© Pearson Education, Inc. publishing as Prentice Hall9-1 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 Hall9-2 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 Hall9-3 1: Indirect Holdings Indirect and Mutual Holdings

© Pearson Education, Inc. publishing as Prentice Hall9-4 Father-Son-Grandson Parent owns 80% of A, and through A, 56% of B (80% x 70%). Types of Indirect Holdings Connecting Affiliates 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. 70% 80% 20% 80% 40%

© Pearson Education, Inc. publishing as Prentice Hall9-5 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 Hall9-6 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: PoeShawTurk Separate earnings Dividends603020

© Pearson Education, Inc. publishing as Prentice Hall9-7 Equity Method Entries Shaw applies equity method (70%): Cash14 Investment in Turk 14 for dividends Investment in Turk28 Income from Turk 28 for income Poe applies equity method (80%): Cash24 Investment in Shaw 24 for dividends Investment in Shaw62.4 Income from Shaw 62.4 for income 80%(50+28)

© Pearson Education, Inc. publishing as Prentice Hall9-8 Allocations to CI and NCI This allocation may look like the "step- down method" allocation presented in cost accounting texts. Mathematically it is! PoeShawTurkCINCITotal Separate income Allocate: Turk ==> 70% Shaw: 30% NCI 28.0(40.0) 12.0 Shaw ==> 80% Poe: 20% NCI62.4(78.0) 15.6 Poe's ==> CI(162.4) Total consolidated income

© Pearson Education, Inc. publishing as Prentice Hall9-9 Allocation Results PoeShawTurkCINCITotal Separate income Allocate: Turk ==> 70% Shaw: 30% NCI 28.0 (40.0) 12.0 Shaw ==> 80% Poe: 20% NCI 62.4 (78.0) 15.6 Poe ==> CI(162.4) Total consolidated income 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 = = $27.6

© Pearson Education, Inc. publishing as Prentice Hall9-10 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. Intercompany profit transactions: –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. PetSalTy Separate income Dividends402010

© Pearson Education, Inc. publishing as Prentice Hall9-11 Calculating Investment Balances Sal: Underlying equityJan 1Dec 31 Capital stock200 Retained earnings5069 Goodwill12 Unrealized profit in inventory(5) Subtotal (split 70:30)276 Unrealized profit on land(10) Total Investment in Sal (70%) * (70% x 276) - 10 = Noncontrolling interest (30%) * 30% x 276 = 82.8 Ty: Underlying equityJan 1Dec 31 Capital stock100 Retained earnings8090 Goodwill12 Total Investment in Ty (60%) Investment in Ty (20%) Noncontrolling interest (20%)

© Pearson Education, Inc. publishing as Prentice Hall9-12 PetSalTyCINCITotal Separate income Unrealized $5 profit on inventory (upstream) (5) Unrealized $10 gain on land (downstream) (10) Allocate: Ty ==> 60% Pet: 20% Sal: 20% NCI (20.0) 4.0 Sal ==> 70% Pet: 30% NCI 23.8(34.0) 10.2 Pet ==> CI (95.8) 95.8 Total consolidated income Dividend distributions: Ty ==> 60% Pet: 20% Sal: 20% NCI 62(10) 2 Sal ==> 70% Pet: 30% NCI 14(20) 6 Pet ==> CI (40) 40 Sal's Income from Ty = $4.0 Pet's Income from Ty = $12.0 Pet's Income from Sal = $ $10 unrealized gain = $13.8

© Pearson Education, Inc. publishing as Prentice Hall9-13 Worksheet Entries Sales15.0 Cost of sales 15.0 Cost of sales5.0 Inventory 5.0 Gain on sale of land10.0 Land 10.0 Income from Ty16.0 Dividends 8.0 Investment in Ty 8.0 both Sal's and Pet's Noncontrolling interest share (Ty)4.0 Dividends 2.0 Noncontrolling interest (Ty) 2.0

© Pearson Education, Inc. publishing as Prentice Hall9-14 Income from Sal13.8 Investment in Sal0.2 Dividends 14.0 including 10 unrealized gain on land Noncontrolling interest share (Sal)10.2 Dividends 6.0 Noncontrolling interest (Sal) 4.2 Capital stock (Ty)100.0 Retained earnings (Ty)80.0 Goodwill12.0 Investment in Ty (Sal & Pet) Noncontrolling interest (Ty) 38.4 Capital stock (Sal)200.0 Retained earnings (Sal)50.0 Goodwill12.0 Investment in Sal Noncontrolling interest (Sal) 78.6

© Pearson Education, Inc. publishing as Prentice Hall9-15 Consolidation Worksheet Income statement:PetSalTyDRCRConsol Sales Income from Sal Income from Ty Gain on land Cost of sales(100.0)(80.0)(50.0) (220.0) Other expenses(40.0)(35.0)(30.0) (105.0) Noncontrolling interest share Controlling interest share

© Pearson Education, Inc. publishing as Prentice Hall9-16 Statement of retained earnings:PetSalTyDRCRConsol Beginning retained earnings Add net income Deduct dividends(40.0)(20.0)(10.0) (40.0) Ending retained earnings Balance sheet:PetSalTyDRCRConsol Other assets Inventories Plant assets, net Investment in Sal (70%) Investment in Ty (60%, 20%) Goodwill Total

