289

Chapter 9

INDIRECT AND MUTUAL HOLDINGS

Electronic Supplement

Solution W9-1

1 Affiliation diagramPerez

60% 80% 70% 20%

Alice Betty Carol

70% 90% 10%

Donna Effie

2 Income allocation schedule

Perez Alice Betty Carol Donna Effie Total

Reported incomes $110,000 $20,000 $35,000 $(15,000) $(20,000) $40,000 $170,000

Dividend income: from Alice (6,000) (2,000) (8,000) from Betty (16,000) (16,000) from Donna (3,500) (3,500) from Effie (13,500) (13,500)

Unrealized gain on sale of equipment to Effie (12,000) (12,000)

Separate realized incomes 88,000 4,500 19,500 (15,000) (20,000) 40,000 $117,000

Allocate Donna 70% to Alice (14,000) 14,000

Net loss of Alice (9,500)

Allocate Alice 60% to Perez (5,700) 5,700 20% to Betty 1,900 (1,900)

Allocate Carol 70% to Perez (10,500) 10,500 10% to Effie 1,500 (1,500)

Net income of Effie 38,500

290 Indirect and Mutual Holdings

Allocate Effie 90% to Betty 34,650 (34,650)

Net income of Betty 52,250

Allocate Betty 80% to Perez 41,800 (41,800)

Consolidated net income $113,600 $113,600

Minority interest expense $(1,900) $10,450 $ (3,000) $ (6,000) $ 3,850 3,400 $117,000() Deduct or loss

291Chapter 9

Solution W9-2

Palmore Corporation and SubsidiariesConsolidated Income Statement

for the year ended December 31, 2006

Sales [$980,000 - $60,000] $920,000

Cost of sales [$520,000 - $60,000 + $15,000] 475,000

Gross profit 445,000

Other expenses [$200,000 - $4,000] 196,000

Total consolidated income 249,000

Less: Minority interest income (see note) 23,900

Consolidated net income $225,100

Note: Computation of minority interest expense

Minority interest expense in Tonkin ($50,000 - $15,000) x 20% $ 7,000Minority interest expense in Summit [$95,000 - ($15,000 x 70%)] x 20% 16,900

Check: Palmore Summit Tonkin

Separate incomes $150,000 $ 60,000 $ 50,000

Unrealized inventory profit (15,000)

Recognition of deferred profit on equipment 4,000

Separate realized incomes 154,000 60,000 35,000

Allocate Tonkin's income

10% to Palmore, 70% to Summit 3,500 24,500 (28,000)

Summit's income 84,500

Allocate Summit's income

80% to Palmore 67,600 (67,600)

Palmore's net income and consolidated net income $225,100

Minority interest expense $ 16,900 $ 7,000

292 Indirect and Mutual Holdings

Solution W9-3

Preliminary computations:Panda

90%

80% Ape 70%

Baboon Chimp

Excess of cost over book value acquired: Book Value

Cost Acquired ExcessPanda's 90% investment in Ape $380,000 $360,000 $20,000Ape's 80% investment in Baboon 220,000 140,000 80,000Ape's 70% investment in Chimp 155,000 105,000 50,000

1 Schedule to adjust investment balances to an equity basis

Panda's 90% Ape's 80% Ape's 70% Investment Investment Investment in Ape in Baboon in Chimp

Investment balance January 1, 2003 $380,000Income from Ape-2003 on equity basis ($80,000 x 90%) - $2,000 patent amortization 70,000Dividends-2003 ($40,000 x 90%) (36,000)

Investment balance January 1, 2004 414,000 $220,000 $155,000Income from Chimp-2004 on equity basis ($30,000 x 70%) - $5,000 patent amortization 16,000Income from Baboon-2004 on equity basis ($50,000 x 80%) - $8,000 patent amortization 32,000Income from Ape-2004 on equity basis ($128,000 x 90%) - $2,000 patent amortizationa 113,200Dividends-2004: from Chimp ($30,000 x 70%) (21,000) from Baboon ($30,000 x 80%) (24,000) from Ape ($60,000 x 90%) (54,000)

Investment balance December 31, 2004 $473,200 $228,000 $150,000

aSeparate earnings of Ape of $80,000 + $16,000 + $32,000

293Chapter 9

Solution W9-3 (continued)

2 Entries on Ape's books

Investment in Baboon $ 8,000Dividend income 24,000

Income from Baboon $ 32,000

To adjust investment in Baboon to an equity basis.

Dividend income $21,000Income from Chimp $ 16,000Investment in Chimp 5,000

To adjust investment in Chimp to an equity basis.

Entries on Panda's books

Investment in Ape $ 93,200Dividend income 54,000

Retained Earnings $ 34,000Income from Ape 113,200

To adjust investment in Ape to an equity basis.

