ADVANCED FINANCIAL ACCOUNTING 10TH EDITION CHRISTENSEN

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Chapter 9 Consolidation Ownership Issues

Answers To Questions

Q9-1 Preferred stock of the subsidiary is eliminated in the consolidation process in a manner comparable to that used in eliminating the common stock of the subsidiary. For preferred shares held by the parent company, a proportionate share of subsidiary income and net assets assigned to the preferred shares is eliminated against the balance in the parent's investment account. Subsidiary income and net assets assigned to preferred shares not held by the parent are included as a part of the noncontrolling interest along with the balances assigned to noncontrolling interest for common stock not held by the parent. The claim of the preferred shareholders normally is computed before the common stock is eliminated so that any priority claim associated with the preferred stock can be properly recognized and assigned to the correct shareholder group

Q9-2 All preferred shares held by the parent are eliminated against the balance in the investment account. Shares held by unrelated parties are included in the total assigned to the noncontrolling interest.

Q9-3 Preferred dividends normally are deducted in arriving at income available to common shareholders. When preferred dividends are paid by the subsidiary to shareholders other than the parent, the income accruing to the common shares held by the parent company is reduced.

Therefore, they must be deducted to arrive at income available to the parent company shareholders. No preferred dividends are deducted if the parent company owns all the shares or if no dividends are declared and the preferred stock is noncumulative.

Q9-4 In the event the preferred shares are redeemed, the subsidiary must pay the call premium and the net assets of the subsidiary will be reduced by the amount of the premium. Because it is more conservative to assume the call premium will be paid, the amount of the premium normally is added to the claim of the preferred shareholders and deducted from the equity assigned to the common shareholders whenever consolidated statements are prepared.

Q9-5 The parent may record the difference between the carrying value and the sale price of the shares as either a gain on sale of investment or an adjustment to its additional paid-in capital No gain or loss on the sale of subsidiary shares should be reported in the consolidated statements. If the parent records a gain on the sale, it should be eliminated in the consolidation process and reclassified as a part of additional paid-in capital of the consolidated entity.

Q9-6 All common shareholders share equally in the net assets of a company. When a subsidiary sells additional shares to a nonaffiliate at a price in excess of existing book value, the effect will be to increase the net book value of all shareholders. Because it is a capital transaction, no gain or loss is recognized on the sale.

Q9-7 Each purchase of additional shares should be examined to determine the difference between the price paid and underlying book value. When an amount greater than book value is paid directly to the subsidiary for the shares, the book value of the shares held by the noncontrolling interest will increase. As a result, the increase in the parent’s claim on the net assets of the subsidiary will be less than the amount paid. When consolidated statements are prepared, additional paid-in capital or retained earnings (if the parent has no additional paid-in capital) must be debited for the increase in the balance assigned to the noncontrolling interest, thereby reducing the amount reported in the consolidated balance sheet.

Q9-8 All the shares of the subsidiary are eliminated in preparing the consolidated statements. Thus, treasury shares reported by the subsidiary are eliminated in the consolidation worksheet The effect of the retirement on the consolidated statements depends on the price paid and whether the shares were purchased from the parent or from a nonaffiliate.

Q9-9 Indirect ownership is a general term used whenever one company owns shares of another company and that company holds ownership in a third company. Indirect control occurs when a majority of the shares of a particular company (Company D) are held by one or more companies (Companies B and C) that are, in turn, under the control of another company (Company A). By exercising its control over those companies (Companies B and C) the parent (Company A) can exercise control of the company indirectly owned (Company D).

Q9-10 A reciprocal relationship exists if Subsidiary A and Subsidiary B hold ownership in each other. If Subsidiary A records investment income based on the reported net income of Subsidiary B and Subsidiary B records investment income based on the reported net income of Subsidiary A, the sum of the reported net income totals for the two companies may be substantially greater than the sum of the reported operating income totals for the two companies. Parent company net income will be overstated if the impact of the reciprocal relationship is ignored when the parent company records investment income on its ownership in the two subsidiaries.

