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Chapter 9
INDIRECT AND MUTUAL HOLDINGS
Answers to Questions
1 An indirect holding of the stock of an affiliated company 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.
3a Father-son-grandson b Connecting affiliates
Controlling stockholdersDirect ownership, 70% interest in Y. Indirect ownership, 42% interest in Z (70% ´ 60%).
Controlling stockholdersDirect ownership, 30% interest in B and 70% interest in A. Indirect ownership, 21% interest in B (70% ´ 30%)
Noncontrolling stockholdersDirect ownership, 30% interest in Y and 40% interest in Z. Indirect ownership, 18% interest in Z (30% ´ 60%).
Noncontrolling stockholdersDirect ownership, 30% interest in A and 40% interest in B. Indirect ownership, 9% interest in B (30% ´ 30%).
4 An indirect holding involves the ability of one corporation to control another corporation by virtue of its control over one or more other corporations. A mutual holding affiliation structure is a special type of indirect holding where affiliates indirectly own themselves.
5 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.
Combined separate earnings of Pat, Sam, and Stan ($100,000 + $80,000 + $50,000) $230,000Less: Noncontrolling interest share computed as follows:
Direct noncontrolling interest in Stan’s income ($50,000 ´ 30%) (15,000)
Indirect noncontrolling interest in Stan’s income ($50,000 ´ 70% ´ 20%) (7,000)Direct noncontrolling interest in Sam’s income
($80,000 ´ 20%) (16,000 )Pat’s net income and consolidated net income $192,000
Approach B Pat Sam Stan
Separate earnings $100,000 $80,000 $50,000Allocate Stan’s income to Sam ($50,000 ´ 70%) + 35,000 -35,000Allocate Sam’s income to Pat ($115,000 ´ 80%) + 92,000 -92,000 0 Consolidated net income $192,000Noncontrolling interest share $ 23,000 $15,000
7 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.
Separate realized earnings 20,000 9,000 5,000Allocate S2’s income + 3,500 -3,500Allocate S1’s income +10,000 -10,000 0 P’s net income $30,000Noncontrolling int. share $ 2,500 $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.
9 A mutual holding situation exists because two affiliated companies hold ownership interests in each other.
10 The treasury stock approach considers parent company 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.
11 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.
12 No. Parent company dividends paid to the subsidiary are eliminated.
13 The theory is that parent company stock purchased by a subsidiary is, in effect, returned to the parent company and constructively retired. By recording the constructive retirement of the parent company stock on parent company books, parent company equity will reflect the equity of stockholders outside the consolidated entity. Also, recording the constructive retirement, by reducing parent company 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 company net income, dividends, and earnings per share which also relate to the outside stockholders of the parent.
14 Consolidated net income is computed as follows:
P = $50,000 + .8SS = $20,000 + .1PP = $50,000 + .8($20,000 + .1P)P = $71,739Consolidated net income = $71,739 ´ 90% = $64,565
15 For eliminating the effect of mutually held parent company stock, two generally accepted approaches are used—the treasury stock approach and the traditional approach. But when the mutually held stock involves subsidiaries holding stock of each other, the treasury stock approach is not applicable.
16 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
Pent Sal Terp Separate earnings of the three affiliates (in thousands) $ 800 $500 $200Add: Dividend income from Sal’s investment in Wint accounted for by the cost method ($100,000 ´ 15%) 15Allocate 60% of Terp’s earnings 120 (120)Allocate 60% of Sal’s earnings 381 (381)Consolidated net income – Contr. Share $1,181Noncontrolling interest share $254 $ 80
Consolidated net income – Contr. Share $354 Noncontrolling interest share $ 30 $ (34)
Solution E9-3Place Corporation and Subsidiaries
Income Allocation Schedulefor the year 2009
Place Lake Marsh Separate incomes $200,000 $80,000 $ 70,000Less: Unrealized profit on land (20,000)Separate realized incomes 200,000 60,000 70,000Allocate Lake’s income
