Advanced Accounting Homework Week 9

Questions

1. What is an indirect holding of the stock of an affiliate?

An indirect holding of stock of an affiliate is when the investor has the ability to control or significantly
influence the decisions of an investee not directly owned through an investee that is directly owned.

2. P owns a 60 percent interest in S, and S owns a 40 percent interest in T. Should T be consolidated? If not, how
should T be included in the consolidated statements of P and Subsidiaries?

T should not be consolidated. Only 40% of T-s stock is held within the affiliated structure. P only owns 24%
of T. Therefore, T should be included under equity investment on the consolidated statements of P and
Subsidiaries. (to get the 24%: 60%*40%)

3. Distinguish between indirect holding affiliation structures and mutual holding affiliation structures.

Indirect holding involves one corporation to control another by virtue of its control over one or more
corporations. Mutual holding is when the affiliates hold ownership interests in each other.

4. Parent Company owns 70 percent of the voting stock of Subsidiary A, and Subsidiary A owns 70 percent of the
stock of Subsidiary B. Is the inside ownership of Subsidiary B more than 50 percent? Should Subsidiary B be
included in the consolidated statements? Explain

70%*70%=49%

The inside ownership of Subsidiary B is only 30% therefore Subsidiary B does need to be included on the
consolidated statements.

5. Pat Corporation owns 80 percent of the stock of Sam Corporation, and Sam owns 70 percent of the stock of
Stan Corporation. Separate earnings of Pat, Sam, and Stan are $200,000, $160,000, and $100,000, respectively.
Compute controlling and noncontrolling interest shares of consolidated net income under two different
approaches.

Approach 1

Combined separate earnings of Pat, Sam, and Stan

($200,000, $160,000, $100,000) 460,000
Noncontrolling interest share computed as follows:
Direct noncontrolling interest in Stan' income
($100,000 * 30%) (30,000)
Indirect noncontrolling interest in Stan's income
($100,000 * 70% * 20%) (14,000)
Direct noncontrolling interest in Sam's income
($160,000 * 20%) (32,000)
Pat's net income and controlling share of consolidated net 384,000
 income

Approach 2

Pat Sam Stan

Separate earnings 200,000 160,000 100,000
Stan's income to Sam ($100,000 * 70%) 70,000 (70,000)
Sam's income to Pat ($230,000 * 80%) 184,000 (184,000)  
Controlling share 384,000
Noncontrolling interest share 46,000 30,000

6. In using the schedule approach for allocating income of subsidiaries to controlling and noncontrolling
stockholders in an indirect holding affiliation structure, why is it necessary to begin with the lowest subsidiary
in the affiliation tier?

The reason for this is so that you can add the investment income from the lowest subsidiary to determine the
subsidiary’s net income before you can continue onto the next one; then you do the same until you get to the
last one.

7. P owns 80 percent of S1, and S1 owns 70 percent of S2. Separate incomes of P, S1, and S2 are $20,000,
$10,000, and $5,000, respectively, for 2011. During 2011, S1 sold land to P at a gain of $1,000. Compute S1’s
income on an equity basis. Discuss why you did or did not adjust S1’s investment in S2’s account for the
unrealized gain.

S1 S2
P 80% 70%
Separate earnings 20,000 10,000 5,000
Unrealized profit (1,000)
Separate realized earnings 20,000 9,000 5,000
S2's income 3,500 (3,500)
S1's income 10,000 (10,000)
P's net income 30,000
Noncontrolling interest
share 2,500 1,500

The reason that S1 did not adjust for unrealized profits was that it would create a difference between S1’s
investment in S2 Account and S1’s share of S2’s equity.

8. If a parent owns 80 percent of the voting stock of a subsidiary, and the subsidiary in turns owns 20 percent of
the stock of the parent, what kind of affiliation structure is involved? Explain.

The type of affiliation structure this is a mutual holding. The parent is mutually owned by both the subsidiary
and the parent.

9. How is the treasury stock approach applied to the elimination of mutually-held stock?

The way that the treasury stock approach is applied to the elimination of mutually held stock is that it is done
at a cost basis and deducted at cost from the stockholders’ equity in the consolidated balance sheet.
10. Are the treasury stock and conventional approaches equally applicable to all mutual holdings. Explain.

