 946 © Pearson Education, Inc. publishing as Prentice Hall 9 -35

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