ch09-Advance Accounting-Mutual Holding

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9 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Indirect and Mutual Holdings

Chapter 9




Learning Objective 1

Prepare consolidated statements

when the parent company

controls through indirect holdings.




Affiliation Structures

The potential complexity of corporate

affiliation structure is limited only by one’s imagination .




Direct Holdings

Parent

SubsidiaryA

80%




Direct Holdings

Parent

SubsidiaryB

70%

SubsidiaryA

80%

SubsidiaryC

90%




Indirect Holdings

Parent

Subsidiary

A

80%

SubsidiaryB

70%




Indirect Holdings

Parent

SubsidiaryA

SubsidiaryB

80% 20%

40%




Mutual Holdings

Parent

SubsidiaryA

80% 10%




Mutual Holdings

Parent

SubsidiaryA

SubsidiaryB

80% 20%

40%

20%




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.




Father-Son-Grandson Structure

Other assets $400 $195 $190Investment in Shaw: (80%) 200 – –

Investment in Turk: (70%) – 105 – $600 $300 $190

Liabilities $100 $ 50 $ 40Capital stock 400 200 100

Retained earnings 100 50 50$600 $300 $190

(in thousands) Poe Shaw Turk

Separate earnings $100 $ 50 $ 40Dividends $ 60 $ 30 $ 20




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






Combined separate earnings:Poe $100,000Shaw 50,000

Turk 40,000 $190,000Less: Minority interest expenses:Direct minority interest inTurk’s income ($40,000 × 30%) $ 12,000

Indirect minority interest inTurk’s income ($40,000 × 70%) 5,600

Direct minority interest inShaw’s income ($50,000 × 20%) 10,000 – 27,600

Poe’s net income and consolidated net income $162,400






(in thousands) Poe Shaw Turk

Separate earnings $100.0 $ 50.0 $ 40.0

Allocate Turk’s income to Shaw ($40,000 × 70%) – + 28.0 – 28.0

Allocate Shaw’s income to Poe

($78,000 × 80%) + 62.4 – 62.4 –

Consolidated net income $162.4Minority interest expense $ 15.6 $ 12.0




Indirect Holdings –

Connecting Affiliates Structure

Pet

20%Sal

70%

Ty

60%




Accounting for Connecting Affiliates

Pet 70% Pet 60% Sal 20%(in thousands) in Sal in Ty in Ty

Cost $178 $100 $20

Less: Book value – 168 – 90 – 20Goodwill $ 10 $ 10 –

Investment Balance 12/31/09

Cost $178 $100 $20

Add: Share of investees’ pre-2008income less dividends 7 18 16

Balance 12/31/07 $185 $118 $36





Pet Sal Ty

Earnings (2008) $70,000 $35,000 $20,000

Dividends $40,000 $20,000 $10,000Pet’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.





(in thousands) Pet Sal Ty

Separate earnings $70.0 $35.0 $20.0Deduct unrealized profit – 10.0 – 5.0 –

Separate realized earnings $60.0 $30.0 $20.0Allocate Ty’s income:

20% to Sal – + 4.0 – 4.060% to Pet +12.0 – – 12.0

Allocate Sal’s income: 70% to Pet +23.8 – 23.8 –

Consolidated net income $95.8Minority interest expense $10.2 $ 4.0





Cash 6,000Investment 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





Reported income ($39,000 × 70%) $27,300

Less: 70% of Sal’s unrealized

profit of $5,000 – 3,500

Less: 100% of unrealized gain on land – 10,000

Total $13,800





Cash 14,000Investment 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





Pet’s investment Investment Investmentaccounts at 12/31/08 in Sal (70%) in Ty (60%)

Balance 12/31/2007 $185,000 $118,000

Add: Investment income 13,800 12,000

Deduct: Dividends – 14,000 – 6,000

Balance 12/31/2008 $183,800 $124,000




Learning Objective 2

Apply consolidated procedures of

indirect holdings to the special

case of mutual holdings.




Mutual Holding – Parent Stock

Held by Subsidiary

Pace

Salt

90% 10%

The 10% interest held by Salt, and the 90%

interest held by Pace, are not outstanding

for consolidation purposes.





Held by Subsidiary

Treasury Stock Approach

Conventional Approach




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.





Held by Subsidiary

Trail balances 12/31/2005 Pace Salt

Debits Other assets $480,000 $260,000

Investment in Salt (90%) 270,000 – Investment in Pace (10%) – 70,000Expenses 70,000 50,000

$820,000 $380,000Credits Capital stock, $10 par $500,000 $200,000Retained earnings 200,000 100,000Sales 120,000 80,000

$820,000 $380,000




Treasury Approach:

Working Papers December 31, 2005Adjustments/ Consol-

Pace Salt Eliminations idated

Sales

Investment income

ExpensesMinority interest expense

Net income

Retained earnings – Pace

Retained earnings – Salt

Add: Net income

Retained earnings

December 31, 2005

$120

27

(70)

$ 77

$200

77

$277

$ 80

(50)