Q9-11 Under the treasury stock method the parent company shares that have been purchased by a subsidiary are reported as treasury stock in the consolidated balance sheet. The carrying value of the shares is the amount paid by the subsidiary when they were purchased.

Q9-12 Consolidated net income will be reduced by $100,000. Income assigned to the controlling interest will be reduced by $72,000 ($100,000 x 0.90 x 0.80) when the unrealized profit of Tiny Corporation is eliminated. A total of $10,000 is treated as a reduction to the income assigned to noncontrolling shareholders of Tiny Corporation ($100,000 x 0.10) and $18,000 is a reduction of the income assigned to noncontrolling shareholders of Subsidiary Company ($100,000 x 0.90 x 0.20).

Q9-13 All three companies should be included in the consolidated financial statements. Slide Company should be consolidated with Bit Company because Bit holds majority ownership of Slide. Bit Company, in turn, should be consolidated with Snapper Corporation because Snapper holds majority ownership of Bit.

Q9-14 A subsidiary's stock dividend results in the capitalization of some portion of its retained earnings. Such an action will have no effect on the consolidated financial statements since the entire stockholders' equity section of the subsidiary is eliminated in preparing the consolidation worksheet.

Q9-15 A 15 percent stock dividend is a small stock dividend and must be recorded by capitalizing retained earnings equal to the market price per share of the stock times the number of shares actually issued. As a result, retained earnings will decrease and the par value of stock outstanding and additional paid-in capital will increase on the subsidiary's books. There should be no change in the investment account balance reported by the parent. Thus, the only change in the eliminating entries is the relative amount debited to each of the three individual stockholders' equity accounts of the subsidiary.

Q9-16 When the parent or other affiliates own all the shares of all companies included in the consolidation, the order in which the consolidation is completed may not be particularly critical. On the other hand, when less than 100 percent ownership is held there is a much greater chance of error in apportioning unrealized profits or other adjustments between noncontrolling ownership and consolidated net income when some other sequence is used. By starting the consolidation with the company furthest away from the parent, the computation of income assigned to noncontrolling interest at each level can be most easily accomplished.

Solutions To Cases

C9-1 Effect of Subsidiary Preferred Stock

When a parent company does not own all the shares of a subsidiary, income assigned to the noncontrolling interest includes (1) a portion of subsidiary preferred dividends and (2) a portion of earnings available to common shareholders.

To determine the amount of income to assign to preferred and common shareholders of the subsidiary, the controller needs to have the following information about the preferred stock:

1. The number of preferred shares outstanding and the number owned by the parent and other affiliates.

2 The annual preferred dividend rate per share and whether the dividends are cumulative or noncumulative.

3. If the dividends are noncumulative, the amount of preferred dividends declared during the period, if any.

In this particular case the parent does not appear to own any of the subsidiary's preferred shares. Once the controller determines the portion of subsidiary income assignable to common shareholders, consolidated net income attributable to the controlling interest is computed by adding the parent's pro rata share of this amount to the parent's income from its own operations.

C9-2 Consolidated Stockholders’ Equity: Theory vs. Practice

a Upon the sale of stock of a subsidiary, Xerox used to recognize a gain or loss in the consolidated income statement equal to the company’s proportionate share of the corresponding increase or decrease in that subsidiary’s equity. Under ASC 810-10-55-4H, the sale of subsidiary shares is viewed as an equity transaction and does not affect income. Instead, the difference between the fair value of the consideration received and the change in the amount of the noncontrolling interest is recognized as an adjustment to stockholders’ equity (usually additional paid-in capital).

b. Occidental Petroleum has generally treated subsidiary preferred stock as a liability (the amount is small). ASC 480-10-25 gives specific guidance on whether or not to treat preferred stock as a liability. Consequently, Occidental's subsidiary preferred stock should be reported as part of the noncontrolling interest.