Advanced accounting 10th by a beams athony ch10

Chapter 10: Subsidiary Preferred Stock, Consolidated Earnings Per Share, and Consolidated Income Taxation 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 © 2009 Pearson Education, Inc publishing as 10-1 Preferred Stock, EPS, and Taxes: Objectives Modify consolidation procedures for subsidiary companies with preferred stock in their capital structure Calculate basic and diluted earnings per share for a consolidated reporting entity Understand the complexities of accounting for income taxes by consolidated entities © 2009 Pearson Education, Inc publishing as 10-2 Subsidiary Preferred Stock, Consolidated Earnings Per Share, and Consolidated Income Taxation 1: Preferred Stock © 2009 Pearson Education, Inc publishing as 10-3 Subsidiary Preferred Stock Subsidiary preferred stock – – Doesn't change consolidation in principle Does impact calculations • • • Common stockholders' equity = total equity less preferred stock at book value Income of subsidiary is first allocated to preferred shareholders, then CI and NCI Subsidiary dividend payments must consider payments to preferred shareholders before common shareholders © 2009 Pearson Education, Inc publishing as 10-4 Who Holds Preferred Stock? Preferred stock is held by outsiders • Preferred stock is a noncontrolling interest Preferred stock is held by parent • May choose between – – Constructive retirement Cost basis © 2009 Pearson Education, Inc publishing as 10-5 Review of Preferred Stock Characteristics • Callable, redeemable • Cumulative or noncumulative • Participative or nonparticipative • Limited voting rights Most is cumulative and nonparticipating Book Value of PS is: Call or redemption price (par value if neither) Plus Dividends in arrears (if cumulative) Income allocated to PS is: Current period dividend • Irrespective of amount declared, if cumulative • Declared amount if noncumulative • Potentially more if participative Preferred stock dividend is: Face value x dividend rate • Also consider: • Arrearage • Participation © 2009 Pearson Education, Inc publishing as 10-6 Example: PS Held by Outsiders Poe buys 90% of Sol for $396 when Sol's equity consists of $100 preferred stock, $200 common stock, $40 other paid in capital and $160 retained earnings The preferred stock is cumulative, nonparticipating, carries a 10% dividend and is callable at 105% of par value There is no arrearage During the year, Sol earns $50 and pays $30 in dividends © 2009 Pearson Education, Inc publishing as 10-7 Calculations for Preferred Stock Cost of 90% of Sol   $396 Implied value of Sol   $440 Sol's total equity $500   Less book value of preferred stock (105)   Book value of common   395 Excess, goodwill   $45 The book value of preferred is its call price (no arrearage), 105%($100 par value) Dividends are cumulative, so the current dividend is $10 = 10%($100 par value) © 2009 Pearson Education, Inc publishing as 10-8 Allocations Income allocation: Sol's net income Amortizations Income to allocate Allocated to preferred Allocated to common   Dividends Allocated to preferred Allocated to common   50 50 (10) 40   30 (10) 20 NCI share – Preferred $10 income $10 dividend CI share (90%) NCI share (10% common) $4 income $2 dividend $36 income $18 dividend © 2009 Pearson Education, Inc publishing as 10-9 Worksheet Entries with Preferred Stock Held by Outsiders There is an entry for NCI share, PS that parallels the entry for NCI share, CS Preferred Stock is eliminated Income from Sol Dividends Investment in Sol Noncontrolling interest share, CS Dividends Noncontrolling interest, CS Noncontrolling interest share, PS Dividends Preferred stock Common stock Other paid in capital Retained earnings Goodwill Investment in Sol Noncontrolling interest, CS Noncontrolling interest, PS © 2009 Pearson Education, Inc publishing as 36       18 18       2 10     100 200 40 160 45       10           396 44 105 10-10 Subsidiary Options and Bonds Convertible into Parent CS Syd's net income is $450 and it has 400 shares of common outstanding all year Options: Syd has options that convert into 60 shares of its parent's (Paddy) common stock at $10 per share The average market price is $15 Convertible bonds: Syd has $1,000 par bonds convertible into 80 shares of Paddy's common stock The bonds were issued at par to yield 7% The effective tax rate is 34% © 2009 Pearson Education, Inc publishing as 10-28 Parent's Data and Basic EPS Paddy has $1,800 income and 1,000 shares of common stock outstanding all year It has no preferred stock or dilutive securities Paddy's basic EPS: $1,800 / 1,000 shares = $1.80 © 2009 Pearson Education, Inc publishing as 10-29 Parent's Diluted EPS Impact of Syd's options for Paddy common: • Numerator: none • Denominator: 60 + (60 x $10/$15) = 20 shares Impact of Syd's bonds convertible to Paddy common: • Numerator: 7% x $1,000 x (1-34%) = $46.2 • Denominator: 80 shares Paddy's diluted EPS: $1,800 + + $46.2 = $1.76 1,000 + 20 + 80 © 2009 Pearson Education, Inc publishing as 10-30 Subsidiary Preferred Stock, Consolidated Earnings