CH 10

Subsidiary Preferred Stock,
Consolidated Earnings per Share,

and Consolidated Income Taxation
Chapter 10
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
10 - 1
Learning Objective 1
Modify consolidation procedures
for subsidiary companies with
preferred stock in their
capital structure.
10 - 2
Subsidiaries with Preferred

Stock Outstanding
When
When preferred
preferred stock
stock has
has aa call
call or
or
redemption
redemption price,
price, this
this amount
amount isis used
used
in
in allocating
allocating the
the investees
investees equity
equity
to
to preferred
preferred stockholders.
stockholders.
10 - 3
Subsidiaries with Preferred

Stock Outstanding
1
IfIf there
there isis no
no redemption
redemption provision,
provision,
the
the equity
equity isis allocated
allocated on
on the
the basis
basis of
of
par
par value
value plus
plus any
any liquidation
liquidation premium.
premium.
Any
Any dividends
dividends in
in arrears
arrears on
on cumulative
cumulative
preferred
preferred stock
stock isis allocated
allocated to
to the
the
preferred
preferred stockholders.
stockholders.
10 - 4
Subsidiary With Preferred Stock

Not Held by Parent
Poe acquired a 90% interest in Sol
on January 1, 2004, for $395,500.
There were no preferred dividends
in arrears as of January 1, 2004.
During 2004, Sol had income of
$50,000 and paid $30,000 dividends.
Dividends were $20,000 on common
stock and $10,000 on preferred stock.
10 - 5

Not Held by Parent
Sols stockholders equity December 31, 2003
$10 preferred stock, $100 par,
cumulative, nonparticipating,
callable at $105 per share
$100,000
Common stock, $10 par
200,000
Other paid-in capital
40,000
Retained earnings
160,000
Total stockholders equity
$500,000
10 - 6

Not Held by Parent
Total Sol stockholders equity
Less: Preferred stockholders
equity (1,000 $105)
Common stockholders equity
$500,000
Price paid for 90% interest

Less: Book and fair value
acquired ($395,000 90%)
Goodwill
$395,500
105,000
$395,000
355,500
$ 40,000
10 - 7

Not Held by Parent
Sols stockholders equity December 31, 2004
Less: Preferred stockholders
equity (1,000 $105)
Common stockholders equity
$520,000
105,000
$415,000
10 - 8
Minority Interest in
Preferred Stock
Minority interest in Sol at December 31, 2004
$105,000 100% of preferred equity $105,000
$415,000 10% of common equity
41,500
Total
$146,500
10 - 9
Subsidiary Preferred Stock

Acquired by Parent
A parent companys purchase of the
outstanding preferred stock of a subsidiary
results in a retirement of the stock purchased
from the viewpoint of the consolidated entity.
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 10

Acquired by Parent
Sol Corporation experienced
a loss of $40,000 in 2005.
No dividends were paid.
What is Sols stockholders
equity at 12/31/2005?
$520,000 $40,000 = $480,000

Acquired by Parent
What is Poes share of this loss?
($40,000 + $10,000 income to preferred) 90%
What is Poes investment in Sol on 12/31/2005?


Acquired by Parent
1/1/2004
12/31/2004
1/1/2005
Poes Investment
395,500 18,000
36,000
413,500 45,000 loss
368,500
Dividends
12/31/2005
Constructive Retirement of
On January 1, 2006, Poe purchased 800 of Sols
preferred shares (80% interest) at $100 per share.
Sol reports net income of $20,000 for 2006.
$115,000 80% = $92,000 book value
$92,000 $80,000 = $12,000
Investment in Sol Preferred
Cash
To record purchase of stock
80,000
80,000
Investment in Sol Preferred

12,000
Other Paid-in Capital
12,000
To adjust other paid-in capital to reflect
constructive retirement
1/1/2004
12/31/2004
1/1/2005
Income
Poes Investment
395,500 18,000
36,000
413,500 45,000 loss
368,500
9,000
377,500
Dividends
12/31/2006
Calculated basic and diluted
earnings per share for a
consolidated reporting entity.
Parent Company and Consolidated

Earnings Per Share
GAAP requires that all firms calculate and
report basic and diluted (where applicable)
earnings per share (EPS).
Consolidated entities disclose (EPS)
on a consolidated basis.
Parent Company and Consolidated

Earnings Per Share
A parent companys net income and EPS
under the equity method are equal to
consolidated net income and consolidated EPS.
Parent Company procedures for computing EPS
depend on the subsidiarys capital structure.
General Format for EPS

