SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE, AND CONSOLIDATED INCOME TAXATION
Answers to Questions 1 Par’s investment income Sam’s net income $ 300,000 Less: Preferred income ($500,000 10%) (50,000) Income to common stockholders 250,000 Par’s percentage owned 60% Investment income $ 150,000 Par’s investment account balance (equal to book value): Sam’s stockholders’ equity $2,500,000 Less: Preferred equity (no arrearages or call premiums) (500,000) Common equity 2,000,000 Par’s percentage ownership 60% Investment account balance $1,200,000 2 The payment of two years preferred dividend requirements would not have affected Par’s investment
income. Since the preferred stock is cumulative, the preferred dividend requirements are deducted from net income each year regardless of whether preferred dividends are declared.
3 The preferred stock of a subsidiary does not appear in a consolidated balance sheet. If there is a
noncontrolling interest in the preferred stock, it is reported as a noncontrolling interest in the consolidated balance sheet. In part a, the investment in preferred is eliminated against the preferred equity and there is no noncontrolling interest in preferred. When 50 percent of the stock is held by the parent (part b), the investment in preferred is eliminated against 50 percent of the preferred equity and the other 50 percent is reported as a noncontrolling interest. In part c, all of the preferred stock is reported as a noncontrolling interest.
4 Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of
noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated to preferred plus 20 percent of the income allocated to common.
5 There is no difference between the controlling share of consolidated EPS and parent company EPS. 6 An investor company’s EPS computations must reflect the potential dilution of an equity investee’s
common stock equivalents and other potentially dilutive securities if the effect is material. 7 Procedures applied in computing a parent company’s EPS computations are the same as those for a
corporation without equity investments except when the subsidiary has outstanding common stock equivalents or other potentially dilutive securities.
8 Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and then
it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary common stock.
9 If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted
earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in subsidiary diluted EPS. Alternatively, when subsidiary securities are convertible into the parent’s common stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities had been issued by the parent.
10-2 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
10 The replacement computation does not involve unrealized profits from downstream sales because these
items relate solely to parent operations and do not affect the noncontrolling interest. In the case of unrealized profits from upstream sales, however, unrealized profits are deducted in the replacement computation which involves subtracting the parent’s equity in subsidiary realized income and adding back the parent’s equity in subsidiary diluted EPS (also based on subsidiary realized income).
11 Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that qualifies
as an “affiliated group” may elect to file consolidated tax returns. Once consolidated returns are elected, it may be difficult to obtain IRS permission to file separate returns.
12 Yes. Consolidated entities that meet the requirements of an affiliated group can and often do elect to file
separate income tax returns. 13 The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against gains
of other members of the affiliated group, (2) intercompany profits between group members are eliminated from taxable income until realized, and (3) intercorporate dividends are fully excluded from taxable income. (But note that 3 is not a unique advantage of filing a consolidated return.)
14 Dividends received by a member of an affiliated group from other group members are excluded from
federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns. 15 Temporary differences result because investors that are not members of an affiliated group record income
from equity investments as it is earned, but pay taxes only when dividends are actually received. 16 In providing for income taxes on undistributed earnings of equity investees, the parent/investor debits
income tax expense and credits deferred tax liability as part of the determination of all income taxes for the period. The investment and investment income accounts are not affected.
17 Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated
entity is a member of an affiliated group and elects to file consolidated tax returns. SOLUTIONS TO EXERCISES Solution E10-1 [AICPA adapted] 1 a Sob income to preferred $20,000 20% owned $ 4,000 Sob income to common $100,000 80% owned 80,000 Income from Sob $ 84,0002 a ($180,000- $30,000) 20% taxable 30% tax rate 3 d All dividend income is excluded from a consolidated group. 4 d
Intercompany profit is deferred in the consolidated tax return until realized through sale to an outside entity.
