Indirect and Mutual Holdings Iman P Hidayat 2009

Indirect and Mutual Holdings Iman P. Hidayat © 2009 Accounting Department, University Of Siliwangi 1

Affiliation Structures The potential complexity of corporate affiliation structure is limited only by one’s imagination. © 2009 Accounting Department, University Of Siliwangi 2

Direct Holdings Parent 80% Subsidiary A © 2009 Accounting Department, University Of Siliwangi 3

Direct Holdings Parent 80% 70% 90% Subsidiary A Subsidiary B Subsidiary C © 2009 Accounting Department, University Of Siliwangi 4

Indirect Holdings Parent 80% Subsidiary A 70% Subsidiary B © 2009 Accounting Department, University Of Siliwangi 5

Indirect Holdings Parent 80% 20% Subsidiary A Subsidiary B 40% © 2009 Accounting Department, University Of Siliwangi 6

Mutual Holdings Parent 80% 10% Subsidiary A © 2009 Accounting Department, University Of Siliwangi 7

Mutual Holdings Parent 80% Subsidiary A 20% 40% 20% © 2009 Accounting Department, University Of Siliwangi Subsidiary B 8

Father-Son-Grandson Structure Poe Corporation acquires 80% of the stock of Shaw Corporation on January 1, 2003. Shaw acquires 70% of the stock of Turk Corporation on January 1, 2004. Both investments are made at book value. © 2009 Accounting Department, University Of Siliwangi 9

Father-Son-Grandson Structure (in thousands) Poe Other assets $400 Investment in Shaw: (80%) 200 Investment in Turk: (70%) – $600 Liabilities $100 Capital stock 400 Retained earnings 100 $600 Separate earnings $100 Dividends $ 60 © 2009 Accounting Department, University Of Siliwangi Shaw $195 – 105 $300 $ 50 200 50 $300 $ 50 $ 30 Turk $190 – – $190 $ 40 100 50 $190 $ 40 $ 20 10

Computational Approaches for Consolidated Net Income Poe’s separate earnings $100, 000 Add: Poe’s share of Shaw’s separate earnings ($50, 000 × 80%) 40, 000 Add: Poe’s share of Turk’s separate earnings ($40, 000 × 80% × 70%) 22, 400 Poe’s net income and consolidated net income $162, 400 © 2009 Accounting Department, University Of Siliwangi 11

Computational Approaches for Consolidated Net Income Combined separate earnings: Poe $100, 000 Shaw 50, 000 Turk 40, 000 Less: Minority interest expenses: Direct minority interest in Turk’s income ($40, 000 × 30%) $ 12, 000 Indirect minority interest in Turk’s income ($40, 000 × 70%) 5, 600 Direct minority interest in Shaw’s income ($50, 000 × 20%) 10, 000 Poe’s net income and consolidated net income © 2009 Accounting Department, University Of Siliwangi $190, 000 – 27, 600 $162, 400 12

Computational Approaches for Consolidated Net Income (in thousands) Separate earnings Allocate Turk’s income to Shaw ($40, 000 × 70%) Allocate Shaw’s income to Poe ($78, 000 × 80%) Consolidated net income Minority interest expense © 2009 Accounting Department, University Of Siliwangi Poe $100. 0 Shaw $ 50. 0 Turk $ 40. 0 – + 28. 0 – 62. 4 – $ 15. 6 $ 12. 0 + 62. 4 $162. 4 13

Indirect Holdings – Connecting Affiliates Structure Pet 70% Sal 60% 20% © 2009 Accounting Department, University Of Siliwangi Ty 14

Accounting for Connecting Affiliates (in thousands) Pet 70% Pet 60% Sal 20% in Sal in Ty Cost Less: Book value Goodwill Investment Balance 12/31/09 Cost Add: Share of investees’ pre-2008 income less dividends Balance 12/31/07 © 2009 Accounting Department, University Of Siliwangi $178 – 168 $ 10 $100 – 90 $ 10 $20 – $178 $100 $20 7 $185 18 $118 16 $36 15