Calculations
Numerator in Dollars ($)
Income to parents common stockholders
Add: Adjustments for parents dilutive securities
Add: Adjustments for subsidiarys potentially
dilutive securities convertible into parent
company stock
Replacement calculation
Deduct: Parents equity in subsidiarys
diluted earnings
Add: Parents equity in subsidiarys
diluted earnings
Parent's diluted earnings = a
A
$$$
+$
N/A
N/A
N/A
$$$
A: Subsidiary does not have potentially dilutive securities outstanding


Calculations
company stock
diluted earnings
diluted earnings
B
$$$
+$
N/A
$
+$
$$$
B: Subsidiary has potentially dilutive securities convertible into

subsidiary common stock

Calculations
company stock
diluted earnings
diluted earnings
C
$$$
+$
+$
N/A
N/A
$$$
C: Subsidiary has potentially dilutive securities convertible into

parent company common stock

Calculations
Denominator in Shares (Y)
Parents common shares outstanding
Add: Shares represented by parents
potentially dilutive securities
Add: Shares represented by subsidiarys
potentially dilutive securities convertible
into parent company common shares
Parents common shares and common
share equivalents = b
A
YYY
Parent Company and Consolidated Diluted EPS
ab
+Y
N/A
YYY
A: Subsidiary does not have potentially dilutive securities outstanding


Calculations
B
YYY
ab
+Y
N/A
YYY
B: Subsidiary has potentially dilutive securities convertible into

subsidiary common stock

Calculations
C
YYY
ab
+Y
+Y
YYY
C: Subsidiary has potentially dilutive securities convertible into

parent company common stock
Dilutive Securities of Subsidiary

Convertible into Subsidiary Shares
Diluted earnings of the parent company are
adjusted by excluding the parents equity in
subsidiary realized income and replacing
that equity with the parents share of
diluted earnings of the subsidiary.
Subsidiary With Convertible

Preferred Stock
Plant Corporation purchased 90% of Seed
Corporations outstanding voting common
stock for $328,000 on January 1, 2003.
During 2003, Seed reports $50,000 net
income and pays $25,000 dividends,
$10,000 to preferred and $15,000 to common.

Preferred Stock
January 1, 2003
Common stock, $5 par, 200,000
shares issued and outstanding
Common stock, $10 par,
20,000 shares outstanding
10% cumulative, convertible
preferred stock, $100 par,
1,000 shares outstanding
Retained earnings
Plant
Seed
$1,000,000
$200,000
500,000
$1,500,000
100,000
120,000
$420,000

Preferred Stock
Plants Income for 2003
Income from Plants operations
Income from Seed
($50,000 $10,000 preferred income) 90%
Plant net income
$150,000
36,000
$186,000

Convertible into Subsidiary
Common
Seeds preferred stock is convertible into
12,000 shares of Seeds common stock.
Neither Plant nor Seed has any other
potentially dilutive securities outstanding.
Seeds diluted EPS:
$50,000 (20,000 + 12,000) = $1.5625

Convertible into Subsidiary
Plants Diluted EPS Common
Net income of Plant
Replacement of Plants equity in Seeds
realized income ($40,000 90%)
with Plants equity in Seeds diluted
earnings (18,000 $1.5625)
Plants diluted earnings = a
$186,000
Plants outstanding shares = b

Plants diluted EPS = a b
200,000
$ 0.89
36,000
28,125
$178,125
Subsidiary Preferred Convertible

into Parent Company Common
Seeds preferred stock is convertible into
24,000 shares of Plants common stock.
Neither Plant nor Seed had other
potentially dilutive securities outstanding.
Seeds diluted EPS is $2 ($40,000 income
to common 20,000 common shares).
What is Plants diluted EPS?
Subsidiary Preferred Convertible

into Parent Company Common
Net income of Plant
Add: Income to preferred stockholders
of Seed assumed to be converted
Plants diluted earnings = a
Plants outstanding shares
Add: Seeds preferred shares
assumed converted
Plant common shares and common
stock equivalents = b
Plants diluted EPS = a b
$186,000
10,000
$196,000
200,000
24,000
224,000
$ 0.88
Subsidiary With Options

and Convertible Bonds
Paddys income 2003
Own operations
$1,500,000
Syds operations
$ 300,000
Syd is 80% owned by Paddy.
80% $450,000 Syd net income
80% $50,000 unrealized profit
Amortization
Income from Syd
$360,000
40,000
20,000
$300,000
Subsidiary With Options

and Convertible Bonds
Paddy: Common stock, 1,000,000 shares
Syd:
Common stock, 400,000 shares