Solution E10-2 [Preferred stock](in thousands) 1 Cost/fair value differential Total stockholders’ equity January 1, 2012 $16,000 Less: Preferred equity (20,000 shares $115) 2,300 Common equity $13,700 Cost $16,200 Implied total fair ($16,200 / 90%) $18,000 Book value of investment 13,700 Excess fair over book value – Goodwill $ 4,300 2 Income from Sir for 2012 Sir’s net income $2,400 Less: Preferred dividends for 2012 200 Income to common $2,200 Income from Sir ($2,200 90%) $1,980 3 Investment in Sir at December 31, 2012 Investment cost January 1, 2012 $16,200 Add: Income from Sir 1,980 Less: Dividends ($1,200 - $400 preferred) 90% (720) Investment in Sir $17,460 4 Noncontrolling interest for 2012 Beginning stockholders’ equity $16,000 Add: Net income 2,400 Less: Dividends (1,200) Stockholders’ equity December 31, 2012 $17,200 Preferred equity ($105 10,000) $2,100 Common noncontroling interest ($17,200,000 + $4,300,000
(Goodwill)-$2,100,000) 10% 1,940 Noncontrolling interest December 31, 2012 $4,040 Solution E10-3 [Preferred stock] 1 Fair value — book value differential Cost of 80% interest $1,536,000 Implied total fair value ($1,536,000 / 80%) $1,920,000 Less: Book value ($2,500,000 total equity - $630,000 preferred equity) (1,870,000) Excess fair value over book value - Goodwill $ 50,000 2 Loss from Sol — 2011 Sol’s net loss $ 100,000 Add: Income to preferred stockholders 72,000 Loss to common stockholders 172,000 Percent owned 80% Loss on investment in Sol $ 137,600
10-4 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution E10-3 (continued) 3 Income from Sol — 2012 Net income $ 500,000 Less: Income to preferred stockholders (72,000) Income to common stockholders 428,000 Percent owned 80% Income from investment in Sol $ 342,400 4 Par’s investment in Sol account Total stockholders’ equity at December 31, 2012 ($2,500,000 - $100,000 loss in 2011 + $500,000 income in 2012 - $344,000 dividends in 2012) $2,556,000 Less: Preferred equity (630,000) Common equity 1,926,000 Percent owned 80% Underlying equity 1,540,800 Add: 80% of Goodwill 40,000 Investment in Sol at December 31, 2012 $1,580,800 Check: Cost of investment $1,536,000 Loss — 2011 (137,600) Income — 2012 342,400 Dividends 2012 ($344,000 - $144,000) 80% (160,000) Investment in Sol at December 31, 2012 $1,580,800 Solution E10-4 [Preferred stock] 1 Investment cost (fair value equals book value) Total stockholders’ equity of San $4,000,000 Less: Preferred equity 10,000 shares ($100 + $5 + $12) 1,170,000 Common equity 2,830,000 Percent owned 80% Investment cost (fair value and book value) $2,264,000 2 Consolidated net income and noncontrolling interest share Pen separate income $3,000,000 Add: Income from San ($500,000 - $120,000) 80% 304,000 Consolidated net income $3,304,000 Noncontrolling interest share ($380,000 common income 20%) + $120,000 preferred income $ 196,000 3 Underlying book value Total stockholders’ equity $4,200,000 Less: Preferred equity (10,000 shares $105 call price) 1,050,000 Common equity 3,150,000 Percent owned 80% Underlying book value December 31, 2012 $2,520,000
Solution E10-5 Preliminary computations Total equity of Son at December 31, 2011 $3,500,000Less: Preferred equity (10,000 shares $115) (1,150,000) Common equity December 31, 2011 $2,350,000 1 Entries to record preferred stock investment Investment in Son — preferred 600,000 Cash 600,000
To record purchase of 50% of Son’s preferred stock. Additional paid-in capital 25,000 Investment in Son — preferred 25,000
To adjust investment in preferred account to underlying equity: $600,000 cost - ($1,150,000 underlying equity 50%) = $25,000.
2 Excess of fair value over book value from common stock investment Cost of 80% investment in common stock $2,000,000 Implied total fair value ($2,000,000 / 80%) $2,500,000 Book value (2,350,000) Excess fair value over book value $ 150,000 3 Pam’s income from Son preferred — 2012 $1,000,000 par 15% 50% owned $ 75,000 4 Pam’s income from Son common — 2012 Equity in Son’s common income ($400,000 income - $150,000 preferred dividends) 80% owned $ 200,000 Income from Son common $ 200,000 5 Noncontrolling interest at December 31, 2012 Total equity at December 31 ($3,500,000 + $400,000 income - $300,000 dividends) $3,600,000 Less: Preferred equity (1,000,000) Common equity $2,600,000 Plus goodwill 150,000 Common equity plus excess fair value $2,750,000 Noncontrol. Int. — preferred ($1,000,000 50%) $500,000 Noncontrol. interest — common ($2,750,000 20%) 550,000 Total noncontrolling interest December 31 $1,050,000
10-6 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution E10-6 [Preferred stock] (in thousands) 1 Fair value — book value differentials Cost of preferred stock $ 6,500 Book value of preferred 60,000 shares ($100 par + $5 call premium + $10 dividend arrearage) (6,900) Excess book value of preferred stock over cost $ (400) Cost of common stock $35,000 Implied total fair value ($35,000 / 70%) $50,000 Book value of common ($60,000 total equity - $11,500 preferred equity) 48,500 Excess fair value over book value of common $ 1,500 2 The $400,000 negative differential should be treated as an increase in
the preferred investment and other paid-in capital accounts on Pay’s books. Pay will record its investment in Set preferred as follows:
Investment in Set preferred 6,500 Cash 6,500
To record purchase of 60% of Set’s preferred stock. Investment in Set preferred 400 Other paid-in capital 400
To adjust other paid-in capital for the constructive retirement of 60% of Set’s preferred shares.