Check: December 31, Stockholders' Percent Underlying Unamortized 2004 Invest- Equity x Owned = Book Value + Excess = ment Balance

Ape $508,000 90% $457,200 $16,000 $473,200Baboon 195,000 80% 156,000 72,000 228,000Chimp 150,000 70% 105,000 45,000 150,000

294 Indirect and Mutual Holdings

Solution W9-4

1 Affiliation structure

Patter 70% 90%

Quiet 80% Stall

60% 20% 10%Time Ridder

2 Separate realized income schedule

Patter Quiet Ridder Stall Time Total

Reported income $180,000 $56,000 $66,000 $80,000 $30,000 $412,000

Less: Dividends from Quiet (21,000) (21,000) from Ridder (24,000) (24,000) from Stall (36,000) (4,000) (40,000) from Time (6,000) (2,000) (8,000)

99,000 50,000 60,000 80,000 30,000 319,000

Less: Intercom- pany profit: Inventories (6,000) (6,000) Land _ (3,000) (3,000)

Separate realized income $ 93,000 $50,000 $60,000 $80,000 $27,000 $310,000

295Chapter 9

Solution W9-4 (continued)

3 Consolidated net income and minority interest expense

Separate Consolidated Minority Interest Realized Income Net Income Expense____

Patter $ 93,000 $ 93,000

Quiet 50,000a 35,000 $15,000

Ridder 60,000b 48,000 12,000

Stall 80,000c 78,400 1,600

Time 27,000d 15,660 11,340

$310,000 $270,060 $39,940

aQuiet's $50,000 realized income is divided 70% to consolidated net income and 30% to minority interest expense.

bRidder's $60,000 realized income is divided 80% to consolidated net income and 20% to minority interest expense.

cStall's $80,000 realized income is divided between consolidated net income and minority interest expense as follows:

Consolidated net income = [.9 + (.8 x .1)] x $80,000 = $78,400Minority interest expense = (.2 x .1) x $80,000 = $1,600

dTime's $27,000 realized income is divided between consolidated net income and minority interest expense as follows:

Consolidated net income = [(.7 x .6) + (.8 x .2)] x $27,000 = $15,660Minority interest expense =

[(.3 x .6) + (.2 x .2) + .2] x $27,000 = $11,340

296 Indirect and Mutual Holdings

Solution W9-5

1 Pascoe Corporation and SubsidiariesConsolidated Balance Sheet

at December 31, 2006

Assets Liabilities and Stockholders' EquityOther assets $1,200,000 Liabilities $ 450,000Patents* 137,500 Stockholders' equity

Capital stock 650,000 Retained earnings 237,500

Total assets $1,337,500 Total equities $1,337,500

*Cost of investments $840,000 Book value acquired in Sartin (100%) (315,000) Book value acquired in Tate (100%) (250,000) Patents $275,000 Less amortization (5/10 x $275,000) 137,500 Remaining patents $137,500

2 Proof of consolidated retained earnings

Retained earnings-Pascoe $300,000Amortization of patents over the time period (137,500)Increase from Sartin ($150,000 - $115,000) 35,000Increase from Tate ($90,000 - $50,000) 40,000 Consolidated retained earnings $237,500

Alternative proof of consolidated retained earnings:P = Pascoe's retained earnings and consolidated retained earningsS = Sartin's retained earnings increase since acquisition on a consolidated basisT = Tate's retained earnings increase since acquisition on a consolidated basis

P = $300,000 - $137,500 + .8S + .7TS = $35,000 + .3TT = $40,000 + .2S

Solve for SS = $35,000 + .3($40,000 + .2S)S = $35,000 + $12,000 + .06SS = $50,000

Determine TT = $40,000 + .2($50,000)T = $50,000

Determine PP = $300,000 - $137,500 + .8($50,000) + .7($50,000)P = $237,500 = Consolidated retained earnings

Note: There is no minority interest.

297Chapter 9

298 Indirect and Mutual Holdings

Solution W9-6

1 Affiliation diagram Punk 90% 10%

Sub-one

80%

Sub-two

2 Schedule of separate earnings

Punk Sub-one Sub-two Total

Net income $140,000 $60,000 $25,000 $225,000Dividends (36,000) (8,000) (7,000) (51,000)

104,000 52,000 18,000 174,000Intercompany profit (2,000) (2,000)

Separate earnings $104,000 $50,000 $18,000 $172,000

3 Treasury stock approach

Punk's separate income $104,000Add: 90% x $50,000 realized income of Sub-one 45,000Add: (90% x 80%) x $18,000 realized income of Sub-two 12,960Less: Dividends of Punk accruing to minority stockholders $7,000 x [20% + (10% x 80%)] (1,960)

Consolidated net income $160,000

Minority interest expense in Sub-two ($18,000 + $7,000) x 20% $ 5,000Minority interest expense in Sub-one ($50,000 x 10%) + [$25,000 x (10% x 80%)] 7,000

Total minority interest income $ 12,000

Note that Sub-two's net assets increased by $15,000 during 2003 ($18,000 separate income plus $7,000 dividends received from Punk less $10,000 dividends paid). This net asset increase must be allocated $12,000 to Sub-one and $3,000 to Sub-two's minority stockholders.