© Pearson Education, Inc. publishing as Prentice Hall9-17 PetSalTyDRCRConsol Liabilities Capital stock Retained earnings Noncontrolling interest Total

© Pearson Education, Inc. publishing as Prentice Hall9-18 2: Mutual Holdings Indirect and Mutual Holdings

© Pearson Education, Inc. publishing as Prentice Hall9-19 Parent Mutually Owned Parent owns 80% of A, and through A, has 8% (80% x 10%) of its own (treasury) stock. Types of Mutual Holdings Connecting Affiliates Mutually Owned 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. 10% 80% 20% 80% 40%

© Pearson Education, Inc. publishing as Prentice Hall9-20 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 Hall9-21 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 Hall9-22 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 Hall9-23 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 Hall9-24 Pace Uses Treasury Stock Method Allocations of income to CI and NCI: Controlling interest share $95.7 Noncontrolling interest share $4.3 Pace's Income from Salt $38.7 – 3.0 = $35.7 PaceSaltCINCITotal Separate Income Parent dividends(3.0)3.0 Allocate: Salt => 90%:10%38.7(43.0) 4.3 Pace => 100%95.7 Totals

© Pearson Education, Inc. publishing as Prentice Hall9-25 Pace's Equity Method Entries Cash18.0 Investment in Salt 18.0 for dividends Investment in Salt38.7 Income from Salt 38.7 for income Income from Salt3.0 Dividends 3.0 for Pace dividends paid to Salt Dividends27.0 Income from Salt3.0 Cash 30.0 In place of the last entry, the Pace could record its dividend directly as:

© Pearson Education, Inc. publishing as Prentice Hall9-26 Worksheet Entries Income from Salt35.7 Dividends 18.0 Investment in Salt 17.7 Noncontrolling interest share4.3 Dividends 2.0 Noncontrolling interest 2.3 Common stock200.0 Retained earnings130.0 Investment in Salt Noncontrolling interests 33.0 Treasury stock70.0 Investment in Pace 70.0

© Pearson Education, Inc. publishing as Prentice Hall9-27 Parent Mutually Held - Data Pace2 owns 90% of Salt2 acquired at fair value equal to cost, no goodwill. Salt owns 10% of Pace. At the start of 2010: Investment in Salt2, $226,154 Noncontrolling interest, $33,846 Salt2's total stockholders' equity –Common stock $200,000 –Retained earnings $130,000 During 2010, Separate income: Pace2 $60,000, Salt2 $40,000 Dividends: Pace2 $30,000, Salt2 $20,000 Investment and noncontrolling interest = 226, ,846 equals underlying equity less mutual holding = 200, ,000 – 70,000.

© Pearson Education, Inc. publishing as Prentice Hall9-28 Solved, substituting 2 nd equation into 1 st : P = 105,495 S = 50,550 CI share = 94,945 NCI share = 5,055 Pace2 Uses Conventional Method Allocation information: Equations: P = $60, S S = $40, P CI share =.9P NCI share =.1S Pace2Salt2CINCITotal Separate Income$60,000$40,000 $100,000 Salt2's allocation.90S.10S Pace2's allocation.10P.90P Conventional method is analogous to reciprocal cost allocation method.

© Pearson Education, Inc. publishing as Prentice Hall9-29 Note on Results: Results: P = 105,495 S = 50,550 CI = 94,945 NCI = 5,055 CI + NCI = $100,000, the total separate income Pace2's Income from Salt2 =.9S -.1P = $34,945 90% of Salt's income – 10% mutual holding CI = Pace2's separate income + Income from Salt2 $60,000 + $34,945 = $94,945 (as a check!)

© Pearson Education, Inc. publishing as Prentice Hall9-30 Pace2's Equity Method Entries Cash18,000 Investment in Salt2 18,000 for dividends Investment in Salt237,945 Income from Salt2 37,945 for income Income from Salt23,000 Dividends 3,000 for Pace2 dividends paid to Salt2

© Pearson Education, Inc. publishing as Prentice Hall9-31 Worksheet Entries - Conventional Income from Salt234,945 Dividends 18,000 Investment in Salt2 15,945 Noncontrolling interest share5,055 Dividends 2,000 Noncontrolling interest 3,055 Common stock200,000 Retained earnings130,000 Investment in Salt2 296,154 Noncontrolling interests 33,846 Investment in Salt270,000 Investment in Pace270,000

© Pearson Education, Inc. publishing as Prentice Hall9-32 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 Hall9-33 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: PolySethUno Separate income112,00051,00040,000 Dividends50,00030,00020,000

© Pearson Education, Inc. publishing as Prentice Hall9-34 Allocate income to CI and NCI Equations: P = 112, S S = 51, U U = 40, S CI = 1P NCI =.3U +.1S 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, ,495 = 23,043 Allocation Info. PolySethUnoCINCITotal Separate income112,00051,00040, ,000 Uno's allocation =>.7U.3U Seth's allocation =>.8S.1S Poly's allocation => 1.0P

© Pearson Education, Inc. publishing as Prentice Hall9-35 A Look at the Results Results: U = 48,495 S = 84,946 P = 179,957 CI share = 179,957 NCI share = 14, ,495 = 23,043 Consolidated income CI and NCI shares = 203,000, total separate income. Intercompany income Poly's Income from Seth =.8S = 67,957 Seth's Income from Uno =.7U = 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 Hall9-36 Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.