Solution E10-7 [EPS] 1 d 2 c 3 d Solution E10-8 [EPS] 1 a Sod’s diluted earnings for consolidated EPS purposes Pal’s equity in Sod’s income $176,000/.8 $ 220,000 2 c Sod’s outstanding shares 50,000 shares Add: Incremental shares 10,000 shares - ($100,000 assumed proceeds/$20 average market price) 5,000 shares Sod’s common shares and common share equivalents 55,000 shares 3 b Pal’s net income $ 316,000 Less: Equity in Sod’s income (176,000) Add: Equity in Sod’s diluted earnings (40,000 shares Sod’s $4 diluted EPS) 160,000 Pal’s diluted earnings $ 300,000 4 d
Pal’s diluted earnings $300,000/300,000 Pal outstanding common shares = $1
Solution E10-9 [EPS] San’s basic and diluted EPS Basic Diluted Income to common (equal to San’s net income) = a $18,000 $18,000 Common shares and common share equivalents: Outstanding shares 5,000 5,000 Additional shares using treasury stock method: 1,000 - (1,000 $9)/$15 400 Common shares and common share equivalents = b 5,000 5,400San’s EPS = a/b $ 3.60 $ 3.33 Put’s basic and diluted EPS Income to common (equal to Put’s net income) $20,000 $20,000 Replacement of Put’s equity in San’s realized income with Put’s equity in San’s diluted earnings: Equity in San’s income to common ($18,000 80%) (14,400) Equity in San’s diluted earnings (4,000 shares $3.33) 13,320 Put’s basic and diluted earnings = a $20,000 $18,920Outstanding common shares = b 8,000 8,000 Put’s EPS = a/b $ 2.50 $ 2.37 Solution E10-10 [EPS] Basic Diluted Sal’s earnings per share a Net income $26,400 $26,400 Sal’s common shares outstanding 20,000 20,000 Incremental shares from warrants Diluted: 5,000 — ($120,000 assumed proceeds/$30 average price) 1,000 b Common shares and equivalents 20,000 21,000 Earnings per share $ 1.32 $ 1.26 Pin’s basic and diluted EPS Pin’s income to common ($80,467 - $12,000 to preferred) $68,467 $68,467 Replacement computation: Equity in Sal’s realized income (21,120) Equity in Sal’s diluted EPS 16,000 shares $1.26 20,160 a Earnings $68,467 $67,507 b Pin’s common shares outstanding 10,000 10,000 a/b Earnings per share $ 6.85 $ 6.75
10-8 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution E10-11 [EPS] Diluted 1 Soy’s earnings per share Soy’s earnings: a Income to Soy common (equals net income) $630,000 Soy’s outstanding shares 50,000 Incremental shares from warrants Diluted: 10,000 — ($240,000 assumed proceeds/$40 average price) 4,000 b Common and equivalent shares 54,000 a/b Soy’s earnings per share $ 11.67 2 Consolidated earnings per share Basic Diluted Pow’s income to common (equals net income) $1,480,000 $1,480,000 Replacement: 80% of Soy’s income (504,000) Equity in diluted earnings 40,000 shares $11.67 diluted EPS 466,800 a Pow’s earnings $1,480,000 $1,442,800 b Pow’s outstanding shares 1,000,000 1,000,000 a/b Consolidated earnings per share $ 1.48 $ 1.44 Solution E10-12 [Tax] 1 b 2 c 3 c 4 b Solution E10-13 [Tax] 1 c Assigned value of equipment $6,000,000 Related deferred tax liability ($6,000,000 - $4,000,000 tax basis) 34% tax rate $ 680,000 2 c Income tax expense = $500,000 investment income 20% taxable 34% tax
rate 3 c
Income taxes currently payable: $30,000 dividends 20% taxable 34% tax rate = $2,040 Income tax expense: $60,000 income from Sap 20% taxable 34% tax rate = $4,080 Deferred tax liability: $30,000 undistributed earnings 20% taxable 34% tax rate = $2,040
Income taxes currently payable: $17,500 dividends 20% taxable 34% tax rate = $1,190 Deferred income taxes: $17,500 share of undistributed earnings 20% taxable 34% tax rate = $1,190
5 a
No income tax is assessed on dividends received from a 100% owned domestic subsidiary in an affiliated group.
Solution E10-14 [Tax] 1 Separate company tax returns Pit’s income taxes currently payable: Pretax accounting income $300,000 34% tax rate = $102,000 Sol’s income taxes currently payable: Pretax accounting income $100,000 34% tax rate = 34,000 Income taxes currently payable 136,000 Less: Increase in deferred tax asset ($200,000 34%) (68,000) Consolidated income tax expense $ 68,000 2 Consolidated tax return Combined pretax accounting income $400,000 Less: Unrealized gain on downstream sale of land (200,000) Taxable income 200,000 Tax rate 34% Consolidated income tax expense $ 68,000 3 Separate tax returns Pit’s income taxes currently payable: Pretax accounting income $300,000 34% tax rate = $102,000 Sol’s income taxes currently payable: Pretax accounting income $100,000 34% tax rate = 34,000 Income taxes currently payable 136,000 Consolidated tax return Combined pretax accounting income $400,000 Less: Unrealized gain on downstream sale of land (200,000) Taxable income 200,000 Tax rate 34% Income taxes currently payable $ 68,000
Note: No tax is paid on intercompany profits when consolidated returns are filed.