Accounting for Connecting Affiliates Pet Sal Ty Earnings (2008) $70, 000 $35, 000 $20, 000 Dividends $40, 000 $20, 000 $10, 000 Pet’s separate earnings of $70, 000 included an unrealized gain of $10, 000 from the sale of land to Sal during 2008. Sal’s separate earnings of $35, 000 included unrealized profit of $5, 000 on inventory items sold to Pet for $15, 000 during 2008, and remaining in Pet’s 12/31/2008 inventory. © 2009 Accounting Department, University Of Siliwangi 16

Accounting for Connecting Affiliates (in thousands) Separate earnings Deduct unrealized profit Separate realized earnings Allocate Ty’s income: 20% to Sal 60% to Pet Allocate Sal’s income: 70% to Pet Consolidated net income Minority interest expense © 2009 Accounting Department, University Of Siliwangi Pet Sal Ty $70. 0 – 10. 0 $60. 0 $35. 0 – 5. 0 $30. 0 $20. 0 – +12. 0 + 4. 0 – – 4. 0 – 12. 0 +23. 8 $95. 8 – 23. 8 – $10. 2 $ 4. 0 17

Accounting for Connecting Affiliates Cash 6, 000 Investment in Ty 6, 000 To record dividends received from Ty Investment in Ty 12, 000 Income from Ty 12, 000 To record income from Ty © 2009 Accounting Department, University Of Siliwangi 18

Accounting for Connecting Affiliates Reported income ($39, 000 × 70%) Less: 70% of Sal’s unrealized profit of $5, 000 Less: 100% of unrealized gain on land Total © 2009 Accounting Department, University Of Siliwangi $27, 300 – 3, 500 – 10, 000 $13, 800 19

Accounting for Connecting Affiliates Cash 14, 000 Investment in Sal 14, 000 To record dividends received from Sal Investment in Sal 13, 800 Income from Sal 13, 800 To record income from Sal © 2009 Accounting Department, University Of Siliwangi 20

Accounting for Connecting Affiliates Pet’s investment accounts at 12/31/08 Investment in Sal (70%) Investment in Ty (60%) Balance 12/31/2007 Add: Investment income Deduct: Dividends Balance 12/31/2008 $185, 000 13, 800 – 14, 000 $183, 800 $118, 000 12, 000 – 6, 000 $124, 000 © 2009 Accounting Department, University Of Siliwangi 21

Mutual Holding – Parent Stock Held by Subsidiary Pace 90% 10% Salt The 10% interest held by Salt, and the 90% interest held by Pace, are not outstanding for consolidation purposes. © 2009 Accounting Department, University Of Siliwangi 22

Mutual Holding – Parent Stock Held by Subsidiary Treasury Stock Approach Conventional Approach © 2009 Accounting Department, University Of Siliwangi 23

Treasury Stock Approach It considers parent company stock held by a subsidiary to be treasury stock of the consolidated entity. The investment account on the books of the subsidiary are maintained on a cost basis and is deducted at cost from stockholders’ equity in the consolidated balance sheet. © 2009 Accounting Department, University Of Siliwangi 24

Mutual Holding – Parent Stock Held by Subsidiary Trail balances 12/31/2005 Pace Debits Other assets $480, 000 Investment in Salt (90%) 270, 000 Investment in Pace (10%) – Expenses 70, 000 $820, 000 Credits Capital stock, $10 par $500, 000 Retained earnings 200, 000 Sales 120, 000 $820, 000 © 2009 Accounting Department, University Of Siliwangi Salt $260, 000 – 70, 000 50, 000 $380, 000 $200, 000 100, 000 80, 000 $380, 000 25

Treasury Approach: Working Papers December 31, 2005 Income Statement Sales Investment income Expenses Minority interest expense Net income Retained earnings – Pace Retained earnings – Salt Add: Net income Retained earnings December 31, 2005 Adjustments/ Consol. Pace Salt Eliminations idated $120 $ 80 $200 27 a 27 (70) (50) (120) d 3 (3) $ 77 $ 30 $ 77 $200 $100 b 100 77 30 77 $277 © 2009 Accounting Department, University Of Siliwangi $130 $277 26