Yes, but it depends on whether the mutually held stock involves the subsidiaries holding the stock of each
other.

11. Under the treasury stock approach, a mutually held subsidiary accounts for its investment in the parent on a
cost basis. Are dividends received by the subsidiary from the parent included in investment income of the
parent under the equity method?

No. The parent dividends paid to the subsidiary are eliminated.

12. Describe the concept of a constructive retirement of parent stock. Should the parent adjust its equity accounts
when its stock is constructively retired?

The concept of a constructive retirement of parent stock is when the subsidiary returns the stock to the
parent and then it is retired. The parent then reduces the parent stock on the books and the retained earnings
to reflect the amounts applicable to controlling stockholders outside the entity. The other accounts to adjust
would be dividends, capital stock and parent net income.

13. P’s separate earnings are $50,000, and S’s separate earnings are $20,000. P owns an 80 percent interest in S,
and S owns a 10 percent interest in P. What is the controlling share of consolidate net income?

50000 0.8 20000 0.1

16000 0.08 1
66000 0.92
71739
20000 0.1 71739
7173.9
71739 0.9 64565

14. How do consolidation procedures for mutual holdings involving the father-son-grandson type of affiliation
structure differ from those for mutually held parent stock?

Father-Son-Grandson can use either treasury stock approach or the conventional approach. The only
approach that can be used for the mutually held parent stock is the treasury stock approach.

15. If companies in an affiliation structure account for investments on an equity basis, how can noncontrolling
interest be determined without the use of simultaneous equations?

Noncontrolling interest can be determined by adding beginning noncontrolling interest and noncontrolling
interest share and subtracting the noncontrolling interest’s percentage of dividends.

Problem E9-1

Calculate consolidated net income

On January 1, 2011, Pen Corporation purchased a 60 percent interest in Sal Corporation at book value (equal to fair
value). At that time, Sal owned a 60 percent interest in Tip Corporation (acquired at book value equal to fair value)
and a 15 percent interest in Win Company. The four companies had the following separate incomes and dividends
for 2011 (separate income does not include investment income or dividend income).

Separate
    Income   Dividends
Pen Corporation 1,600,000 600,000
Sal Corporation 1,000,000 400,000
Tip Corporation 400,000 200,000
Win Company 600,000 200,000

Required: Determine the controlling and noncontrolling interest shares of consolidated net income.

  Pen Sal Tip

Separate earnings of the three affiliates 1,600,000 1,000,000 400,000
Add: Dividend income from Sal's      
investment in Win accounted for by      
the cost method (100,000 x 15%)   30,000  
Allocated 60% of Tip's earnings   240,000 -240,000
Allocated 60% of Sal's earnings 762,000 762,000  
Consolidated net income - Controlling Share 2,362,000    
Noncontrolling interest share   508,000 160,000

E 9-2 Allocate investment income and loss

Pub Corporation owns 60 percent of Sam Corporation and 80 percent of Time Corporation. Tim owns 20 percent of
Sam. Separate income and loss data (not including investment income) for the three affiliates for 2011 are as
follows:

Pub $800,000 separate income

Sam $300,000 separate income
Tim ($400,000) separate income

There are no differentials or unrealized profits to consider in measuring 2011 income.

REQUIRED: Calculate the controlling share of consolidated net income for 2011

Pub Corporation and Subsidiaries

Income Allocation Schedule for the year 2011

Pub Sam Tim

Separate earnings or loss 800,000 300,000 (400,000)

Sam's income
 $180,00 $(180,00
To Pub (300,000 * 60%) 0 0)
(60,000
To Tim (300,000 * 15%) ) $60,000
(272,000
Tim's loss to Pub (340,000* 80% )   272,000
$708,00
Controlling share of consolidated income 0
$(68,00
Noncontrolling interest share $60,000 0)

E 9-5 Prepare income allocation schedule

Pat Corporation owns 80 percent each of the voting common stock of Sal and Tea Corporations. Sal owns 60
percent of the voting common stock of Won Corporation and 10 percent of the voting stock of Tea. Tea owns 70
percent of the voting stock of Val and 10 percent of the voting stock of Won.