10-10 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution E10-15 [Tax] Preliminary computations — Because there is only one tax rate, a schedule approach to this solution is not necessary. Pan Sum Sales $8,000,000 $4,000,000Gain on equipment 200,000 Cost of sales (5,000,000) (2,000,000)Other expenses(includes $50,000 patent amortization) (1,850,000) (1,200,000)Pretax operating income 1,350,000 800,000 Income taxes payable on operating income at 34% income tax rate (459,000) (272,000) Income taxes payable on dividends ($400,000 paid 70% interest 20% taxable 34%) (19,040) ___________ Income taxes currently payable (478,040) (272,000)Increase in deferred tax asset* 48,307 ___________ Income tax expense (429,733) (272,000)Separate incomes 920,267 528,000 Add: Income from Sum ($528,000 70% owned - $160,000 unrealized gain) 209,600 Net income $1,129,867 $ 528,000 * Deferred tax asset ($160,000 unrealized gain 34%) - ($128,000 future dividends
Pan Corporation and Subsidiary Consolidated Income Statement
for the year 2011 Consolidated sales $12,000,000 Less: Cost of sales (7,000,000)Less: Other expenses ($3,000,000 + $50,000 - $40,000) (3,010,000) Income before income taxes and noncontrolling interest share 1,990,000Income tax expense** (701,733) Total consolidated income 1,288,267Noncontrolling interest share (158,400) Controlling share of onsolidated net income $ 1,129,867 ** Taxes currently payable of $478,040 for Pan + $272,000 for Sum - $48,307 increase
Solution E10-16 [Tax] 1 One-line consolidation entries Separate tax returns are filed Income from Sun 40,000 Investment in Sun 40,000
To eliminate unrealized profit on downstream sale of merchandise. Computation: $50,000 gross profit 80% unrealized. Note: that the tax effect of the unrealized profit is $13,600, but that amount is a deferred tax asset to be included in the computation of Ped’s income tax expense. The deferred tax asset may be reduced by a valuation allowance.
Consolidated income tax returns are filed Income from Sun 40,000 Investment in Sun 40,000
To eliminate unrealized profit on downstream sale of merchandise. Computation: $50,000 gross profit 80% unrealized. Note: since no tax is paid on the inventory profit, no income tax adjustment is necessary.
2 Consolidation working paper entries Separate Income Tax
Returns Filed Consolidated Income Tax Returns Filed
Sales 100,000 100,000 Cost of goods sold 100,000 100,000
To eliminate reciprocal sales and cost of goods sold. Cost of goods sold 40,000 40,000 Inventory 40,000 40,000
To eliminate unrealized profits in ending inventory.
Note: No adjustments for tax effects are needed because consolidated income tax is equal to combined separate company income taxes under GAAP.
Solution E10-17 [Tax] 1 One-line consolidation entry Income from Son 80,000 Investment in Son 80,000
To eliminate unrealized profit on upstream sale. Computation: $100,000 unrealized profit 80% owned.
2 Consolidation working paper entries Gain on sale of equipment 100,000 Equipment 100,000
To eliminate unrealized gain and reduce equipment to its cost basis.
10-12 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution E10-17 (continued) 3 Noncontrollig interest share Net income of Son (includes the tax effect of the gain) $800,000 Less: Unrealized profit (100,000) Realized income of Son 700,000 Noncontrolling interest percentage 20% Noncontrolling interest share $140,000 Solution E10-18
Possible Estimated Outcome
Individual Probability
of Occurring (%)
Cumulative Probability of Occurring (%)
$500,000 10 10
400,000 25 35
300,000 25 60
200,000 20 80
100,000 10 90
0 10 100 Because $300,000 is the largest amount of benefit that is greater than 50 percent likely of being realized, Pax would recognize a tax benefit of $300,000. in the financial statements (Deferred tax asset of $500,000 less a valuation allowance of $200,000). Solution E10-19
Possible Estimated Outcome
Individual Probability
of Occurring (%)
Cumulative Probability of Occurring (%)
$150,000 50 50
125,000 20 70
100,000 10 80
50,000 10 90
0 10 100 Because $125,000 is the largest amount of benefit that is greater than 50 percent likely of being realized, Pun would recognize a tax benefit of $125,000. in the financial statements (Deferred tax asset of $150,000 less a valuation allowance of $25,000).
