Indirect and Mutual Holdings

Chapter 9

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-1
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-2
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-3
 Learning Objective 1

Prepare consolidated statements

when the parent company
controls through indirect holdings.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-4
 Affiliation Structures

The potential complexity of corporate

affiliation structure is limited only
by one’s imagination .

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-5
 Direct Holdings

Parent

80%
Subsidiary
A

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-6
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-7
 Direct Holdings

Parent

80% 70% 90%

Subsidiary Subsidiary Subsidiary
A B C

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9-8
 Indirect Holdings

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

Parent
80% 20%

Subsidiary Subsidiary
A 40% B

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 10

 Mutual Holdings

Parent

80% 10%
Subsidiary
A

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 11

 Mutual Holdings

Parent
80% 20%

Subsidiary 40% Subsidiary

A 20% B

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 12

 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.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 13

 Father-Son-Grandson Structure
(in thousands) Poe Shaw Turk
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
Separate earnings $100 $ 50 $ 40
Dividends $ 60 $ 30 $ 20
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 14
 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 15

 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
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 16
 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 17

 Indirect Holdings –
Connecting Affiliates Structure

Pet
70% 60%

Sal Ty
20%

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 18

 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 19

 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.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 20

 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
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 21
 Accounting for Connecting Affiliates

Cash 6,000
Investment in Ty 6,000
To record dividends received from Ty
Investment in Ty 12,000
Income from Ty 12,000
To record income from Ty

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 22

 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 23

 Accounting for Connecting Affiliates

Cash 14,000
Investment in Sal 14,000
To record dividends received from Sal
Investment in Sal 13,800
Income from Sal 13,800
To record income from Sal

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 24

 Accounting for Connecting Affiliates

Pet’s investment Investment 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 25

 Learning Objective 2

Apply consolidated procedures of

indirect holdings to the special
case of mutual holdings.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 26

 Mutual Holding – Parent Stock
Held by Subsidiary
Pace

90% 10%

Salt

The 10% interest held by Salt, and the 90%

interest held by Pace, are not outstanding
for consolidation purposes.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 27
 Mutual Holding – Parent Stock
Held by Subsidiary

Treasury Stock Approach

Conventional Approach

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 28

 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.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 29

 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
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 30
 Treasury Approach:
Working Papers December 31, 2005
Adjustments/ Consol-
Income Statement Pace Salt Eliminations idated
Sales $120 $ 80 $200
Investment income 27 a 27
Expenses (70) (50) (120)
Minority interest expense d 3 (3)
Net income $ 77 $ 30 $ 77
Retained earnings – Pace $200 $200
Retained earnings – Salt $100 b 100
Add: Net income 77 30 77
Retained earnings
December 31, 2005 $277 $130 $277

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 31

 Treasury Approach:
Working Papers December 31, 2005
Adjustments/ Consol-
Balance Sheet Pace Salt Eliminations idated
Other assets $480 $260 $740
Investment in Salt (90%) 297 a 27
b 270
Investment in Pace (10%) 70 c 70
$777 $330 $740
Capital stock – Pace $500 $500
Capital stock – Salt $200 b 200
Retained earnings 277 130 277
$777 $330
Treasury stock c 70 (70)
Minority interest b 30
d 3 33
$740
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 32
 Treasury Approach:
Working Papers December 31, 2006
Adjustments/ Consol-
Income Statement Pace Salt Eliminations idated
Sales $140 $100 $240
Income from Salt 35.7 a 35.7
Dividend income 3 a 3
Expenses (80) (60) (140)
Minority interest expense d 4.3 (4.3)
Net income $ 95.7 $ 43 $ 95.7
Retained earnings – Pace $277 $277
Retained earnings – Salt $130 b 130
Dividends (27) (20) a 18
d 2 (27)
Add: Net income 95.7 43 95.7
Retained earnings
December 31, 2006 $345.7 $153 $345.7
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 33
 Treasury Approach:
Working Papers December 31, 2006
Adjustments/ Consol-
Balance Sheet Pace Salt Eliminations idated
Other assets $528 $283 $811
Investment in Salt (90%) 317.7 a 20.7
b 297
Investment in Pace (10%) 70 c 70
$845.7 $353 $811
Capital stock – Pace $500 $500
Capital stock – Salt $200 b 200
Retained earnings 345.7 153 345.7
$845.7 $353
Treasury stock c 70 (70)
Minority interest b 33
d 2.3 35.3
$811
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 34
 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.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 35

 Conventional Approach

January 1, 2005 Pace Consolidated

Capital stock $500,000 $450,000
Retained earnings 200,000 180,000
Stockholders’ equity $700,000 $630,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 36

 Conventional Approach

January 1, 2005
Investment in Salt 270,000
Cash 270,000
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
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 37
 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 38

 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 39

 Allocation of Mutual Income

P S Total
Before allocation: $50,000 $30,000 $ 80,000
After allocation: $84,615 $38,462 $123,077

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 40

 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
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 41
 Accounting for Mutual Income

($38,462 × 90%) – ($84,615 × 10%) = $26,154

How does Pace record its investment income?
Investment in Salt 26,154
Income from Salt 26,154
To record income from Salt

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 42

 Conventional Approach:
Working Papers December 31, 2005
Adjustments/ Consol-
Income Statement Pace Salt Eliminations idated
Sales $120,000 $ 80,000 $200,000
Investment income 26,154 b 26,154
Expenses (70,000) (50,000) (120,000)
Minority interest (3,846)
expense d 3,846
Net income $ 76,154 $ 30,000 $ 76,154
Retained earnings – P $180,000 $180,000
Retained earnings – S $100,000 c 100,000
Add: Net income 76,154 30,000 76,154
Retained earnings
December 31, 2005 $256,154 $130,000 $256,154
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 43
 Conventional Approach:
Working Papers December 31, 2005
Adjustments/ Consol-
Balance Sheet Pace Salt Eliminations idated
Other assets $480,000 $260,000 $740,000
Investment in S 226,154 a 70,000 b 26,154
c 270,000
Investment in P 70,000 a 70,000
$756,154 $330,000 $740,000
Capital stock – P $450,000 $450,000
Capital stock – S $200,000 c 200,000
Retained earnings 256,154 130,000 256,154

$706,154 $330,000
Minority interest b 30,000
d 3,846 33,846
$740,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 44
 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 45

 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
S = $53,000 + (0.1 × $160,110) = $69,011
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

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

 Subsidiary Stock Mutually Held

The mutually held stock involves subsidiaries

holding the stock of each other, and the
treasury stock approach is not applicable.

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

 Subsidiary Stock Mutually Held

Poly
80%
Seth
70% 10%
Uno

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

 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).

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

 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.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 50

 Subsidiary Stock Mutually Held
(in thousands 12/31/2006) Poly Seth Uno
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
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 51
 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

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 52

 End of Chapter 9

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 9 - 53