2. 9 - 1 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Indirect and Mutual Holdings Chapter 9

3. 9 - 2 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 1 Prepare consolidated statements when the parent company controls through indirect holdings.

4. 9 - 3 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Affiliation Structures The potential complexity of corporate affiliation structure is limited only by one’s imagination.

5. 9 - 4 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Direct Holdings Parent Subsidiary A 80%

6. 9 - 5 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Direct Holdings Parent Subsidiary B 70% Subsidiary A 80% Subsidiary C 90%

7. 9 - 6 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Indirect Holdings Parent Subsidiary A 80% Subsidiary B 70%

8. 9 - 7 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Indirect Holdings Parent Subsidiary A Subsidiary B 80% 20% 40%

9. 9 - 8 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Mutual Holdings Parent Subsidiary A 80%10%

10. 9 - 9 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Mutual Holdings Parent Subsidiary A Subsidiary B 80%20% 40% 20%

11. 9 - 10 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 11 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 12 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 13 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 14 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 15 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Indirect Holdings – Connecting Affiliates Structure Pet 20% Sal 70% Ty 60%

17. 9 - 16 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 17 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 18 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 19 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 20 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 21 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 22 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 23 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 2 Apply consolidated procedures of indirect holdings to the special case of mutual holdings.

25. 9 - 24 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 25 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Mutual Holding – Parent Stock Held by Subsidiary Treasury Stock Approach Conventional Approach

27. 9 - 26 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 27 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 28 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 29 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 30 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 31 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 32 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 33 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 34 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 35 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 36 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 37 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Allocation of Mutual Income P S Total Before allocation:$50,000$30,000$ 80,000 After allocation:$84,615$38,462$123,077

39. 9 - 38 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 39 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 40 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 41 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 42 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 43 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 44 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 45 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Subsidiary Stock Mutually Held Poly Seth Uno 70%10% 80%

47. 9 - 46 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 47 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 48 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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. 9 - 49 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 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

51. 9 - 50 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn End of Chapter 9