$ 30

$100

30

$130

a 27

d 3

b 100

$200

(120)(3)

$ 77

$200

77

$277

Income Statement




Treasury Approach:

Working Papers December 31, 2005

Other assetsInvestment in Salt (90%)

Investment in Pace (10%)

Capital stock – PaceCapital stock – SaltRetained earnings

Treasury stock Minority interest

$480297

$777$500

277

$777

$260

70$330

$200130

$330

a 27b 270

c 70

b 200

c 70b 30d 3

$740

$740$500

277

(70)

33$740

Balance SheetAdjustments/ Consol-





Treasury Approach:


Pace Salt Eliminations idatedSalesIncome from SaltDividend income

ExpensesMinority interest expenseNet incomeRetained earnings – PaceRetained earnings – Salt

Dividends

Add: Net incomeRetained earningsDecember 31, 2006

$14035.7

(80)

$ 95.7$277

(27)

95.7

$345.7

$100

3

(60)

$ 43

$130

(20)

43

$153

a 35.7a 3

d 4.3

b 130

a 18d 2

$240

(140)(4.3)

$ 95.7$277

(27)95.7

$345.7

Income Statement




Treasury Approach:


Other assetsInvestment in Salt (90%)

Investment in Pace (10%)

Capital stock – PaceCapital stock – SaltRetained earnings

Treasury stock Minority interest

$528317.7

$845.7$500

345.7

$845.7

$283

70$353

$200153

$353

a 20.7b 297

c 70

b 200

c 70b 33d 2.3

$811

$811$500

345.7

(70)

35.3$811







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.





Capital stock $500,000 $450,000

Retained earnings 200,000 180,000

Stockholders’ equity $700,000 $630,000

January 1, 2005 Pace Consolidated





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 20,000Investment in Salt 70,000

To record the constructive retirement of 10% of Pace’s

outstanding stock




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





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





P S Total

Before allocation: $50,000 $30,000 $ 80,000

After allocation: $84,615 $38,462 $123,077





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




Accounting for Mutual Income

($38,462 × 90%) – ($84,615 × 10%) = $26,154

How does Pace record its investment income?Investment in Salt 26,154

Income from Salt 26,154

To record income from Salt

C ti l A h




Conventional Approach:



Sales

Investment income

ExpensesMinority interest

expense

Net income

Retained earnings – P

Retained earnings – S

Add: Net income

Retained earnings

December 31, 2005

$120,000

26,154

(70,000)

$ 76,154

$180,000

76,154

$256,154

$ 80,000

(50,000)

$ 30,000

$100,000

30,000

$130,000

b 26,154

d 3,846

c 100,000

$200,000

(120,000)(3,846)

$ 76,154

$180,000

76,154

$256,154

Income Statement

C ti l A h




Conventional Approach:


Other assetsInvestment in S

Investment in P

Capital stock – PCapital stock – SRetained earnings

Minority interest

$480,000226,154

$756,154$450,000

256,154

$706,154

$260,000

70,000$330,000

$200,000130,000

$330,000

a 70,000 b 26,154c 270,000

a 70,000

c 200,000

b 30,000d 3,846

$740,000

$740,000$450,000

256,154

33,846$740,000



C i t E it M th d




Conversion to Equity Method on

Separate Company Book

P S TotalSeparate earnings 2005 $ 50,000 $ 30,000 $ 80,000

Separate earnings 2006 + 60,000 + 40,000 + 100,000

Less dividends declared – 30,000 – 20,000 – 50,000

Add dividends received + 18,000 + 3,000 + 21,000Increase in net assets $ 98,000 $ 53,000 $ 151,000

C i t E it M th d




Conversion to Equity Method on

Separate Company Book

P = $98,000 + 0.9S S = $53,000 + 0.1 P

P = $98,000 + 0.9($53,000 + 0.1 P ) = $160,110

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

S = $53,000 + (0.1 × $160,110) = $69,011




Subsidiary Stock Mutually Held

The mutually held stock involves subsidiaries

holding the stock of each other, and the

treasury stock approach is not applicable.





Poly

Seth

Uno

70% 10%

80%





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 onJanuary 3, 2006, for $115,000 ($10,000 goodwill).





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.





Cash $ 64 $ 40 $ 20Other current assets 200 85 80Plant and equipment – net 500 240 110Investment in Seth (80%) 336 – – Investment in Uno (70%) – 135 – Investment in Seth (10%) – – 40

Total $1,100 $500 $250Liabilities $ 200 $100 $ 70Capital stock 500 200 100Retained earnings 400 200 80

Total $1,100 $500 $250

(in thousands 12/31/2006) Poly Seth Uno





Poly 80% Seth 70% Uno 10%in Seth in Uno in Seth

Cost $260,000 $115,000 $40,000

Add: Income less

dividends (2005) 32,000 – –

Add: Income less

dividends (2006) 48,000 21,000 – Balance 12/31/2006 $340,000 $136,000 $40,000



End of Chapter 9

ch09-Advance Accounting-Mutual Holding

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