Per Share, and Consolidated Income Taxation 3: Income Taxes © 2009 Pearson Education, Inc publishing as 10-31 Consolidated Tax Return • Advantages • Disadvantages – – – Offset affiliate losses (excluding preacquisition loss carry forwards) Exclude intercompany dividends Defer intercompany profits until realized (losses are also deferred) – – Loss of flexibility Difficult to switch back to unconsolidated • Cannot file as consolidated again for years © 2009 Pearson Education, Inc publishing as 10-32 Income Tax Allocation • Permanent differences • Temporary difference – – – – Dividends from affiliates are excluded from taxable income Dividends from affiliates that are not members of the affiliated group are allowed an 80% dividends received deduction Undistributed income from domestic affiliates (FASB Statement No 109) Undistributed income from foreign affiliates and from domestic affiliated earnings preceding FASB Statement No 109 may be permanent © 2009 Pearson Education, Inc publishing as 10-33 Undistributed Earnings Parson owns 30% of Seaton's common stock • Seaton's income, $600 • Seaton's dividends, $200 • Parson's applicable tax rate = 34% Parson's deferred tax liability = [30%($600 - $200)] x 20% x 34% = $8.16 Seaton's earnings are allowed the 80% deduction, so only 20% is subject to tax If Seaton was a consolidated subsidiary, its earnings would be excluded and Parson would have no deferred tax liability © 2009 Pearson Education, Inc publishing as 10-34 Unrealized Profits and Losses • Separate tax returns – – Unrealized gains (losses) are taxed (deducted) in the separate returns Consolidation procedures • • • • Remove the unrealized gain (loss) Record a deferred tax asset (liability) Tax effect impacts the income tax expense of the selling affiliate Consolidated tax return – Unrealized gains (losses) are excluded © 2009 Pearson Education, Inc publishing as 10-35 Example Pool owns 90% of Sal The tax rate is 34% Pretax operating income of Pool and Sal are $150 and $50 Sal paid dividends of $20 and Sal's dividends are subject to the 100% exclusion During the year, intercompany sales were $50 and there remains $10 in unrealized profits in ending inventory © 2009 Pearson Education, Inc publishing as 10-36 Consolidated Tax Return Downstream sales • Pool's income $150 - $10 = $140 • Sal's income $50 • Consolidated taxes ($140 + $50) x 34% = $64.6 – Allocate (140/(140+50)) x $64.6 = $47.6 to Pool (50/(140+50)) x $64.6 = $17.0 to Sal Upstream sales • Pool's income $150 • Sal's income $50 - $10 = $40 • Consolidated taxes ($150 + $40) x 34% = $64.6 – Allocate (150/(150+40)) x $64.6 = $51.0 to Pool (40/(150+40)) x $64.6 = $13.6 to Sal © 2009 Pearson Education, Inc publishing as 10-37 Entries with Consolidated Return Pool and Sal would each record their own share of the income tax expense and income tax payable The unrealized profit does not give rise to any temporary differences – – – Deferred for consolidation purposes Deferred for tax purposes That is, it is not income now and it is not taxed now! No special considerations for consolidation worksheet © 2009 Pearson Education, Inc publishing as 10-38 Separate Tax Returns Downstream sales • Pool's accounting income $150 - $10 = $140 – Pool's taxes payable $150 x 34% = $51.0 – Pool's deferred taxes $10 x 34% = $3.4 – Income tax expense $47.6 • Sal's income $50 – Sal's taxes $50 x 34% = $17.0 Upstream sales • Pool's income $150 – Pool's taxes $150 x 34% = $51.0 • Sal's income $50 - $10 = $40 – Sal's taxes payable $50 x 34% = $17.0 – Sal's deferred taxes $10 x 34% = $3.4 – Sal's income tax expense $13.6 © 2009 Pearson Education, Inc publishing as 10-39 Business Combinations Tax free combinations – – – Mergers or consolidations Exchange of voting stock for another corporation's stock Exchange of voting stock for another corporation's assets Purchase acquisitions may be either – – Tax free Taxable © 2009 Pearson Education, Inc publishing as 10-40 Tax Free Business Combinations Tax free business combinations give rise to differences between book values and tax values At acquisition – – Assign assets value based on gross fair value Except • – – Goodwill, bargain purchase, deferred taxes, pension assets, leveraged leases Tax bases carry forward from predecessor Record deferred tax asset/liability for temporary differences © 2009 Pearson Education, Inc publishing as 10-41 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 © 2009 Pearson Education, Inc publishing as 10-42 ... capital and $160 retained earnings The preferred stock is cumulative, nonparticipating, carries a 10% dividend and is callable at 105% of par value There is no arrearage During the year, Sol earns... declared, if cumulative • Declared amount if noncumulative • Potentially more if participative Preferred stock dividend is: Face value x dividend rate • Also consider: • Arrearage • Participation... = 10%($100 par value) © 2009 Pearson Education, Inc publishing as 10-8 Allocations Income allocation: Sol's net income Amortizations Income to allocate Allocated to preferred Allocated to common