Chapter 9: Indirect and Mutual Holdings by Jeanne M David, Ph.D., Univ of Detroit Mercy to accompany Advanced Accounting, 10th edition by Floyd A Beams, Robin P Clement, Joseph H Anthony, and Suzanne Lowensohn © Pearson Education, Inc publishing as Prentice 9-1 Indirect and Mutual Holdings: Objectives Prepare consolidated statements when the parent company controls through indirect holdings Apply consolidation procedures of indirect holdings to the special case of mutual holdings © Pearson Education, Inc publishing as Prentice 9-2 Indirect and Mutual Holdings 1: Indirect Holdings © Pearson Education, Inc publishing as Prentice 9-3 Types of Indirect Holdings Father-Son-Grandson Connecting Affiliates Parent Parent 80% Subsidiary A 70% Subsidiary B Parent owns 80% of A, and through A, 56% of B (80% x 70%) 80% 20% Subsidiary A Subsidiary B 40% 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 © Pearson Education, Inc publishing as Prentice 9-4 Equity Method for Father-SonGrandson 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 9-5 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: Poe Shaw Turk Separate earnings Dividends 100 50 40 60 30 20 © Pearson Education, Inc publishing as Prentice 9-6 Equity Method Entries Shaw applies equity method (70%): Cash Investment in Turk for dividends 14 Investment in Turk Income from Turk for income 28 Poe applies equity method (80%): Cash Investment in Shaw for dividends 28 24 Investment in Shaw Income from Shaw for income 80%(50+28) © Pearson Education, Inc publishing as Prentice 14 24 62.4 62.4 9-7 Allocations to CI and NCI Poe Separate income 100.0 Allocate: Turk ==> 70% Shaw: 30% NCI Shaw ==> 62.4 80% Poe: 20% NCI Poe's ==> (162.4) CI Total consolidated income Shaw 50.0 Turk 40.0 28.0 (40.0) 12.0 15.6 (78.0) CI NCI Total 190.0 162.4 162.4 27.6 190.0 This allocation may look like the "stepdown method" allocation presented in cost accounting texts Mathematically it is! © Pearson Education, Inc publishing as Prentice 9-8 Allocation Results Poe Separate income 100.0 Allocate: Turk ==> 70% Shaw: 30% NCI Shaw ==> 62.4 80% Poe: 20% NCI Poe ==> (162.4) CI Total consolidated income Shaw 50.0 Turk 40.0 28.0 (40.0) 12.0 15.6 (78.0) CI NCI Total 190.0 162.4 162.4 27.6 190.0 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 = 12.0 + 15.6 = $27.6 © Pearson Education, Inc publishing as Prentice 9-9 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 Pet Sal Ty Intercompany profit transactions: 70 Separate income 35 20 – Downstream: Dividends Pet sold Sal land 40 with 20 a gain 10 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 © Pearson Education, Inc publishing as Prentice 9-10 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 9-22 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 9-23 Pace Uses Treasury Stock Method Allocations of income to CI and NCI: Pace Salt CI NCI Separate Income 60.0 40.0 Parent dividends (3.0) 3.0 Allocate: Salt => 90%:10% 38.7 (43.0) 4.3 Pace => 100% 95.7 95.7 •Totals 95.7 4.3 Controlling interest share $95.7 • Noncontrolling interest share $4.3 • Pace's Income from Salt $38.7 – 3.0 = $35.7 © Pearson Education, Inc publishing as Prentice Total 100.0 100.0 9-24 Pace's Equity Method Entries Cash Investment in Salt for dividends Investment in Salt Income from Salt for income Income from Salt Dividends for Pace dividends paid to Salt 18.0 18.0 38.7 38.7 3.0 3.0 In place of the last entry, the Pace could record its dividend directly as: Dividends Income from Salt Cash 27.0 3.0 © Pearson Education, Inc publishing as Prentice 30.0 9-25 Worksheet Entries