SOLUTIONS TO PROBLEMS Solution P10-1 [Preferred stock] (amounts in thousands) 1 Goodwill from Par’s investment in Sun Cost of 360,000 shares of common stock $7,200 Implied total fair value ($7,200 / 90%) $8,000 Less: Book value Stockholders equity $8,300 Less: Preferred equity (20,000 $115)* 2,300 Common equity 6,000 Excess fair value = Goodwill $2,000 * Preferred equity at liq. Pref. (20,000 $105)
+ Div. in arrears ($200,000)
2 Income from Sun Sun’s reported income $1,000 Less: Preferred dividend for 2011 ( 200) Sun’s adjusted income to common $ 800 90% of Sun’s adjusted income $ 720 3 Noncontrolling interest share for 2011 Income allocable to preferred $ 200 Sun’s adjusted income $800 Noncontrol. common interest share (10%) $ 80 Noncontrolling interest share $ 280 4 Noncontrolling interest December 31, 2011 Total stockholders’ equity ($8,300 + $1,000 net income - $800 dividends) $8,500 Less: Preferred equity (No div. in
arrears) 2,100 100% $2,100
Common equity – book value $6,400 Plus Unamortized goodwill at 12/31 2,000 Common equity at fair value $8,400 10% 840 Noncontrolling interest December 31 $2,940 5 Investment in Sun December 31, 2011 Investment cost $7,200 Add: Income from Sun 720 Less: Dividends ($800 - $200 preferred dividends in arrears - $200 current preferred dividends) 90% (360) Investment in Sun December 31 $7,560 Check: Equity of common ($6,400 90%) $5,760 Undepreciated excess ($2,000 90%) 1,800 Investment in Sun December 31 $7,560
10-14 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-2 [Preferred stock] Preliminary computations Stockholders’ equity July 1, 2011 $900,000 - ($46,000 income 1/2 year) $877,000Less: Preferred equity July 1, 2011 Par value with call premium $210,000 Dividend arrearage — 2010 ($200,000 9%) 18,000
Dividend arrearage — 2011 ($200,000 9% 1/2 year) 9,000 237,000Common equity July 1, 2011 $640,000 Cost of 90% interest in Set’s common stock $630,000 Implied total fair value ($630,000 / 90%) $700,000 Book value of common equity (640,000)Goodwill $ 60,000 Cost of 80% interest in Set’s preferred stock $175,000Book value acquired ($237,000 80%) (189,600) Book value over cost of preferred $(14,600)
1 Investment account balances at December 31, 2011 Common Preferred Investment cost $630,000 $175,000 Adjust preferred to book value and recognize a constructive retirement 14,600 Income to preferred ($18,000 1/2 year 80%) 7,200 Income to common ($28,000 1/2 year 90%) 12,600 ________ Investment balances December 31 $642,600 $196,800 2 Consolidated balance sheet working paper entries 9% preferred stock, $100 par 200,000 Retained earnings — Set 46,000 Investment in Set — preferred 196,800 Noncontrolling interest — preferred 49,200
To eliminate reciprocal preferred equity and investment balances and enter noncontrolling interest. The preferred stockholders’ claim on Set’s retained earnings consists of $18 per share preferred dividends in arrears plus a $5 per share call premium. Computations: Investment in Set preferred = $123 1,600 shares. Noncontrolling interest — preferred = $123 400 shares.
Capital stock, $10 par — Set 500,000 Paid-in capital in excess of par — Set 40,000 Retained earnings — Set 114,000 Goodwill 60,000 Investment in Set — common 642,600 Noncontrolling interest — common 71,400
To eliminate reciprocal common equity and investment amounts and enter goodwill and noncontrolling interest in common. NOTE: Noncontrolling interest includes 10% of Goodwill.
Solution P10-3 [Preferred stock](in thousands) Preliminary computations Cost of 70% interest in Sal January 1, 2010 $490 Implied total fair value of Sal ($490 / 70%) $700Book value acquired of common equity 700 Excess of fair value over book value $ 0 Cost of 20% interest in Sal April 1, 2011 $152 Implied total fair value of Sal ($152 / 20%) $760 Book value of Sal($850 + $22.5 - $12.5 - $100) 760 Excess of fair value over book value $ 0 Pat’s investment income from Sal for 2011 Sal’s net income $ 90Less: Preferred income ($100 10%) 10 Income to common $ 80 Income from Sal($80 70% 1 year)+($80 20% 3/4 year) $ 68
10-16 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Pat Corporation and Subsidiary Consolidation Working Papers
for the year ended December 31, 2011 (in thousands)
Pat
Sal
Adjustments andEliminations
ConsolidatedStatements
Income Statement Sales
$1,233
$ 700
$1,933
Income from Sal 68 a 68 Cost of sales 610* 400* 1,010* Other expenses 390* 210* 600* Preacquisition income b 4 4* Noncontrolling int. share d 18 18* Controlling share of NI $ 301 $ 90 $ 301