60% to Place 36,000 (36,000)20% to Marsh (12,000) 12,000
Allocate Marsh’s income70% to Place 57,400 (57,400)
Consolidated net income – Contr. Share $293,400Noncontrolling interest share $12,000 $ 24,600
Solution E9-4
1 cIncome from Seron is equal to:
70% of Seron’s $160,000 income $112,00070% of Seron’s 80% interest in Trane’s $100,000 income 56,000
Income from Seron $168,000
2 dNoncontrolling interest share is equal to:
30% direct noncontrolling interest in Seron’s $160,000 income $ 48,00020% direct noncontrolling interest in Trane’s $100,000 income 20,00030% ´ 80% indirect noncontrolling interest in Trane’s $100,000 income 24,000
3 dConsolidated net income is equal to:Combined separate incomes of $360,000 + $160,000 + $100,000 $620,000Less: Noncontrolling interest share 92,000 Controlling interest share of Consolidated net income $528,000
Alternative computation: Paine’s separate income $360,000Add: 70% of Seron’s $160,000 income 112,000Add: (70% ´ 80%) of Trane’s $100,000 income 56,000 Controlling interest share of Consolidated net income $528,000
Solution E9-5
Pal Sal Tall Ulti Val Separate earnings $ 50,000 $30,000 $35,000 $(20,000) $40,000Less: Unrealized profit - 5,000Separate realized earnings 50,000 30,000 30,000 (20,000) 40,000Allocate Val’s income
70% to Tall +28,000 - 28,000Allocate Ulti’s income
10% to Tall - 2,000 + 2,00060% to Sal -12,000 + 12,000
Allocate Tall’s income80% to Pal + 44,800 -44,80010% to Sal + 5,600 - 5,600
Allocate Sal’s income80% to Pal + 18,880 -18,880
Pal’s net income (or consolidated net income) $113,680Noncontrolling interest share $ 4,720 $ 5,600 $ (6,000) $12,000
1 bSeparate income of Savoy (net income) $ 80,000Separate income of Trent $40,000 - ($80,000 ´ 10%) 32,000Separate income of Pasko $240,000 - ($40,000 ´ 70%) - ($80,000 ´ 80%) 148,000 Total separate income $260,000
2 d Pasko Savoy Trent
Separate income $148,000 $80,000 $32,000Unrealized profit on inventory (10,000)Unrealized profit on land (15,000 )Separate realized income $148,000 $70,000 $17,000
3 aPasko’s separate income $148,000Add: Investment income from Savoy ($70,000 ´ 80%) 56,000Add: Investment income from Trent [$17,000 + ($70,000 ´ 10%)] ´ 70% 16,800 Parent’s income (consolidated net income) $220,800
4 dTotal separate realized income $235,000Less: Consolidated net income 220,800
Noncontrolling interest share $ 14,200
Alternative solutionDirect noncontrolling interest in Savoy ($70,000
´ .1)$ 7,000
Indirect noncontrolling interest in Savoy ($70,000 ´ .3 ´ .1) 2,100Direct noncontrolling interest in Trent ($17,000
´ .3) 5,100
Noncontrolling interest share $ 14,200
Solution E9-9
Consolidated net incomeP = Income of Pant on a consolidated basis (including mutual income)
S = Income of Solo 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
Solve for SS = $120,000 + .8($80,000 + .1S)S = $184,000 + .08SS = $200,000
Compute P and TP = $200,000 + .7($200,000)P = $340,000
T = $80,000 + .1($200,000)T = $100,000
Income AllocationConsolidated net income (equal to P) $340,000Noncontrolling interest share in Smedley ($200,000 ´ 20%) 40,000Noncontrolling interest share in Tweed ($100,000 ´ 20%) 20,000
1 dCombined separate income $160,000Less: Noncontrolling interest share 6,750 Consolidated net income $153,250
Alternatively:Petty’s separate income $100,000Add: Soma’s net income of $67,500 ´ 90% 60,750Less: Dividends received from Petty ($50,000 ´ 15%) (7,500 )Controlling interest share of Consolidated net income $153,250
2 b P = $100,000 + .9($60,000 + .15P).865P = $154,000 P = $178,035 S = $60,000 + $26,705 = $86,705
Consolidated net income = $178,035 ´ .85 = $151,330Noncontrolling interest share = $86,705 ´ .10 = 8,670 Total income $160,000
Investment in Scat balance December 31, 2009Investment balance December 31, 2008 $245,700Add: Income from Scat 26,900Less: Dividends received from Scat (24,000)Add: Dividends paid to Scat 6,000 Investment in Scat December 31, 2009 $254,600
Supporting computationsComputation of income from Scat:Scat’s separate income $ 50,000Add: Scat’s dividend income from Pumel 6,000 Scat’s net income 56,000Pumel’s ownership interest 70 %Pumel’s equity in Scat’s income 39,200Less: Dividends paid to Scat ($60,000 ´ 10%) (6,000)Less: Excess amortization ($9,000 x 70%) (6,300 )Income from Scat $ 26,900
