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

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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.

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Indirect and Mutual Holdings

1: Indirect Holdings

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Types of Indirect Holdings

Father-Son-Grandson
Parent 80% Subsidiary A 70% Subsidiary B 80%

Connecting Affiliates
Parent
20%

Subsidiary A
40%

Subsidiary B

Parent owns 80% of A, and through A, 56% of B (80% x 70%).

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.
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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)
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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 60 50 30 40 20

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Equity Method Entries

Shaw applies equity method (70%): Cash Investment in Turk
for dividends

14 14 28 28 24 24 62.4 62.4
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Investment in Turk Income from Turk

for income

Poe applies equity method (80%): Cash Investment in Shaw

for dividends

Investment in Shaw Income from Shaw

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for income 80%(50+28)

Allocations to CI and NCI

Separate income Allocate: Turk ==> 70% Shaw: 30% NCI Shaw ==> 80% Poe: 20% NCI Poe's ==> CI Total consolidated income Poe 100.0 Shaw 50.0 28.0 62.4 (162.4) (78.0) 162.4 162.4 27.6 190.0 Turk 40.0 (40.0) CI NCI Total 190.0

12.0 15.6

This allocation may look like the "stepdown method" allocation presented in cost accounting texts. Mathematically it is!
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Allocation Results
Separate income Allocate: Turk ==> 70% Shaw: 30% NCI Shaw ==> 80% Poe: 20% NCI Poe ==> CI Total consolidated income Poe 100.0 Shaw 50.0 Turk 40.0 (40.0) CI NCI Total 190.0

28.0 62.4
(162.4) (78.0)

12.0 15.6
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
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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.
Separate income Dividends Pet 70 40 Sal 35 20 Ty 20 10

Indirect Holdings with Connecting Affiliates

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.
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Calculating Investment Balances

Sal: Underlying equity Capital stock Retained earnings Goodwill Unrealized profit in inventory Subtotal (split 70:30) Unrealized profit on land Total Investment in Sal (70%)
* (70% x 276) - 10 = 183.2

Jan 1 Dec 31 200 200 50 69 12 12 (5) 276 262 183.4 78.6 (10) 266 183.2 82.8

Ty: Underlying equity Jan 1 Dec 31 Capital stock 100 100 Retained earnings 80 90 Goodwill 12 12 Total 192 202 Investment in Ty 115.2 121.2 (60%) Investment in Ty 38.4 40.4 (20%) Noncontrolling 38.4 40.4 interest (20%)

Noncontrolling interest (30%) * 30% x 276 = 82.8

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 Separate income Unrealized $5 profit on inventory (upstream)

Unrealized $10 gain on land (downstream)

Pet 70.0 (10)

Sal 35.0 (5)

Ty 20.0

CI

NCI Total 125.0 (5) (10) 4.0 10.2

Allocate: 12.0 4.0 (20.0) Ty ==> 60% Pet: 20% Sal: 20% NCI 23.8 (34.0) Sal ==> 70% Pet: 30% NCI (95.8) Pet ==> CI Total consolidated income Dividend distributions: 6 2 (10) Ty ==> 60% Pet: 20% Sal: 20% NCI 14 (20) Sal ==> 70% Pet: 30% NCI (40) Pet ==> CI

95.8 95.8 14.2 110.0 2 6 40

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
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Worksheet Entries
Sales Cost of sales Cost of sales Inventory Gain on sale of land Land Income from Ty Dividends Investment in Ty both Sal's and Pet's Noncontrolling interest share (Ty) Dividends Noncontrolling interest (Ty)
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15.0 15.0 5.0 5.0 10.0 10.0 16.0 8.0 8.0 4.0 2.0 2.0
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Income from Sal Investment in Sal Dividends including 10 unrealized gain on land Noncontrolling interest share (Sal) Dividends Noncontrolling interest (Sal) Capital stock (Ty) Retained earnings (Ty) Goodwill Investment in Ty (Sal & Pet) Noncontrolling interest (Ty) Capital stock (Sal) Retained earnings (Sal) Goodwill Investment in Sal Noncontrolling interest (Sal)
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13.8 0.2 14.0 10.2 6.0 4.2 100.0 80.0 12.0 153.6 38.4 200.0 50.0 12.0 183.4 78.6
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Consolidation Worksheet
Income statement: Sales Income from Sal Income from Ty Gain on land Cost of sales Other expenses Noncontrolling interest share Controlling interest share Pet Sal 200.0 150.0 13.8 12.0 4.0 10.0 (100.0) (80.0) (40.0) (35.0) Ty DR CR 100.0 15.0 13.8 16.0 10.0 (50.0) 5.0 15.0 (30.0) 10.2 4.0 20.0 Consol 435.0 0.0 0.0 0.0 (220.0) (105.0) 14.2 95.8