Retained Earnings
Retained earnings — Pat
$ 501
$ 501
Retained earnings — Sal $ 200 b 200
Net income 301 90 301
Dividends 200* 50* a 34 d 14 b 2
200*
Retained earnings December 31
$ 602
$ 240
$ 602
Balance Sheet Cash
$ 191
$ 50
$ 241
Other current assets 200 300 500 Plant assets 900 600 1,500 Investment in Sal** 711 a 34
b 677
$2,002 $ 950 $2,241
Current liabilities $ 200 $ 60 $ 260 $10 preferred stock 100 c 100 Common stock 1,200 500 b 500 1,200 Other paid-in capital 50 b 50 Retained earnings 602 240 602
$2,002 $ 950
Noncontrolling interest — common b 75
Noncontrolling interest — preferred c 100
Noncontrolling interest December 31 d 4 179 $2,241 * Deduct ** Common equity of Sal = $790 x 90% = $711
Solution P10-4 [Preferred stock] Preliminary computations Fair value — book value differential Investment cost $240,000 Implied total fair value of Sam ($240,000 / 80%) $300,000Less: Book value acquired Sam’s stockholders’ equity January 1, 2010 $325,000 Less: Preferred equity 100,000 Sam’s common equity 225,000 Excess fair value over book value = Goodwill $ 75,000 Income from Sam for 2011 Equity in Sam’s income ($60,000 - $10,000 pf) 80% $ 40,000 Add: Intercompany profits beginning inventory ($50,000 40% 3/5) 12,000 Less: Intercompany profits ending inventory ($60,000 40% 4/6) (16,000) Add: Realization of 80% of $10,000 profit deferred on land from 2010 8,000Add: Constructive gain on bonds ($9,000 80%) 7,200 Less: Piecemeal recognition of gain ($9,000/3 years 1/2 year 80%) (1,200) Income from Sam $ 50,000 Investment in Sam December 31, 2011 Underlying book value ($390,000 - $100,000) 80% $232,000 Add: 80% of Goodwill 60,000Less: Unrealized inventory profit (16,000) Add: Constructive gain less 1/2 year piecemeal recognition ($9,000 - $1,500) 80% 6,000 Investment in Sak December 31 $282,000 Noncontrolling interest share — common Sam’s reported income less income to preferred ($60,000 - $10,000) $ 50,000Recognition of previously deferred gain on land 10,000 Constructive gain on bonds less 1/2 year piecemeal recognition of gain ($9,000 - $1,500) 7,500Sam’s realized income to common 67,500 Noncontrolling interest percentage 20% Noncontrolling interest share — common $ 13,500
10-18 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-5 [EPS](in thousands) Requirement 1 Requirement 2 Diluted Diluted Sir’s EPS Sir’s net income (equal to income to common stockholders) $ 60 $ 60 Add: Net-of-tax interest on convertible bonds 6 NASir’s earnings = a $ 66 $ 60 Sir’s outstanding common shares 50 50Add: Shares from assumed conversion of bonds 10 NA Common shares and common share equivalents = b 60 50Sir’s EPS = a/b $1.10 $1.20 Pal’s EPS Pal’s net income (equal to income to common stockholders) $150 $150Add: Net-of-tax interest on convertible bonds of Sir 6Replacement of Pal’s equity in Sir’s income with Pal’s equity in Sir’s diluted (42) (42)a EPS (35,000 shares $1.10) and convertible 38.5
to Pal securities (35,000 shares $1.20) 42a Pal’s earnings = a $146.5 $156 Pal’s outstanding common shares 100 100Add: Shares from assumed conversion of bonds 10 Common shares and common share equivalents = b 100 110Pal’s EPS = a/b $1.47 $1.42 a When subsidiary securities are convertible into parent common stock, the
replacement calculation is not needed. The replacement is included in this solution only to show that it has no effect on the calculation.
Solution P10-6 [EPS] Basic Diluted She’s earnings per share Income to common $ 45,000 $ 45,000 Income to preferred assumed converted 10,000 a Earnings $ 45,000 $ 55,000 Common shares and common share equivalents: Common shares outstanding 10,000 10,000 Add: Common shares issuable on preferred 3,000 Add: Incremental shares issuable on options 2,000 - [($2,000 $15)/$30] 1,000 b Common and common equivalent shares 10,000 14,000 EPS a/b $ 4.50 $ 3.93 Pen’s earnings per share Income to common $150,000 $150,000 Replacement calculation Equity in She’s income to common ($45,000 80%) (36,000)a (36,000) Equity in She’s EPS 8,000 $4.50 basic EPS 36,000a 8,000 $3.93 diluted EPS 31,440 a Earnings $150,000 $145,440b Common shares 20,000 20,000 EPS a/b $ 7.50 $ 7.27 a A replacement calculation is never needed when calculating basic earnings per
share. It is only included here to illustrate the point that the replacement will have no impact on the earnings per share calculation.