Treasury Approach: Working Papers December 31, 2005 Balance Sheet Other assets Investment in Salt (90%) Investment in Pace (10%) Capital stock – Pace Capital stock – Salt Retained earnings Treasury stock Minority interest Pace $480 297 $777 $500 277 $777 © 2009 Accounting Department, University Of Siliwangi Salt $260 Adjustments/ Eliminations 70 $330 $200 b 200 130 $330 c 70 a 27 b 270 c 70 Consolidated $740 $500 277 b 30 d 3 (70) 33 $740 27

Treasury Approach: Working Papers December 31, 2006 Income Statement Sales Income from Salt Dividend income Expenses Minority interest expense Net income Retained earnings – Pace Retained earnings – Salt Dividends Add: Net income Retained earnings December 31, 2006 Pace $140 35. 7 (80) $ 95. 7 $277 (27) 95. 7 Adjustments/ Consol. Salt Eliminations idated $100 $240 a 35. 7 3 a 3 (60) (140) d 4. 3 (4. 3) $ 43 $ 95. 7 $277 $130 b 130 (20) a 18 d 2 (27) 43 95. 7 $345. 7 $153 © 2009 Accounting Department, University Of Siliwangi $345. 7 28

Treasury Approach: Working Papers December 31, 2006 Balance Sheet Pace Salt Other assets $528 $283 Investment in Salt (90%) 317. 7 Investment in Pace (10%) Capital stock – Pace Capital stock – Salt Retained earnings Treasury stock Minority interest Adjustments/ Eliminations 70 $845. 7 $353 $500 $200 b 200 345. 7 153 $845. 7 $353 c 70 © 2009 Accounting Department, University Of Siliwangi a 20. 7 b 297 c 70 Consolidated $811 $500 345. 7 b 33 d 2. 3 (70) 35. 3 $811 29

Conventional Approach It accounts for the subsidiary investment in parent company stock on an equity basis. Parent company stock held by a subsidiary is constructively retired. Capital stock and retained earnings applicable to the interest held by the subsidiary do not appear in the consolidated financial statements. © 2009 Accounting Department, University Of Siliwangi 30

Conventional Approach January 1, 2005 Capital stock Retained earnings Stockholders’ equity © 2009 Accounting Department, University Of Siliwangi Pace Consolidated $500, 000 200, 000 $700, 000 $450, 000 180, 000 $630, 000 31

Conventional Approach January 1, 2005 Investment in Salt 270, 000 Cash 270, 000 To record acquisition of a 90% interest in Salt at book value January 5, 2005 Capital Stock, $10 par 50, 000 Retained Earnings 20, 000 Investment in Salt 70, 000 To record the constructive retirement of 10% of Pace’s outstanding stock © 2009 Accounting Department, University Of Siliwangi 32

Allocation of Mutual Income Determine income on a consolidated basis. P = Pace’s separate earnings of $50, 000 + 90%S S = Salt’s separate earnings of $30, 000 + 10%P © 2009 Accounting Department, University Of Siliwangi 33

Allocation of Mutual Income P = $50, 000 + 0. 9($30, 000 + 0. 1 P) P = $50, 000 + $27, 000 + 0. 09 P 0. 91 P = $77, 000 P = $84, 615 S = $30, 000 + 0. 1($84, 615) S = $30, 000 + $8, 462 = $38, 462 © 2009 Accounting Department, University Of Siliwangi 34

Allocation of Mutual Income P Before allocation: $50, 000 After allocation: $84, 615 © 2009 Accounting Department, University Of Siliwangi S $30, 000 $38, 462 Total $ 80, 000 $123, 077 35

Allocation of Mutual Income Determine Pace’s net income on an equity basis and minority interest. P = 84, 615 × 90% = $76, 154 MI = 38, 462 × 10% = $3, 846 $76, 154 + $3, 846 = $80, 000 © 2009 Accounting Department, University Of Siliwangi 36

Accounting for Mutual Income ($38, 462 × 90%) – ($84, 615 × 10%) = $26, 154 How does Pace record its investment income? Investment in Salt Income from Salt To record income from Salt © 2009 Accounting Department, University Of Siliwangi 26, 154 37