The affiliates had separate incomes during 2011 as follows:

Pal Corporation $50,000

Sal Corporation $30,000
Tea Corporation $35,000
Won Corporation -$20,000(loss)
Val Corporation $40,000

The only intercompany profits included in the separate incomes of the affiliates consisted of $5,000 on merchandise
that Pal acquired from Tea and which remained in Pal’s December 31, 2011, inventory.

REQUIRED: Compute controlling and noncontrolling interest shares of consolidated net income.

Pal Sal Tea Won Val

$50,00 $30,00 $(20,000 $40,00
Separate earnings or loss 0 0 $35,000 ) 0
Unrealized profit     (5,000)    
Separate realized earnings 50,000 30,000 30,000 (20,000) 40,000
Val's income to Tea 70% 28,000 (28,000)
Won's income to Tea 10% (2,000) 2,000
Won's income to Sal 60% (12,000) 12,000
Tea's income to Pal 80% 44,800 (44,800)
Tea's income to Sal 10% 5,600 (5,600)
Sal's income to Pal 80% 18,880 (18,880)      
Pal's net income/controlling $113,68
share 0
of consolidated net income
$4,72 $5,60 $12,00
Noncontrolling interest share 0 0 $(6,000) 0
E 9-8 Correcting net income for unrealized profits

Pat Corporation owns an 80 percent interest in Sam Corporation and a 70 percent interest in Ten Corporation. Ten
owns a 10 percent interest in Sam. These investment interests were acquired at fair value equal to book value.

The net incomes of the affiliates for 2011 were as follows:

Pat $240,000
Sam $ 80,000
Ten $ 40,000

On December 31, 2011, Pat’s inventory included $10,000 of unrealized profits on merchandise received from Sam
during 2011, and Sam’s land account reflected $15,000 unrealized profit on land purchased from Ten during 2011.
These unrealized profits have not been eliminated from the net income amounts shown. Except for adjustments
related to unrealized profits, the net income amounts were determined on a correct equity basis.

1. The separate incomes of Pat, Sam, and Ten for 2011 were:
a. $240,000, $80,000, and $32,000, respectively.
b. $148,000, $80,000, and $32,000, respectively.
c. $148,000, $72,000, and $40,000, respectively.
d. $240,000, $72,000, and $40,000, respectively.

Separate income of Sam (net income) 80,000

Separate income of Ten 40,000 - (80,000 * 10%) 32,000
Separate income of Pat 240,000 - (40,000 * 70%) - (80,000 * 80%) 148,000
Total separate income 260,000

2. The separate realized incomes of Pat, Sam, and Ten for 2011 were:
a. $138,000, $80,000, and $25,000, respectively
b. $138,000, $70,000, and $25,000, respectively
c. $123,000, $80,000, and $17,000, respectively
d. $148,000, $70,000, and $17,000, respectively

Pat Sam Ten

Separate income 148,000 80,000 32,000
Unrealized profit on inventory (10,000)
Unrealized profit on land     (15,000)
Separate unrealized profit 148,000 70,000 17,000

3. Controlling share of consolidated net income for Pat Corporation and Subsidiaries for 2011 was:
a. $220,000
b. $215,900
c. $214,400
d. $212,400
Pat's separate income 148,000
Investment income from Sam (70,000 * 80%) 56,000
Investment income from Ten [17,000 + (70,000 * 10%)] *70% 16,800
Pat's income/controlling share of consolidated net income 220,800

4. Noncontrolling interest share that should appear in the consolidated income statement for Pat Corporation and
Subsidiaries for 2011 is:
a. $23,600
b. $21,200
c. $19,100
d. $14,200

Direct noncontrolling interest in Sam (70,000 * .1) 7,000

Indirect noncontrolling interest in Sam (70,000 * .3 * .1) 2,100
Noncontrolling interest share of consolidate net income (17,000 * .3) 5,100
Noncontrolling interest share 14,200