Advanced Accounting II Chapter 9

ADVANCED
ACCOUNTING II
CHAPTER 9
INDIRECT AND MUTUAL HOLDINGS
Objectives
1. Prepare consolidated statements when the parent company
controls through indirect holdings.
2. Apply consolidation procedures of indirect holdings to the special
case of mutual holdings.
ADVANCED ACCOUNTING 1 2
Types of Indirect Holdings
Father-Son-Grandson Connecting Affiliates
80% 80% 20%
70% 40%
Parent owns 80% of A,
Parent owns 80% of A, 20% of B,
and through A, and through A an additional
32% of B (80% x 40%).
56% of B (80% x 70%). Parent owns a total of 52% of B.
Equity Method for Father-Son-
Grandson 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)
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 100 50 40
Dividends 60 30 20
Equity Method Entries
Allocations to CI and NCI
Allocation Results
 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
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.
 Intercompany profit transactions:

• Downstream: Pet sold Sal land with a gain 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.
Calculating Investment Balances
Sal: Ty:
Underlying equity Jan 1 Dec 31 Underlying equity Jan 1 Dec 31
Capital stock 200 200 Capital stock 100 100
Retained earnings 50 69 Retained earnings 80 90
Goodwill 12 12 Goodwill 12 12
Unrealized profit in Total 192 202
inventory (5) Investment in Ty
Subtotal (split 70:30) 276 (60%) 115.2 121.2
Unrealized profit on Investment in Ty
land (10) (20%) 38.4 40.4
Total 262 266 Noncontrolling
Investment in Sal (70%) 183.4 183.2 interest (20%) 38.4 40.4
* (70% x 276) - 10 = 183.2
Noncontrolling interest
(30%) 78.6 82.8
* 30% x 276 = 82.8
Calculating Investment Balances
 Sal's Income from Ty =

$4.0
 Pet's Income from Ty =
$12.0
 Pet's Income from Sal =
$23.8 - $10 unrealized gain
= $13.8
Worksheet Entries
Worksheet Entries
Consolidation Worksheet
Types of Mutual Holdings
Connecting Affiliates
Parent Mutually Owned Mutually Owned
80% 10% 80% 20%

20%
40%
Parent owns 80% of A, Parent owns 80% of A,
and through A, 20% of B,
has 8% (80% x 10%) of through A an additional
its own (treasury) stock. 32% (80% x 40%) of B, and
through B an additional 4%
(20% x 20%) of A.
Treasury Stock or Conventional
 Treasury stock method
• Treats parent mutually held stock as treasury stock
• Parent has fewer shares outstanding
• "Interdependency" assumed eliminated by treasury stock treatment
 Conventional method for mutual holding
• Treats stock as retired
• Parent has fewer shares outstanding
• Simultaneous set of equations
• Fully recognizes interdependencies
Parent Stock Mutually Held
One or more affiliates holds parent company stock
 Treasury stock method
• Recognize treasury stock at cost of subsidiary's investment in parent
• Reduce Investment in subsidiary
 Conventional method
• Parent treats stock as retired, reducing common stock, and
additional paid in capital or retained earnings
• Reduce Investment in subsidiary
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
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
Pace Uses Treasury Stock Method
Allocations of income to CI and NCI:
 Controlling interest share $95.7

 Noncontrolling interest share $4.3
 ADVANCED ACCOUNTING 1
Pace's Income from Salt $38.7 – 3.0 = $35.7
22
Pace's Equity Method Entries
Cash 18.0
Investment in Salt 18.0
for dividends
Income from Salt 38.7
for income
Dividends 3.0
for Pace dividends paid to Salt
In place of the last entry, the Pace could record its dividend directly as:
Dividends 27.0
Cash 30.0
Worksheet Entries
Dividends 18.0
Noncontrolling interest share 4.3
Dividends 2.0
Noncontrolling interest 2.3
Common stock 200.0
Retained earnings 130.0
Noncontrolling interests 33.0
Treasury stock 70.0
Investment in Pace 70.0
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 startInvestment
of 2010:and
noncontrolling interest
 Investment in Salt2, $226,154
 Noncontrolling interest, $33,846 = 226,154 + 33,846
 Salt2's total stockholders' equity equals underlying equity
• Common stock $200,000 less mutual holding
• Retained earnings $130,000 = 200,000 + 100,000 –
During 2010, 70,000.
 Separate income: Pace2 $60,000, Salt2 $40,000

 Dividends: Pace2 $30,000, Salt2 $20,000
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
allocation .10P .90P
Solved, substituting 2nd
Equations: equation into 1st:
P = $60,000 + .9S
P = 105,495
S = $40,000 + .1P
CI share = .9P
S = 50,550
NCI share = .1S CI share = 94,945
NCI share = 5,055
Conventional method is analogous to reciprocal cost allocation method.
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!)
Pace2's Equity Method Entries
Cash 18,000
Investment in Salt2 18,000
for dividends
Income from Salt2 37,945
for income
Dividends 3,000
for Pace2 dividends paid to Salt2
Worksheet Entries - Conventional
Dividends 18,000
Noncontrolling interest share 5,055
Dividends 2,000
Noncontrolling interest 3,055
Common stock 200,000
Retained earnings 130,000
Noncontrolling interests 33,846
Investment in Pace2 70,000
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
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: Poly Seth Uno
Separate income 112,000 51,000 40,000
Dividends 50,000 30,000 20,000
Allocate income to CI and NCI
Allocation Info. Poly Seth Uno CI NCI Total
Separate income 112,000 51,000 40,000 203,000
Uno's allocation => .7U .3U
Seth's allocation => .8S .1S .1S
Poly's allocation
=> 1.0P nd
Equations: Solving, substituting 2 equation
P = 112,000 + .8S into 3rd (or 3rd into 2nd):
S = 51,000 + .7U U = 48,495
U = 40,000 + .1S S = 84,946
CI = 1P P = 179,957
NCI = .3U + .1S CI share = 179,957
NCI share = 14,548 + 8,495 = 23,043
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

Advanced Accounting II Chapter 9

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ADVANCED

80% 80% 20%

Poe Shaw Turk

 On separate income statements:

 Intercompany profit transactions:

 Sal's Income from Ty =

80% 10% 80% 20%

 Controlling interest share $95.7

 Separate income: Pace2 $60,000, Salt2 $40,000

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