Conventional Approach: Working Papers December 31, 2005 Adjustments/ Consol. Income Statement Pace Salt Eliminations idated Sales $120, 000 $ 80, 000 $200, 000 Investment income 26, 154 b 26, 154 Expenses (70, 000) (50, 000) (120, 000) Minority interest (3, 846) expense d 3, 846 Net income $ 76, 154 $ 30, 000 $ 76, 154 Retained earnings – P $180, 000 Retained earnings – S $100, 000 c 100, 000 Add: Net income 76, 154 30, 000 76, 154 Retained earnings December 31, 2005 $256, 154 $130, 000 $256, 154 © 2009 Accounting Department, University Of Siliwangi 38

Conventional Approach: Working Papers December 31, 2005 Adjustments/ Eliminations Balance Sheet Other assets Investment in S Consolidated $740, 000 Pace Salt $480, 000 $260, 000 226, 154 a 70, 000 b 26, 154 c 270, 000 Investment in P 70, 000 a 70, 000 $756, 154 $330, 000 $740, 000 Capital stock – P $450, 000 Capital stock – S $200, 000 c 200, 000 Retained earnings 256, 154 130, 000 256, 154 Minority interest $706, 154 $330, 000 © 2009 Accounting Department, University Of Siliwangi b 30, 000 d 3, 846 33, 846 $740, 000 39

Conversion to Equity Method on Separate Company Book Separate earnings 2005 Separate earnings 2006 Less dividends declared Add dividends received Increase in net assets P S $ 50, 000 + 60, 000 – 30, 000 + 18, 000 $ 98, 000 $ 30, 000 + 40, 000 – 20, 000 + 3, 000 $ 53, 000 © 2009 Accounting Department, University Of Siliwangi Total $ 80, 000 + 100, 000 – 50, 000 + 21, 000 $ 151, 000 40

Conversion to Equity Method on Separate Company Book P = $98, 000 + 0. 9 S S = $53, 000 + 0. 1 P P = $98, 000 + 0. 9($53, 000 + 0. 1 P) = $160, 110 S = $53, 000 + (0. 1 × $160, 110) = $69, 011 Pace’s RE increase: $160, 110 × 90% = $144, 099 MI RE increase: 69, 011 × 10% = $6, 901 Net asset increase: $144, 099 + $6, 901= $151, 000 © 2009 Accounting Department, University Of Siliwangi 41

Subsidiary Stock Mutually Held The mutually held stock involves subsidiaries holding the stock of each other, and the treasury stock approach is not applicable. © 2009 Accounting Department, University Of Siliwangi 42

Subsidiary Stock Mutually Held Poly 80% Seth 70% 10% Uno © 2009 Accounting Department, University Of Siliwangi 43

Subsidiary Stock Mutually Held Poly acquired 80% interest in Seth on January 2, 2005, for $260, 000 ($20, 000 goodwill). Seth’s stockholders’ equity consisted of $200, 000 capital stock and $100, 000 retained earnings. Seth acquired 70% interest in Uno on January 3, 2006, for $115, 000 ($10, 000 goodwill). © 2009 Accounting Department, University Of Siliwangi 44

Subsidiary Stock Mutually Held Uno’s stockholders’ equity consisted of $100, 000 capital stock and $50, 000 retained earnings. Uno acquired 10% interest in Seth on December 31, 2006, for $40, 000. Seth’s stockholders’ equity consisted of $200, 000 capital stock and $200, 000 retained earnings. © 2009 Accounting Department, University Of Siliwangi 45

Subsidiary Stock Mutually Held (in thousands 12/31/2006) Cash Other current assets Plant and equipment – net Investment in Seth (80%) Investment in Uno (70%) Investment in Seth (10%) Total Liabilities Capital stock Retained earnings Total © 2009 Accounting Department, University Of Siliwangi Poly $ 64 200 500 336 – – $1, 100 $ 200 500 400 $1, 100 Seth $ 40 85 240 – 135 – $500 $100 200 $500 Uno $ 20 80 110 – – 40 $250 $ 70 100 80 $250 46

Subsidiary Stock Mutually Held Cost Add: Income less dividends (2005) Add: Income less dividends (2006) Balance 12/31/2006 Poly 80% in Seth $260, 000 Seth 70% Uno 10% in Uno in Seth $115, 000 $40, 000 32, 000 – – 48, 000 $340, 000 21, 000 $136, 000 – $40, 000 © 2009 Accounting Department, University Of Siliwangi 47