Indirect and Mutual Holdings

Patriani Wahyu Dewanti, S.E., M.Acc.

Accounting Department
Faculty of Economics
Yogyakarta State University
EFFECT OF A NONCONTROLLING INTEREST

When a subsidiary is less than wholly owned, the

consolidation procedures must be modified slightly to
recognize the noncontrolling interest
Consolidated Net Income
• In the absence of transactions between companies
included in the consolidation, consolidated net income is
equal to:
• The parent’s income from its own operations, excluding any
investment income from consolidated subsidiaries, plus the net
income from each of the consolidated subsidiaries, adjusted for
any differential write-off
The income attributable to the subsidiary noncontrolling
interest is deducted from consolidated net income on
the face of the income statement to arrive at
consolidated net income attributable to the controlling
interest
• The income attributable to a noncontrolling interest in a
subsidiary is based on a proportionate share of that
subsidiary’s net income
Consolidated retained earnings
• That portion of the consolidated entity’s
undistributed earnings accruing to the parent’s
stockholders
• Calculated by adding the parent’s share of
subsidiary cumulative net income since
acquisition to the parent’s retained earnings
from its own operations and subtracting the
parent’s share of any differential write-off
Consolidated retained earnings
• Retained earnings related to subsidiary
noncontrolling shareholders is included in the
Noncontrolling Interest amount reported in
the equity section of the consolidated balance
sheet
• More consistent with the parent company
theory rather than the entity approach
 Illustration of consolidated net income and
consolidated retained earnings
Push Corporation acquires 80 percent of the stock of Shove Company for an amount
equal to 80 percent of Shove’s total book value. During 20X1, Shove reports net
income of $25,000, while Push reports net income of $120,000, including equity-
method income from Shove of $20,000 ($25,000 x .80). Consolidated net income for
20X1 is computed and allocated as follows:

Push’s net income $120,000

Less: Equity-method income from Shove (20,000)
Shove’s net income 25,000
Consolidated net income $125,000
Income attributable to noncontrolling interest (5,000)
Income attributable to controlling interest $120,000
Net income and dividends during the two years following acquisition are:
Push Shove
Retained earnings, January 1, 20X1 $400,000 $250,000
Net income, 20X1 120,000 25,000
Dividends, 20X1 (30,000) (10,000)
Retained earnings December 31, 20X1 $490,000 $265,000
Net income, 20X2 148,000 35,000
Dividends, 20X2 (30,000) (10,000)
Retained earnings, December 31, 20X2 $608,000 $290,000

Consolidated retained earnings at December 31, 20X2, two years after the date of
combination, is computed as follows, assuming no differential:

Push’s retained earnings, December 31, 20X2 $608,000

Equity accrual from Shove since acquisition
($25,000 + $35,000) x .80 (48,000)
Push’s retained earnings from its own operations,
December 31, 20X2 $560,000
Push’s share of Shove’s net income since acquisition
$60,000 x .8 48,000
Consolidated retained earnings, December 31, 20X2 $608,000
Consolidated Balance Sheet with Majority-Owned
Subsidiary
On January 1, 20X1, Peerless acquires 80 percent of the common stock of Special
Foods for $310,000. At that date, the fair value of the noncontrolling interest is
estimated to be $77,500.

• Peerless records the acquisition on its books with the following entry:

Investment in Special Foods Stock 310,000

Cash 310,000
Record purchase of Special Foods stock.
 Balance Sheets of Peerless Products and Special Foods,
January 1, 20X1, Immediately after Combination
Peerless Special
Products Foods
Assets
Cash $40,000 $50,000
Accounts Receivable 75,000 50,000
Inventory 100,000 60,000
Land 175,000 40,000
Buildings and Equipment 800,000 600,000
Accumulated Depreciation (400,000) (300,000)
Investment in Special Foods Stock 310,000
Total Assets $1,100,000 $500,000
Liabilities and Stockholders’ Equity
Accounts Payable $100,000 $100,000
Bonds Payable 200,000 100,000
Common Stock 500,000 200,000
Retained Earnings 300,000 100,000
Total Liabilities and Equity $1,100,000 $500,000
Values of Select Assets of Special Foods
Fair Value
Book Value Fair Value Increment
Inventory $60,000 $65,000 $5,000
Land 40,000 50,000 10,000
Buildings and Equipment 300,000 360,000 60,000
$400,000 $475,000 $75,000
Consolidated Balance Sheet with Majority-
Owned Subsidiary
Workpaper for Consolidated Balance Sheet,
January 1, 20X1, Date of Combination;
80 Percent Acquisition at More than Book Value
Consolidated Balance Sheet with Majority-
Owned Subsidiary
Eliminating entries

E(2) Common Stock—Special Foods 200,000

Retained Earnings 100,000
Differential 87,500
Investment in Special Foods Stock 310,000
Noncontrolling Interest 77,500
Eliminate investment balance and establish
noncontrolling interest.