Income from Salt Dividends Investment in Salt Noncontrolling interest share Dividends Noncontrolling interest Common stock Retained earnings Investment in Salt Noncontrolling interests Treasury stock Investment in Pace © Pearson Education, Inc publishing as Prentice 35.7 18.0 17.7 4.3 2.0 2.3 200.0 130.0 297.0 33.0 70.0 70.0 9-26 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 Investment and • Noncontrolling interest, $33,846 noncontrolling interest • Salt2's total stockholders' equity = 226,154 + 33,846 – Common stock $200,000 – Retained earnings $130,000 equals underlying equity less mutual holding During 2010, • Separate income: Pace2 $60,000, Salt2 $40,000 = 200,000 + 100,000 – • Dividends: Pace2 $30,000, Salt2 $20,00070,000 © Pearson Education, Inc publishing as Prentice 9-27 Pace2 Uses Conventional Method Allocation information: Pace2 Salt2 CI NCI Total Separate Income $60,000 $40,000 $100,000 Salt2's allocation 90S 10S Pace2's 10P substituting 90P Solved, 2nd allocation Equations: equation into 1st: P = $60,000 + 9S P = 105,495 S = $40,000 + 1P S = 50,550 CI share = 9P CI share = 94,945 NCI share = 1S NCI share = 5,055 Conventional method is analogous to reciprocal cost allocation method © Pearson Education, Inc publishing as Prentice 9-28 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 9-29 Pace2's Equity Method Entries Cash Investment in Salt2 for dividends Investment in Salt2 Income from Salt2 for income Income from Salt2 Dividends for Pace2 dividends paid to Salt2 18,000 © Pearson Education, Inc publishing as Prentice 18,000 37,945 37,945 3,000 3,000 9-30 Worksheet Entries - Conventional Income from Salt2 Dividends Investment in Salt2 Noncontrolling interest share Dividends Noncontrolling interest Common stock Retained earnings Investment in Salt2 Noncontrolling interests Investment in Salt2 Investment in Pace2 © Pearson Education, Inc publishing as Prentice 34,945 18,000 15,945 5,055 2,000 3,055 200,000 130,000 296,154 33,846 70,000 70,000 9-31 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 9-32 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: Separate income Dividends Poly Seth Uno 112,000 51,000 40,000 50,000 30,000 20,000 © Pearson Education, Inc publishing as Prentice 9-33 Allocate income to CI and NCI Allocation Info Separate income Poly Seth Uno CI NCI 112,000 51,000 40,000 Total 203,000 Uno's allocation => 7U 3U Seth's allocation => 8S 1S 1S Poly's allocation => Equations: P = 112,000 + 8S S = 51,000 + 7U U = 40,000 + 1S CI = 1P NCI = 3U + 1S Solving, substituting 2nd equation into 3rd (or 3rd into 2nd): U = 48,495 S = 84,946 P = 179,957 CI share = 179,957 NCI share = 14,548 + 8,495 = 23,043 1.0P © Pearson Education, Inc publishing as Prentice 9-34 A Look at the Results Results: U = 48,495 S = 84,946 P = 179,957 CI share = 179,957 NCI share = 14,548 + 8,495 = 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 9-35 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 Copyright © 2009 Pearson Education, Inc Publishing as Prentice Hall © Pearson Education, Inc publishing as Prentice 9-36 ... Holdings Father-Son-Grandson Connecting Affiliates Parent Parent 80% Subsidiary A 70% Subsidiary B Parent owns 80% of A, and through A, 56% of B (80% x 70%) 80% 20% Subsidiary A Subsidiary B 40% Parent... 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 Pet Sal Ty Intercompany profit transactions:... of Mutual Holdings Parent Mutually Owned Connecting Affiliates Mutually Owned Parent Parent 80% 10% Subsidiary A Parent owns 80% of A, and through A, has 8% (80% x 10%) of its own (treasury)