2 Conventional approach
Pumel’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
S = $50,000 + .1($159,892) S = $65,989
Pumel’s net income and consolidated net income ($159,892 ´ 90%) $143,903Noncontrolling interest share ($65,989 ´ 30%) 19,797
Total income $163,700
Income from ScatConsolidated net income $143,903Less: Pumel’s separate income 120,000
Pida Corporation and SubsidiariesSchedule to Compute Consolidated Net Income and Noncontrolling Interest Share
for the year 2009
Pida Staley Axel Bean Separate income (loss) $500,000 $300,000 $150,000 $(20,000)
Less: Unrealized profit (20,000 )
Separate realized income (loss) 500,000 300,000 130,000 (20,000)Allocate Bean’s loss 70% to Staley (14,000) 14,000
Allocate Axel’s income 60% to Staley 78,000 (78,000)Patent (12,000 )
352,000Allocate Staley’s income 90% to Pida 316,800 (316,800)Patent (40,000 )
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 Staley + $52,000 noncontrolling interest share in Axel - $6,000 noncontrolling interest share (loss) in Bean = $858,000
Income to allocate: $500,000 Pida income + $300,000 Staley income + $130,000 realized income of Axel - $20,000 loss of Bean - $52,000 patent = $858,000
Investment in Thayer (70%) 147,000Cash 147,000To record purchase of a 70% interest in Thayer Corporation.
Cash 7,000Investment in Thayer (70%) 7,000To record dividends received from Thayer ($10,000 ´ 70%).
Investment in Thayer (70%) 17,500Income from Thayer 17,500To record investment income computed as follows:Share of Thayer’s net income ($30,000 ´ 70%) $ 21,000Less: Unrealized profit from upstream sale of inventory items ($5,000 ´ 70%) (3,500 )
$ 17,500
Posey’s books
Cash 24,000Investment in Seaton (80%) 24,000To record dividends received from Seaton ($30,000 ´ 80%).
Investment in Seaton (80%) 44,000Income from Seaton 44,000To record investment income computed as follows:
Share of Thayer’s net income($50,000 + $17,500) ´ 80% $ 54,000Less: Unrealized gain on land sold to Thayer (10,000 )
Total liabilities and equity $1,144,000 $387,500 $270,000
Note: Posey’s assets other than investments consist of $800,000 assets at the beginning of the year, plus separate earnings of $150,000 and dividend income of $24,000, less dividends paid of $50,000.
Seaton’s assets other than investments consist of $350,000 assets at the beginning of the period, plus separate earnings of $50,000 and dividend income of $7,000, less investment cost of $147,000 and dividends paid of $30,000.
Check on consolidated net income Pony Star Teel Total
Net income as stated $184,500 $90,000 $25,000 $299,500Less: Investment income (84,500 ) (10,000) (94,500 )Separate income 100,000 80,000 25,000 205,000Add: Unrealized profit in beginning inventory 8,000 8,000Less: Unrealized profit in ending inventory (20,000) (20,000 )Separate realized incomes 108,000 80,000 5,000 193,000Allocate Teel’s income
50% to Pony 2,500 (2,500)40% to Star 2,000 (2,000)
Star’s net income 82,000Allocate Star’s income
80% to Pony 65,600 (65,600)Less: Depreciation on excess allocated to plant and Equipment (5,000) ( 1,250) (6,250 )Total income of consolidated Entity $186,750Controlling share of NI $171,100 171,100Noncontrolling int. share $ 15,150 $ 500 15,650
$186,750
Investment in Star (80%) $420,000
Implied total fair value of Star ($420,000 / 80%) $ 525,000Book value of Star (500,000 )Excess of fair value over book value $ 25,000
Excess allocated to equipment wit a four year lfe Amortization ($25,000 / 4 yrs) $ 6,250
Investment in Teel (50%) $ 75,000
Implied total fair value of Teel ($75,000 / 50%) $ 150,000Book value of Star (120,000 )Excess of fair value over book value – Goodwill $ 30,000
Income allocationConsolidated net income = P = $320,408Noncontrolling interest share in Swift ($112,245 ´ .1) 11,225Noncontrolling interest share in Tolbert ($61,224 ´ .3) 18,367
Income allocationConsolidated net income = P = $293,673.48Noncontrolling interest share in Swift ($110,204.08 ´ 10%) 11,020.40Noncontrolling interest share in Tolbert ($51,020.41 ´ 30%) 15,306.12
Dividend income 10,000Dividends 28,000Investment in Skill 9,000To eliminate income from Skill, dividend income, and 90% of Skill’s dividends, and return the investment in Skill account to the beginning-of-the-period balance under the equity basis.