Options to purchase 60,000 shares
of stock at $10 per share (average
market price is $15 per share)
7% convertible bonds, $1,000,000
par outstanding, convertible into
80,000 shares of common stock
Options and Bonds Convertible

into Subsidiary Common Stock
Syds income to common stockholders
Less: Unrealized profit on sale of land
Add: Net-of-tax interest expense assuming
bonds converted into subsidiary shares
($1,000,000 7% 66% net of tax)
Subsidiary adjusted earnings = a
$450,000
50,000
46,200
$446,200

Syds common shares outstanding
Incremental shares
60,000 ($600,000 $15)
Additional shares assuming bonds
converted into subsidiary shares
Syds adjusted shares = b
Syds diluted EPS = a b
($446,200 500,000)
400,000
20,000
80,000
500,000
$
0.89

Paddys income to common stockholders
Replacement of Paddys equity in
Syds realized income ($400,000 80%)
with Paddys equity in Syds
diluted EPS (320,000 $0.89)
Paddy adjusted earnings = a
$1,800,000
Paddy outstanding shares = b

Paddys diluted EPS = a b
1,000,000
$
1.76
320,000
284,800
$1,764,800

into Parents Common Stock
Paddys income to common stockholders

Add: Net-of-tax interest expense assuming
bonds were converted into shares
($1,000,000 7% 66% net-of-tax effect)
Paddys adjusted earnings = a
$1,800,000
46,200
$1,846,200

into Parents Common Stock
Paddys common shares outstanding
Incremental shares
60,000 ($600,000 $15)
Additional shares assuming bonds
are converted into parent shares
Paddys adjusted shares = b
Paddys diluted EPS = a b
($1,846,200 1,100,000)
1,000,000
20,000
80,000
1,100,000
$
1.68
Understand the complexities of
accounting for income taxes
by consolidated entities.
Accounting for Income Taxes

of Consolidated Entities
An
An affiliated
affiliated group
group exists
exists when
when aa common
common
parent
parent corporation
corporation owns
owns at
at least
least 80%
80% of
of the
the
voting
voting power
power of
of all
all classes
classes of
of stock
stock and
and 80%
80%
or
or more
more of
of the
the total
total value
value of
of all
all outstanding
outstanding
stock
stock of
of each
each of
of the
the includable
includable corporations.
corporations.
Accounting for Income Taxes

of Consolidated Entities
A
Aconsolidated
consolidated entity
entity that
that isis an
an
affiliated
affiliated group
group may
may elect
elect to
to file
file
consolidated
consolidated income
income tax
tax returns.
returns.
All
All other
other consolidated
consolidated entities
entities must
must
file
file separate
separate income
income tax
tax returns
returns for
for
each
each affiliated
affiliated company.
company.
Advantages of Filing
Consolidated Returns
1
Losses
Losses are
are offset
offset against
against income
income
between
between members.
members.
Intercorporate
Intercorporate dividends
dividends are
are
excluded
excluded from
from taxable
taxable income.
income.
Intercompany
Intercompany profits
profits are
are deferred
deferred
from
from income
income until
until realized.
realized.
Disadvantages of Filing
Consolidated Returns
1
Decrease
Decrease in
in flexibility.
flexibility.
Commitment
Commitment to
to consolidated
consolidated
returns
returns year
year after
after year.
year.
Deconsolidated
Deconsolidated corporations
corporations
cannot
cannot rejoin
rejoin the
the group
group for
for 55 years.
years.
Income Tax Allocation

FASB Statement No. 109, Accounting for
Income Taxes, is the primary source of
GAAP for accounting for income taxes.
Events that have future tax consequences
are designated temporary differences.
Income Tax Allocation

The objectives of accounting for
income taxes are to recognize the amount
of taxes payable or refundable for the
current year and to recognize deferred tax
liabilities and assets for the tax consequences
of events that have been recognized in the
financial statements or tax returns.
Accounting for Distributed

and Undistributed Income
Parson owns a 30% interest in Seaton
Corporation, a domestic corporation.
Seaton reports $600,000 net income
and pays dividends of $200,000.
The income tax rate is 34%.
What is Parsons share
of Seatons income?