E(3) Inventory 5,000

Land 10,000
Buildings and Equipment 60,000
Goodwill 12,500
Differential 87,500
Assign differential.
Continuing with the earlier illustration, with respect to the assets to which the
$87,500 differential relates, assume that all of the inventory is sold during 20X1, the
buildings and equipment have a remaining economic life of 10 years from the date of
combination, and straight-line depreciation is used.
Assume that management determines at the end of 20X1 that the goodwill is
impaired and should be written down by $3,125.
Management has determined that the goodwill arising in the acquisition of Special
Foods relates proportionately to the controlling and noncontrolling interests, as
does the impairment. Assume that Peerless accounts for its investment using the
equity method.

Income and Dividend Information about Peerless Products

and Special Foods for the Year 20X1
20X1:
Separate operating income, Peerless $140,000
Net income, Special Foods $50,000
Dividends $60,000 $30,000
 Initial year of ownership
Parent Company Entries
Investment in Special Foods Stock 310,000
Cash 310,000
Record purchase of Special Foods stock.
Cash 24,000
Investment in Special Foods Stock 24,000
Record dividends from Special Foods:
$30,000 x .80
Investment in Special Foods Stock 40,000
Income from Subsidiary 40,000
Record equity-method income:
$50,000 x .80
Income from Subsidiary 4,000
Investment in Special Foods Stock 4,000
Adjust income for differential related to inventory sold:
$5,000 x .80
Income from Subsidiary 4,800
Investment in Special Foods Stock 4,800
Amortize differential related to buildings and equipment:
($60,000 x .80) / 10 years
Initial year of ownership – Eliminating Entries
• Refer Figure 5-5 in the text for the equity-method workpaper for consolidated
financial statement
Noncontrolling Interest, 20X1
Consolidated Net Income and Retained
Earnings, 20X1
 Second Year of Ownership
Income and Dividend Information about Peerless Products
and Special Foods for the Year 20X2:
Separate operating income, Peerless $160,000
Net income, Special Foods $75,000
Dividends $60,000 $40,000

Parent Company Entries

Cash 32,000
Investment in Special Foods Stock 32,000
Record dividends from Special Foods:
$40,000 x .80
Investment in Special Foods Stock 60,000
Income from Subsidiary 60,000
Record equity-method income:
$75,000 x .80
Income from Subsidiary 4,800
Investment in Special Foods Stock 4,800
Amortize differential related to buildings and equipment
• Summary of changes in the parent’s investment account
for 20X1 and 20X2:

• The workpaper to prepare a complete set of

consolidated financial statements for the year 20X2 is
illustrated in Figure 5–8 in the text
Elminating Entries:
E(18) Income from Subsidiary 55,200
Dividends Declared 32,000
Investment in Special Foods Stock 23,200
Eliminate income from subsidiary.
E(19) Income to Noncontrolling Interest 13,800
Dividends Declared 8,000
Noncontrolling Interest 5,800
Assign income to noncontrolling interest.
E(20) Common Stock—Special Foods 200,000
Retained Earnings, January 1 122,500
Differential 73,375
Investment in Special Foods Stock 317,200
Noncontrolling Interest 78,675
Eliminate beginning investment balance:
$122,500 = $120,000 + $2,500
E(21) Land 10,000
Buildings and Equipment 60,000
Goodwill 9,375
Differential 73,375
Accumulated Depreciation 6,000
Assign beginning differential.
E(22) Depreciation Expense 6,000
Accumulated Depreciation 6,000
Amortize differential related to buildings
and equipment: $60,000 / 10 years
 Noncontrolling Interest, 20X2;
80 Percent Acquisition at More than Book Value
 Consolidated Net Income and Retained
Earnings, 20X2;
80 Percent Acquisition at More than Book Value
DISCONTINUANCE OF CONSOLIDATION
• A parent should subsidiary from future consolidation
if the parent can no longer exercise control over it
• If a parent loses control of a subsidiary and no longer
holds an equity interest in the former subsidiary, it
recognizes a gain or loss for the difference between any
proceeds received from the event leading to loss of
control and the carrying amount of the parent’s equity
interest
• If the parent loses control but maintains a
noncontrolling equity interest in the former
subsidiary, it must recognize in income a gain or
loss for the difference, at the date control is lost,
between:
1. The sum of any proceeds received by the parent and
the fair value of its remaining equity interest in the
former subsidiary, and
2. The carrying amount of the parent’s total interest in the
subsidiary
Treatment of Other Comprehensive Income
• FASB 130 requires that companies separately report
other comprehensive income
• Includes revenues, expenses, gains, and losses that under
GAAP are excluded from net income
• Other comprehensive income accounts are temporary
accounts that are closed at the end of each period to a
special stockholders’ equity account, Accumulated Other
Comprehensive Income
• The consolidation workpaper normally includes an
additional section for other comprehensive income
Assume that during 20X2 Special Foods purchases $20,000 of investments
classified as available-for-sale. By December 31, 20X2, the fair value of the
securities increases to $30,000. Other than the effects of accounting for Special
Foods’ investment in securities, the financial information reported at December 31,
20X2, is identical to that presented in Figure 5–8 in the text.