10-22 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-7 [EPS] 1 Basic Diluted Sit’s earnings per share Income to common $50,000 - $14,000 $36,000 $ 36,000 Add: Income to preferred assumed converted 14,000 a Earnings $36,000 $ 50,000 Common shares outstanding 6,000 6,000 Common shares from conversion of preferred 4,000 b Common and common equivalent shares 6,000 10,000 EPS a/b $ 6.00 $ 5.00 Consolidated earnings per share Net income to Pro $93,800 $ 93,800 Replacement calculation for diluted EPS $36,000 80% share of realized income (28,800) $5.00 diluted EPS 4,800 shares 24,000 a Earnings $93,800 $ 89,000 b Outstanding common shares 20,000 20,000 EPS a/b $ 4.69 $ 4.45 2 Net income of Pro $93,800 $ 93,800 Add: Income to preferred 14,000 a Earnings $93,800 $107,800 Common stock of Pro 20,000 20,000 Common shares from conversion of Preferred 5,000 b Common and common share equivalents 20,000 25,000 EPS a/b $ 4.69 $ 4.312 Solution P10-8 [EPS] Pin’s net income $1,262,000 Replacement calculation: Pin’s equity in Sum’s realized income ($500,000 - $60,000) 80% $352,000 Pin’s equity in Sum’s diluted EPS (40,000 shares $7.44) 297,600 54,400 Consolidated diluted earnings = a $1,207,600Pin’s outstanding common shares = b 100,000 Consolidated diluted EPS = a/b $ 12.08
Solution P10-9 [EPS](in thousands) Basic Diluted Sim’s earnings per share Income to common $200 $200 Less: Unrealized profit — upstream sale (20) (20) Add: Income to preferred 100 a Earnings $180 $280 Common shares outstanding 50 50 Add: Shares from conversion of preferred 30 Add: Incremental shares from warrants 10,000 - ($150,000/$20) 2.5b Common and common equivalent shares 50 82.5 EPS a/b $3.60 $3.3939
Consolidated (and Pit’s) earnings per share Pit’s income to common $450 $450 Replacement calculation Equity in Sim’s realized income ($200,000 - $20,000) 80% (144) Equity in Sim’s diluted EPS 40,000 $3.39 135.6a Earnings $450 $441.6 b Outstanding common shares 100 100 EPS a/b $4.50 $4.42 Solution P10-10 [Tax]
Par Corporation Income Statement
for the current year (in thousands)
(a) (b) Assuming Separate Assuming Consolidated Tax Returns Tax Return Sales $2,400 $2,400Gain on sale of land 100 100 Income from Sama 98 98Cost of sales (1,200) (1,200) Operating expenses (700) (700) Income before income taxes 698 698 Income tax expenseb (170) (170) Net income $ 528 $ 528
Supporting computations a Income from Sam Equity in Sam’s income ($300 - $102 income taxes) 100% $ 198 $198 Less: Unrealized profit (100) (100) Income from Sam $ 98 $ 98 b Income tax expense Income tax currently payable: Par’s $600 taxable income 34% $204 Consolidated taxable income of $800 34% $500/$800 $170 Deferred income taxes: Deferred tax asset ($100 34%) (34) ____ Income tax expense $ 170 $170Note: There is no tax on undistributed income because Par and Sam are an affiliated group.
10-24 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-11 [Tax] Preliminary computations Investment cost $577,500 Implied total fair value of Sir($577,500 / 70%) $825,000Less: Book value of Sir 800,000 Excess fair value over book value = Goodwill $ 25,000 1 Income tax expense (separate tax returns required) Pan Sir Tax on operating income ($500,000 34%) $170,000 ($200,000 34%) $ 68,000 Tax on dividends received ($50,000 70%) 20% taxable 34% tax rate 2,380 Income taxes currently payable 172,380 68,000 Deferred tax on undistributed income ($49,000* 70%) 20% taxable 34% tax rate 2,332 Deferred tax asset on unrealized inventory profit ($50,000 34%) ________ (17,000) Income tax expense $174,712 $ 51,000
* Undistributed income (Sir’s operating income of $200,000 - $51,000 tax - $50,000 unrealized profit - $50,000 dividends paid) = $49,000
2 Income from Sir Equity in Sir’s net income ($200,000 - $51,000 tax) 70% $104,300 Unrealized inventory profit ($50,000 70%) (35,000) Income from Sir $ 69,300 3 Pan Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales ($5,000,000 - $120,000) $4,880,000 Cost of sales ($2,550,000 + $50,000 - $120,000) 2,480,000 Gross profit 2,400,000 Operating expenses 1,750,000 Income before income taxes and noncontrolling interest 650,000 Less: Income taxes ($174,712 + $51,000) 225,712 Total consolidated income 424,288 Less: Noncontrolling interest share ($149,000 net income - $50,000 unrealized) 30% 29,700 Controlling share of NI $ 394,588 Check: Pan’s separate income ($500,000 - $174,712) $ 325,288 Income from Sir 69,300 Pan’s and Controlling share of NI $ 394,588
Pub Corporation and Subsidiary Partial Consolidation Working Papers for the year ended December 31, 2011
Pub 70% Sew
Adjustments andEliminations
Noncont.Interest
Consolidated Statements
Income Statement Sales
$500,000
$300,000
a 90,000
$ 710,000
Dividends received from Sew
28,000
c 28,000