299Chapter 9

Solution W9-6 (continued)

4 Conventional approach

P = Punk's income on a consolidated basisS1 = Sub-one's income on a consolidated basisS2 = Sub-two's income on a consolidated basis

EquationsP = $104,000 + .9S1S1 = $50,000 + .8S2S2 = $18,000 + .1P

S1 = $50,000 + .8($18,000 + .1P)S1 = $64,400 + .08P

P = $104,000 + .9($64,400 + .08P)P = $104,000 + $57,960 + .072P.928P = $161,960P = $174,525.86

S1 = $64,400 + .08($174,525.86)S1 = $78,362.07

S2 = $18,000 + .1($174,525.86)S2 = $35,452.59

Allocation of incomeConsolidated net income (90% of P) $157,073.27Minority interest expense of Sub-one (10% of S1) 7,836.21Minority interest expense of Sub-two (20% of S2) 7,090.52

$172,000.00

300 Indirect and Mutual Holdings

Solution W9-7

Incomplete equity-to-equity conversion schedule

Pamol's Beginning Retained Investment Income from Pamol's Earnings in Seward Seward DividendsPrior years' effectsPatent amortization ignored ($5,000 per year) $(20,000) $(20,000)Unrealized inventory profit ($10,000 x 90%) (9,000) (9,000)Unrealized gain on equip- ment (13,500) (13,500)

Current year's effectsPatent amortization (5,000) $(5,000)Unrealized profit in begin- ning inventory x 90% 9,000 9,000Unrealized profit in ending inventory x 90% (4,500) (4,500)Piecemeal recognition of gain on equipment 3,000 3,000Loss on land x 90% 9,000 9,000Dividends paid to Seward (3,000) $(3,000)

Increase (decrease) $(42,500) $(31,000) $ 8,500 $(3,000)

Minority interest expenseNet income of Seward $50,000Add: Unrealized profits in beginning inventory 10,000Less: Unrealized profits in ending inventory (5,000)Add: Unrealized loss on upstream sale of land 10,000Realized income 65,000Minority interest percentage 10%

Minority interest expense $ 6,500

Minority interest December 31, 2008(Seward's $470,000 stockholders equity - $5,000 profits in ending inventory + $10,000 unrealized loss on land) x 10% minority interest = $47,500.

475,000Investment in SewardBalance per books December 31, 2008 $473,000Correct balance: Underlying equity ($470,000 x 90%) $423,000 Less: Inventory profit ($5,000 x 90%) (4,500) Less: Unrealized gain on equipment (10,500) Add: Loss on land ($10,000 x 90%) 9,000 Add: Unamortized patents 25,000 442,000

Overstatement at December 31, 2008 $ 31,000

301Chapter 9

Solution W9-7 (continued)

Pamol Corporation and SubsidiaryConsolidation Working Papers

for the year ended December 31, 2008 | | 90% | Adjustments and |Consolidated | Pamol | Seward | Eliminations | Statements | | | | | Income Statement | | | | | Sales |$ 700,000 |$307,000 |b 50,000| | $ 957,000 Income from Seward | 45,000 | |g 53,500|a 8,500| Dividend Income | | 3,000 |g 3,000| | Cost of sales | 400,000*| 150,000*|d 5,000|b 50,000| | | | |c 10,000| 495,000 * Depreciation expense | 100,000*| 40,000*| |e 3,000| 137,000*Other expenses | 50,000*| 60,000*|i 5,000| | 115,000*Loss on sale of land | | 10,000*| |f 10,000| Minority expense | | |l 6,500| | 6,500*Net income |$ 195,000 |$ 50,000 | | | $ 203,500 | | | | |Retained Earnings | | | | |Retained earnings - Pamol |$ 215,000 | |a 42,500| | $ 172,500 Retained earnings Seward| |$150,000 |h 150,000| | Net income | 195,000 | 50,000 | | | 203,500 Dividends | 60,000*| 30,000*| |a 3,000|

|l 3,000| | | | |g 27,000| 57,000 * Retained earnings | | | | | December 31, 2008 | $ 350,000 |$170,000 | | | $ 319,000 | | | | | Balance Sheet | | | | | Cash |$ 77,000 |$ 60,000 | | | $ 137,000 Receivables - net | 90,000 | 80,000 | |j 25,000| 145,000 Inventories | 100,000 | 70,000 | |d 5,000| 165,000 Plant assets - net | 610,000 | 250,000 |f 10,000|e 10,500| 859,500 Investment in | 473,000 | |c 9,000|a 31,000| Seward 90% | | |e 13,500|g 29,500| | | | |h 435,000| Investment in Pamol 5% | | 60,000 | |k 60,000| Patents | | |h 30,000|i 5,000| 25,000 | $1,350,000 |$520,000 | | | $1,331,500 | | | | |Payables and accruals |$ 200,000 |$ 50,000 |j 25,000| | $ 225,000 Capital stock | 800,000 | 300,000 |h 300,000| | 800,000 Retained earnings | 350,000 |170,000 | | | 319,000 |$1,350,000 |$520,000 | | | | | |Minority interest January 1, 2008 |c 1,000|h 45,000| Treasury stock |k 60,000| | 60,000*Minority interest December 31, 2008 | |l 3,500| 47,500 | | | $1,331,500 | | | *Deduct