95.8

39.0

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Statement of retained earnings: Beginning retained earnings Add net income Deduct dividends

Pet 223.0 95.8 (40.0)

Sal

Ty

50.0 80.0 39.0 20.0 (20.0) (10.0)

DR 80.0 50.0

CR Consol 223.0 95.8 8.0 2.0 14.0 6.0 (40.0)

Ending retained earnings Balance sheet: Other assets Inventories Plant assets, net Investment in Sal (70%) Investment in Ty (60%, 20%) Goodwill Total

278.8 Pet 50.6 50.0 400.0 183.2 121.2

69.0 90.0 Sal Ty 19.6 85.0 40.0 15.0 200.0 100.0 40.4

DR

0.2 12.0 12.0

278.8 CR Consol 155.2 5.0 100.0 10.0 690.0 183.4 0.0 8.0 0.0 153.6 24.0 969.2
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805.0

300.0

200.0

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Liabilities Capital stock Retained earnings Noncontrolling interest Total

Pet 126.2 400.0 278.8

Sal 31.0 200.0 69.0

Ty 10.0 100.0 90.0

DR 100.0 200.0

CR

Consol 167.2 278.8

2.0 4.2 38.4 78.6 805.0 300.0 200.0

123.2 969.2

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Indirect and Mutual Holdings

2: Mutual Holdings

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Types of Mutual Holdings

Parent Mutually Owned Parent 80% 10% Connecting Affiliates Mutually Owned Parent 80% Subsidiary A
20% 40%

20% Subsidiary B

Subsidiary A Parent owns 80% of A, and through A, has 8% (80% x 10%) of its own (treasury) stock.

Parent owns 80% of A, 20% of B, through A an additional 32% (80% x 40%) of B, and through B an additional 4% (20% x 20%) of A.
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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
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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
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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
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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
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Pace Uses Treasury Stock Method

Allocations of income to CI and NCI:
Separate Income Parent dividends Allocate: Salt => 90%:10% Pace => 100% Pace Salt CI 60.0 40.0 (3.0) 3.0 38.7 95.7 (43.0) 95.7 NCI Total 100.0 4.3

Totals 95.7 4.3 100.0 Controlling interest share $95.7 Noncontrolling interest share $4.3 Pace's Income from Salt $38.7 3.0 = $35.7
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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
Dividends Income from Salt Cash
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18.0 18.0 38.7 38.7 3.0 3.0

27.0 3.0 30.0
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In place of the last entry, the Pace could record its dividend directly as:

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
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35.7 18.0 17.7 4.3 2.0 2.3 200.0 130.0 297.0 33.0 70.0 70.0
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Parent Mutually Held - Data

Pace2 owns 90% of Salt2 acquired at fair value equal to cost, no goodwill. Salt owns 10% of Investment and Pace. At the start of 2010: noncontrolling interest Investment in Salt2, $226,154 = 226,154 + 33,846 Noncontrolling interest, $33,846 underlying Salt2's total stockholders' equity equals equity less mutual holding Common stock $200,000 Retained earnings $130,000 = 200,000 + 100,000 70,000. During 2010, Separate income: Pace2 $60,000, Salt2 $40,000 Dividends: Pace2 $30,000, Salt2 $20,000
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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 nd .10P substituting .90P Solved, 2 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.
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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!)

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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 18,000 37,945 37,945 3,000 3,000

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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
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34,945 18,000 15,945 5,055 2,000 3,055 200,000 130,000 296,154 33,846 70,000 70,000
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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

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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
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Allocate income to CI and NCI

Allocation Info. Separate income Uno's allocation => Seth's allocation => .8S Poly's allocation => Equations: P = 112,000 + .8S S = 51,000 + .7U U = 40,000 + .1S CI = 1P NCI = .3U + .1S Poly Seth .7U .1S Uno CI NCI .3U .1S Total 203,000 112,000 51,000 40,000

1.0P 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
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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
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