3. Indirect and Mutual Holdings Pertemuan 15-16 Mata kuliah: F0074 - Akuntansi Keuangan Lanjutan II Tahun: 2010

4. Affiliation Structures The potential complexity of corporate affiliation structure is limited only by one’s imagination.

5. Direct Holdings Parent Subsidiary A 80%

6. Direct Holdings Parent Subsidiary B 70% Subsidiary A 80% Subsidiary C 90%

7. Indirect Holdings Parent Subsidiary A 80% Subsidiary B 70%

8. Indirect Holdings Parent Subsidiary A Subsidiary B 80% 20% 40%

9. Mutual Holdings Parent Subsidiary A 80%10%

10. Mutual Holdings Parent Subsidiary A Subsidiary B 80%20% 40% 20%

11. 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.

12. Father-Son-Grandson Structure Other assets$400$195$190 Investment in Shaw: (80%) 200 – – Investment in Turk: (70%) – 105 – $600$300$190 Liabilities$100$ 50$ 40 Capital stock 400 200 100 Retained earnings 100 50 50 $600$300$190 (in thousands) PoeShaw Turk Separate earnings$100$ 50$ 40 Dividends$ 60$ 30$ 20

13. 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

14. Computational Approaches for Consolidated Net Income Combined separate earnings: Poe$100,000 Shaw 50,000 Turk 40,000$190,000 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 – 27,600 Poe’s net income and consolidated net income$162,400

15. Computational Approaches for Consolidated Net Income (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$162.4 Minority interest expense$ 15.6$ 12.0

16. Indirect Holdings – Connecting Affiliates Structure Pet 20% Sal 70% Ty 60%

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

18. 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.

19. Accounting for Connecting Affiliates (in thousands) Pet Sal Ty Separate earnings$70.0$35.0$20.0 Deduct unrealized profit–10.0– 5.0 – Separate realized earnings$60.0$30.0$20.0 Allocate Ty’s income: 20% to Sal –+ 4.0– 4.0 60% to Pet+12.0 ––12.0 Allocate Sal’s income: 70% to Pet+23.8–23.8 – Consolidated net income$95.8 Minority interest expense$10.2$ 4.0

20. Accounting for Connecting Affiliates Cash 6,000 Investment in Ty 6,000 To record dividends received from Ty Investment in Ty12,000 Income from Ty12,000 To record income from Ty

21. Accounting for Connecting Affiliates 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

22. Accounting for Connecting Affiliates Cash14,000 Investment in Sal14,000 To record dividends received from Sal Investment in Sal13,800 Income from Sal13,800 To record income from Sal

23. Accounting for Connecting Affiliates Pet’s investmentInvestment Investment accounts 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

24. Learning Objective 2 Apply consolidated procedures of indirect holdings to the special case of mutual holdings.

25. 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.

26. Mutual Holding – Parent Stock Held by Subsidiary Treasury Stock Approach Conventional Approach

27. 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.

28. Mutual Holding – Parent Stock 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%) – 70,000 Expenses 70,000 50,000 $820,000$380,000 Credits Capital stock, $10 par$500,000$200,000 Retained earnings 200,000 100,000 Sales 120,000 80,000 $820,000$380,000 Debits Other assets$480,000$260,000 Investment in Salt (90%) 270,000 – Investment in Pace (10%) – 70,000 Expenses 70,000 50,000 $820,000$380,000 Credits Capital stock, $10 par$500,000$200,000 Retained earnings 200,000 100,000 Sales 120,000 80,000 $820,000$380,000

29. Treasury Approach: Working Papers December 31, 2005 Adjustments/ Consol- Pace Salt Eliminations idated Sales Investment income Expenses Minority 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

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

31. Treasury Approach: Working Papers December 31, 2006 Adjustments/ Consol- Pace Salt Eliminations idated 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 $140 35.7 (80) $ 95.7 $277 (27) 95.7 $345.7 $100 3 (60) $ 43 $130 (20) 43 $153 a 35.7 a 3 d 4.3 b 130 a 18 d 2 $240 (140) (4.3) $ 95.7 $277 (27) 95.7 $345.7 Income Statement

32. Treasury Approach: Working Papers December 31, 2006 Other assets Investment in Salt (90%) Investment in Pace (10%) Capital stock – Pace Capital stock – Salt Retained earnings Treasury stock Minority interest $528 317.7 $845.7 $500 345.7 $845.7 $283 70 $353 $200 153 $353 a 20.7 b 297 c 70 b 200 c 70 b 33 d 2.3 $811 $500 345.7 (70) 35.3 $811 Balance Sheet Adjustments/ Consol- Pace Salt Eliminations idated

33. 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.

34. Conventional Approach Capital stock$500,000$450,000 Retained earnings 200,000 180,000 Stockholders’ equity$700,000$630,000 January 1, 2005Pace Consolidated

35. Conventional Approach January 1, 2005 Investment in Salt270,000 Cash270,000 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

36. 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

37. Allocation of Mutual Income P = $50,000 + 0.9($30,000 + 0.1P) P = $50,000 + $27,000 + 0.09P 0.91P = $77,000  P = $84,615 S = $30,000 + 0.1($84,615) S = $30,000 + $8,462 = $38,462

38. Allocation of Mutual Income P S Total Before allocation:$50,000$30,000$ 80,000 After allocation:$84,615$38,462$123,077

39. 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

40. Accounting for Mutual Income ($38,462 × 90%) – ($84,615 × 10%) = $26,154 How does Pace record its investment income? Investment in Salt26,154 Income from Salt26,154 To record income from Salt

41. Conventional Approach: Working Papers December 31, 2005 Adjustments/ Consol- PaceSalt Eliminations idated Sales Investment income Expenses Minority 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

42. Conventional Approach: Working Papers December 31, 2005 Other assets Investment in S Investment in P Capital stock – P Capital stock – S Retained earnings Minority interest $480,000 226,154 $756,154 $450,000 256,154 $706,154 $260,000 70,000 $330,000 $200,000 130,000 $330,000 a 70,000 b 26,154 c 270,000 a 70,000 c 200,000 b 30,000 d 3,846 $740,000 $450,000 256,154 33,846 $740,000 Balance Sheet Adjustments/ Consol- PaceSaltEliminations idated

43. Conversion to Equity Method on Separate Company Book P S Total Separate 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+ 21,000 Increase in net assets$ 98,000 $ 53,000$ 151,000

44. Conversion to Equity Method on Separate Company Book P = $98,000 + 0.9S S = $53,000 + 0.1P P = $98,000 + 0.9($53,000 + 0.1P) = $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

45. Subsidiary Stock Mutually Held The mutually held stock involves subsidiaries holding the stock of each other, and the treasury stock approach is not applicable.

46. Subsidiary Stock Mutually Held Poly Seth Uno 70%10% 80%

47. 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).

48. 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.

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

50. Subsidiary Stock Mutually Held 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