• Adjusting entry recorded by subsidiary

Investment in Available-for-Sale Securities 10,000
Unrealized Gain on Investments (OCI) 10,000
Record increase in fair value of available-for-sale securities.

• Adjusting entry recorded by parent company

Investment in Special Foods Stock 8,000
Other Comprehensive Income from Subsidiary— 8,000
Unrealized Gain on Investments (OCI)
Record Peerless’s proportionate share of the increase in
value of available-for-sale securities held by subsidiary.
 Consolidation of Subsidiaries
Acquired Prior to 2009
• FASB 141R governs accounting for business
combinations that are completed in fiscal years that
begin on or after December 15, 2008
• Most acquired subsidiaries currently held by parent
companies and included in their consolidated financial
statements were acquired prior to the effective date of FASB
141R
• Because companies are prohibited from applying FASB 141R
retroactively, they are faced with consolidating numerous
subsidiaries under the previous standards
Differences in Consolidation Procedures
• General approach to consolidation is the same under
both current and prior standards
• The major differences are that:
• The current standards place greater emphasis on fair value
than previous standards
• The computation of the differential relates to the entire
subsidiary rather than just the parent’s share of less-than-
wholly owned subsidiaries
 Illustration of Consolidation under
Previous Accounting Standards
Consolidation in Initial Year of Ownership
In the current example, the entries on Peerless’s books are the same under both
current and prior standards.

The differential is $70,000, the difference between Peerless’s $310,000 purchase price
for its stock in Special Foods and the $240,000 book value of the shares it acquired
($300,000 x .80).

Assume that, during 20X1, management determines that the goodwill is impaired
and must be written down by $2,500.

The workpaper to prepare consolidated financial statements for 20X1 using the prior
accounting standards is shown in Figure 5–14 in the text. The eliminating entries are
shown in the next slide.
Illustration of Consolidation under
Previous Accounting Standards
• Under the previous standards, consolidated net income generally
referred to the parent’s share of the income of the consolidated
entity, the amount remaining after deducting the income allocated
to the noncontrolling interest
• Previously, the presentation of the noncontrolling interest was not
specified
• Most companies reported the noncontrolling interest in the
consolidated balance sheet as a “mezzanine” item between liabilities
and stockholders’ equity
 Illustration of Consolidation under
Previous Accounting Standards

• Consolidation in second year of ownership

• Basically the same as under current standards
• The only difference is that the amounts of most elimination entries
are different because of the difference in the differential, and
accordingly the consolidated amounts are different
 ADDITIONAL CONSIDERATIONS

• Subsidiary valuation accounts at acquisition

• FASB 141R indicates that all assets and liabilities
acquired in a business combination should be valued at
their acquisition-date fair values and no valuation
accounts are to be carried over
• Its application in consolidation following a stock acquisition is
less clear
• Negative retained earnings of subsidiary at acquisition
• A parent company may acquire a subsidiary with a negative in its
retained earnings account
• The investment elimination entry appears as follows:
Other stockholders’ equity accounts
• In general, all stockholders’ equity accounts accruing to
the common shareholders receive the same treatment as
common stock and are eliminated at the time common
stock is eliminated
Subsidiary’s disposal of differential-related assets
• Both the parent’s equity-method income and consolidated net income
are affected
• Parent’s books: The portion of the differential included in the subsidiary
investment account that relates to the asset sold must be written off by
the parent under the equity method as a reduction in both the income
from the subsidiary and the investment account
• In consolidation, the portion of the differential related to the asset sold is
treated as an adjustment to consolidated income
Inventory
• Any inventory-related differential is assigned to inventory
for as long as the subsidiary holds the units
• In the period in which the inventory units are sold, the
inventory-related differential is assigned to Cost of Goods
Sold
• The inventory costing method used by the subsidiary
determines the period in which the differential cost of goods
sold is recognized
• FIFO: The inventory units on hand on the date of combination are
viewed as being the first units sold after the combination
• LIFO: The inventory units on the date of combination are viewed
as remaining in the subsidiary’s inventory
Fixed Assets
• A differential related to land held by a subsidiary is added to the Land
balance in the consolidation workpaper each time a consolidated
balance sheet is prepared
• If the subsidiary sells the land to which the differential relates, the
differential is treated in the consolidation workpaper as an adjustment to the
gain or loss on the sale of the land in the period of the sale
• The sale of differential-related equipment is treated in the same
manner as land except that the amortization for the current and
previous periods must be considered
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