Share of distributed earnings (dividends)
($200,000 30%)
Share of undistributed earnings
(retained earnings increase)
($400,000 30%)
Equity in Seatons earnings
$ 60,000
120,000
$180,000

The income tax expense equals income tax
liability for the dividends received.
$60,000 20% taxable 34% tax rate = $4,080
December 31, 2003
Income Tax Expense
8,160
Deferred Income Taxes
8,160
To provide for taxes on undistributed earnings
($120,000 20% 34% = $8,160)
Unrealized Gains and Losses

from Intercompany Transactions
Unrealized and constructive gains and losses create
temporary differences that may affect deferred tax
calculations when filing separate income tax returns.
This is not the case when filing consolidated returns.
Separate Company Tax Returns

with Intercompany Gain
Paco Corporation paid $375,000 for a 75%
interest in Step on January 1, 2003.
Steps equity consisted of $300,000 capital

stock and $200,000 retained earnings.

Paco had a deferred tax liability of
$10,200, consisting of $30,000 tax/book
depreciation differences that reverse in
equal ($7,500) amounts over the years.
On January 8, 2003, Paco sold equipment
to Step at a gain of $20,000.
Step is depreciating the equipment
over five years (S/L).

12/31/2003
Sales
Gain on equipment sale
Income from Step
Cost of sales
Operating expenses
Income tax expense
Net income
Add: Beginning retained earnings
Deduct: Dividends (December)
Retained earnings 12/31/2003
Paco
$380,000
20,000
23,600
200,000
100,000
31,253
$ 92,347
357,653
50,000
$400,000
Step
$300,000
180,000
40,000
27,200
$ 52,800
200,000
28,000
$224,800
One-Line Consolidation
January 1, 2003
Investment in Step
375,000
Cash
375,000
To record purchase of 75% interest
December 2003
Cash
21,000
Investment in Step
To record dividends received
21,000
One-Line Consolidation
December 31, 2003
Investment in Step
23,600
Income from Step
23,600
To record income from Step
Pacos share of Step net income
($52,800 75%)
$39,600
Less: Unrealized profit
20,000
Add: Piecemeal recognition of gain
4,000
Income from Step
$23,600
Schedule of Deferred
Income Tax Liability
Temporary
Difference
2003
Depreciation
Gain on equipment
$20,000
Piecemeal recognition 4,000
Future dividends
3,720
Taxable in future years
Enacted tax rate
Deferred tax liability
2004-7
$ 7,500
Future
Years
4,000
$3,720
$ 3,500
$3,720
34%
34%
$ 1,190
$1,265
Business Combination
Taxable combination
Tax-free reorganization
Business Combination
In a purchase business combination,
the cost/book value differential is
allocated to the assets and liabilities
acquired at gross fair values, and
a deferred tax asset or liability is
recorded for the related tax effect.
Financial Statement Disclosures

for Income Taxes
GAPP divides deferred assets or liabilities.
Current
Noncurrent
Financial Statement Disclosures

for Income Taxes
GAPP requires disclosure for income
tax expense and benefits allocated to:
Continuing operations
Discontinued operations
Extraordinary items
Cumulate effect type
Prior period adjustments
End of Chapter 10

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Subsidiary Preferred Stock,

Consolidated Earnings per Share,

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Subsidiaries with Preferred

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Subsidiaries with Preferred

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Subsidiary With Preferred Stock

Subsidiary With Preferred Stock

Subsidiary With Preferred Stock

Price paid for 90% interest

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Subsidiary With Preferred Stock

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Subsidiary Preferred Stock

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 10

Subsidiary Preferred Stock

Subsidiary Preferred Stock

What is Poes investment in Sol on 12/31/2005?

Subsidiary Preferred Stock

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 14

Investment in Sol Preferred

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 17

Parent Company and Consolidated

Parent Company and Consolidated

General Format for EPS

A: Subsidiary does not have potentially dilutive securities outstanding

General Format for EPS

B: Subsidiary has potentially dilutive securities convertible into

General Format for EPS

C: Subsidiary has potentially dilutive securities convertible into

General Format for EPS

Parent Company and Consolidated Diluted EPS

A: Subsidiary does not have potentially dilutive securities outstanding

General Format for EPS

Parent Company and Consolidated Diluted EPS

B: Subsidiary has potentially dilutive securities convertible into

General Format for EPS

Parent Company and Consolidated Diluted EPS

C: Subsidiary has potentially dilutive securities convertible into

Dilutive Securities of Subsidiary

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 26

Subsidiary With Convertible

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 27

Subsidiary With Convertible

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 28

Subsidiary With Convertible

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 29

Subsidiary Preferred Stock

Subsidiary Preferred Stock

Plants outstanding shares = b

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 31

Subsidiary Preferred Convertible

Subsidiary Preferred Convertible

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 10 - 33

Subsidiary With Options