Slide CHAPTER 3 PARTIALLY OWNED CREATED SUBSIDIARIES

Slide FOCUS OF CHAPTER 3 l Partially Owned Created Subsidiaries n Preparing Consolidated Statements: s The Cost Method s The Equity Method l Control Other Than by Owning a Majority Voting Interest l Unconsolidated Subsidiaries--Ways to Value the Parent’s Investment l Taxation of domestic subsidiaries.

Slide Proportional vs. Full Consolidation: At Opposite Ends of the Spectrum

Slide Parent Company Concept vs. Economic Unit Concept: Not Much Difference for “Created “ Subsidiaries

Slide Control by Other Means: A Classic Substance vs. Form Issue l Ways to Control Without Having a Majority Voting Interest--A HIGHLY JUDGMENTAL AREA: n Having stock options exercisable at will that can result in majority ownership. n Lending arrangements--borrower’s powers are severely restricted. l Safest Course of Action If Publicly Owned: n Run it by the SEC (some try to slide it by).

Slide Unconsolidated Subsidiaries: 100% Ownership Situations l Permissible Valuation Methods (for when control has been lost ) : n Equity Method --but ONLY IF significant influence exists. n Cost Method --makes sense to use when realization of sub’s expected future earnings is doubtful. s The default method if NO significant influence exists.

Slide Unconsolidated Subsidiaries: Partial Ownerships--NCI Shares Are NOT Publicly Traded l Permissible Valuation Methods (for when control has been lost ) : n Equity Method --but ONLY IF significant influence exists. n Cost Method. s The default method if NO significant influence exists.

Slide Unconsolidated Subsidiaries: Partial Ownerships--NCI Shares ARE Publicly Traded l Permissible Valuation Methods (for when control has been lost ) : n Equity Method --but ONLY IF significant influence exists. n Fair Value Method (the new kid) -- must use if significant influence does NOT exist. WSJ--12/31/04....”33 7/8” Look for a new kid on the block.

Slide Review Question #1 l Which of the following is NOT permitted under GAAP? A. The economic unit concept. B. The parent company concept. C. Full consolidation. D. Proportional consolidation. E. None of the above.

Slide Review Question #1--With Answer l Which of the following is NOT permitted under GAAP? A. The economic unit concept. B. The parent company concept. C. Full consolidation. D. Proportional consolidation. E. None of the above.

Slide Review Question #2 l The noncontrolling interest (NCI) is reported OUTSIDE consolidated stockholders’ equity under: A. The economic unit concept. B. The parent company concept. C. Full consolidation. D. Proportional consolidation. E. None of the above.

Slide Review Question #2--With Answer l The noncontrolling interest (NCI) is reported OUTSIDE consolidated stockholders’ equity under: A. The economic unit concept. B. The parent company concept. C. Full consolidation. D. Proportional consolidation. E. None of the above.

Slide Review Question #3 l The noncontrolling interest (NCI) is reported AS PART OF consolidated stockholders’ equity under: A. The economic unit concept. B. The parent company concept. C. Full consolidation. D. Proportional consolidation. E. None of the above.

Slide Review Question #3--With Answer l The noncontrolling interest (NCI) is reported AS PART OF consolidated stockholders’ equity under: A. The economic unit concept. B. The parent company concept. C. Full consolidation. D. Proportional consolidation. E. None of the above.

Slide Review Question #4 l On 1/1/04, Parco invested $900,000 in Sarco (90%-owned). For 2004, Sarco: (1) earned $60,000, (2) declared dividends of $50,000, and (3) paid dividends of $40,000. What amounts does Parco report? Cost Equity Investment income for Investment in Sarco at Y/E Retained earnings increase

Slide Review Question #4--With Answer l On 1/1/04, Parco invested $900,000 in Sarco (90%-owned). For 2004, Sarco: (1) earned $60,000, (2) declared dividends of $50,000, and (3) paid dividends of $40,000. What amounts does Parco report? Cost Equity Investment income for Investment in Sarco at Y/E Retained earnings increase $45,000 $54,000 $900,000 $909,000 $45,000 $54,000

Slide Review Question #5 l On 1/1/04, Parco invested $900,000 in Sarco (90%-owned) and NCI shareholders invested $100,000. For 2004, Sarco: (1) earned $60,000, (2) declared dividends of $50,000, and (3) paid dividends of $40,000. What amounts does Parco report for the items below? NCI in net income for ……. _________ NCI in net assets at 12/31/04….. _________ Con. retained earnings increase.. _________

Slide Review Question #5--With Answer l On 1/1/04, Parco invested $900,000 in Sarco (90%-owned) and NCI shareholders invested $100,000. For 2004, Sarco: (1) earned $60,000, (2) declared dividends of $50,000, and (3) paid dividends of $40,000. What amounts does Parco report for the items below? NCI in net income for ……. $ 6,000 NCI in net assets at 12/31/04….. $101,000 Con. retained earnings increase.. $54,000

Slide Review Question #6 l A 100%-owned subsidiary is NOT consolidated. The parent could definitely NOT use: A. The cost method B. The equity method. C. The lower of cost or market method. D. The fair market value method. E. None of the above.

Slide Review Question #6--With Answer l A 100%-owned subsidiary is NOT consolidated. The parent could definitely NOT use: A. The cost method B. The equity method. C. The lower of cost or market method. D. The fair market value method. E. None of the above.

Slide Review Question #7 l A LESS THAN 100%-owned subsidiary is NOT consolidated--the NCI shares ARE publicly traded. The parent definitely could NOT use: A. The cost method B. The equity method. C. The fair market value method. D. None of the above.

Slide Review Question #7--With Answer l A LESS THAN 100%-owned subsidiary is NOT consolidated--the NCI shares ARE publicly traded. The parent definitely could NOT use: A. The cost method B. The equity method. C. The fair market value method. D. None of the above.

Slide End of Chapter 3 (Appendix material follows) l Time to Clear Things Up-- Any Questions?

Slide Appendix: Domestic Subs: Recording Taxes at Parent Level on Sub’s Income l Double vs. Triple Taxation--Ways to Easily Avoid the THIRD Tax: n Own 80% or More of Sub’s Stock: s Can file a consolidated tax return or s File separate tax returns-- parent uses a dividend received deduction of 100%. Sub files its own IRS Form 1120

Slide Appendix: Consolidated Tax Returns-- Advantages Versus Disadvantages l Major Advantages : n Can offset X’s LOSS against Y’s INCOME. n Can offset X’s CAPITAL LOSS against Y’s CAPITAL GAIN. n Avoids Sec. 482 transfer pricing problems. l Major Disadvantages : n X’s loss on intercompany sale is deferred. n Complexity.

Slide Appendix: Domestic Subs: Less Than 80% Ownership Situations l Triple Taxation CANNOT be Entirely Avoided: n Dividend received deduction is only 80%. n FASB: Parent must record any triple tax in the year in which sub earns its income-- NO EXCEPTIONS ARE ALLOWED FOR DOMESTIC SUBSIDIARIES. Sub must file its own IRS Form 1120