b Capital stock — Skill 200,000Retained earnings — Skill 200,000Goodwill 50,000
Investment in Skill 405,000Noncontrolling interest — beginning 45,000To eliminate reciprocal investment and equity accounts, and enter beginning-of-the-period patent and noncontrolling interest.
c Treasury stock 80,000Investment in Prill 80,000To reclassify investment in Prill to treasury stock.
d Noncontrolling Interest Share 3,000Dividends 2,000Noncontrolling Interest 1,000To record noncontrolling interest share of subsidiary income and dividends.
Income from ScimpParoll separate income (140,000 - 80,000) $ 60,000Scimp separate income (100,000 + 3,000 - 60,000) $ 43,000
Formula:P income = Adjusted Paroll income + % interest ´ S incomeAdjusted Paroll income = $60,000 + $2,000 delayed gain on land
- $4,000 patent amortization (80%)S income = Scimp income + % interest ´ P incomeP income = $58,000 + 80% ´ ($43,000 + 20% ´ P income)P income = $92,400 + .16 ´ P incomeP income = $110,000S income = $43,000 + 20% ´ $110,000S income = $65,000Controlling share of consolidated net income = P income ´ % outstandingControlling share = $88,000Noncontrolling share = S income ´ % outstandingNoncontrolling share = $12,000 [($65,000 - $5,000 amortiz.) x 20%]Income from Scimp = consolidated income less P separate incomeIncome from Scimp = $28,000 ($88,000-$60,000)
Working paper entriesa Investment in Scimp 2,000
Gain on sale of land 2,000To recognize previously deferred gain on sale of land.
b Dividend income 4,000Investment in Scimp 4,000To eliminate intercompany dividends paid to Scimp
c Income from Scimp 28,000Dividends 16,000Investment in Scimp 12,000To eliminate income from Scimp and 80% of Scimp’s dividends, and return the investment in Scimp account to the beginning-of-the-period balance under the equity basis.
d Investment in Scimp 100,000Investment in Paroll 100,000To eliminate reciprocal investments.
e Capital stock — Scimp 50,000Retained earnings — Scimp 180,000Patent 20,000
Investment in Scimp 195,710Noncontrolling interest — beginning 54,290To eliminate reciprocal investment and equity accounts, and enter beginning-of-the-period patent and noncontrolling interest.
f Expenses 5,000Patent 5,000To record current year’s amortization of patent.
Income allocationConsolidated net income ($143,478 ´ 90% outside ownership) $129,130Noncontrolling interest share ($54,348 ´ 20%) 10,870
Total (separate incomes) $140,000
2 Entries to account for investments on an equity basisPanco’s books
Capital stock 60,000Retained earnings 20,000
Investment in Stoco 80,000To record constructive retirement of 10% of Panco’s stock.
Investment in Stoco (80%) 29,130Income from Stoco 29,130To record income from Stoco computed as follows: 80%($54,348) - 10%($143,478) = $29,130. Alternatively $129,130 - $100,000 separate income = $29,130.
Cash 16,000Investment in Stoco 16,000To record receipt of 80% of Stoco’s dividends.
Dividends 5,000To eliminate dividends on stock that was constructively retired and to adjust the investment in Stoco account for the transfer equal to 10% of Panco’s dividends.
a Income from Panco 14,348Dividends 5,000Investment in Panco 9,348To eliminate investment income and dividends from Panco and return the investment account to its beginning-of-the-period balance.
b Investment in Stoco 80,000Investment in Panco 80,000To eliminate investment in Panco balance and increase the investment in Stoco for the constructive retirement of Panco’s stock that was charged to the investment in Stoco account.
c Dividends 5,000Investment in Stoco 5,000To eliminate dividends.
d Income from Stoco 29,130Dividends 16,000Investment in Stoco 13,130To eliminate income and dividends from Stoco and return the investment in Stoco to its beginning-of-the-period balance.
e Capital stock — Stoco 150,000Retained earnings — Stoco 100,000Patent 12,500
Investment in Stoco 208,000Noncontrolling interest 54,500To eliminate Stoco’s equity account balances and the investment in Stoco, enter beginning-of-the-period patent and noncontrolling interest.
f Noncontrolling interest share 10,870Dividends 4,000Noncontrolling Interest 6,870To record the noncontrolling interest share of subsidiary income and dividends.