Cost of sales 250,000* 120,000* b 10,000 a 90,000 290,000* Operating expenses 78,000* 80,000* 158,000* Income tax expense 58,222* 34,000* 92,222* Noncont. Share** $19,800 19,800* Control. Share - NI $141,778 $ 66,000 $ 149,978 Note: The offsetting credits to entries b and c are to inventory and dividend accounts, respectively. * Deduct ** Noncontrolling interest share = $66,000 30% Supporting computations Pub Sew Income taxes currently payable Taxes on operating income ($172,000 34%) $58,480
($100,000 34%) $ 34,000Tax on dividends received ($40,000 70%) 20% taxable 34% tax rate 1,904 60,384 34,000Tax on undistributed income ($26,000 70%) 20% taxable 34% tax rate 1,238 Less: Deferred tax on inventory profit $10,000 34% tax rate (3,400)Income tax expense $58,222 $ 34,000 Consolidated net income check Sew’s net income of $66,000 70% $ 46,200 Less: Unrealized inventory profit (10,000) Income from Sew — equity basis 36,200Less: Sew’s income — cost basis (28,000)Cost — equity method difference 8,200 Add: Pub’s reported net income 141,778 Controlling share of NI $149,978
10-26 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-13 [Tax] Preliminary computations Investment cost $900,000 Implied total fair value of Soo($900,000 / 90%) $1,000,000Less: Book value of Soo 900,000 Excess fair value over book value = Goodwill $ 100,000
Pen
Soo Adjustments andEliminations Consolidated
Sales $800,000 $200,000 $1,000,000 Gain on land sale 20,000 a 20,000 Income from Soo 36,430 b 36,430 Cost of sales (400,000) (75,000) (475,000) Expenses (150,000) (30,000) (180,000) Income tax expense (85,000)a (32,300) (117,300) Noncontrolling share (6,270) Controlling share of NI $221,430 $ 62,700 $ 221,430 a Pen’s income tax expense is calculated: Sales 800,000 Cost of Sales (400,000) Expenses (150,000) Pretax income 250,000 Tax rate .34 Income tax expense 85,000 Preliminary computations Income from Soo for 2011 Share of Soo’s net income ($62,700 90%) $ 56,430 Less: Unrealized profit on intercompany sale of land (20,000) Income from Soo $ 36,430 Investment in Soo account December 31, 2011 Cost of 90% interest in Soo January 1 $900,000Add: Income from Soo 36,430 Less: Dividends from Soo (45,000) Investment December 31 $891,430 a Gain on sale of land 20,000 Land 20,000
To eliminate unrealized intercompany profit from downstream sale of land.
b Income from Soo 36,430 Investment in Soo 8,570 Dividends from Soo 45,000
To eliminate investment income and dividends and return the investment in Soo account to its beginning of the period balance.
c Capital stock — Soo 500,000 Retained earnings — Soo 400,000 Goodwill 100,000 Investment in Soo 900,000 Noncontrolling interest January 1 100,000 Noncontrolling interest share 6,270 Dividends 5,000 Noncontrolling interest 1,270
To eliminate reciprocal beginning of the period investment and equity balances, establish beginning noncontrolling interest, and enter goodwill.
Solution P10-14 [Tax] 1 Allocation schedule Cost of investment = Fair value (100% purchase) $280,000 Book value 170,000 Excess fair value over book value $110,000 Excess allocated Land $ 40,000 Buildings — net 30,000 (10 year life) Equipment — net 10,000 (2 year life) Goodwill for the remainder 30,000 Excess fair value over book value $110,000
Note: In a taxable combination transaction there are no deferred tax liabilities since the tax basis and book basis are the same. A current tax deduction will affect the future recognized income from Sad Corporation.
2 Allocation schedule Cost (fair value) of investment $280,000 Book value 170,000 Excess fair value over book value $110,000 Excess allocated: Land $ 40,000 Buildings — net 30,000 (10 year life) Equipment — net 10,000 (2 year life) Deferred tax liability ($80,000 35%) (28,000)a Goodwill for the remainder 58,000 Excess fair value over book value $110,000
a On a tax-free reorganization a deferred tax liability must be set up for all the tax basis/book basis differentials, other than goodwill. Since the transaction is recorded at purchase price on the books but has no change in tax basis from the original books, differences in basis occur and are equal to any fair value write-ups of the assets.
3 Par’s income from Sad for 2011 Taxable Sad’s reported income $ 50,000 Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) (3,000) Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) (5,000) Add: Income tax reductions due to the prior adjustments 2,800a Income from Sad $ 44,800
a Since all three items are currently deductible for tax purposes they will reduce the income taxes Par will have to pay.
10-28 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution P10-14 (continued) Tax free Sad’s reported income $50,000Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) (3,000) Add: Amortization of deferred tax liability allocated to buildings ($3,000 .35) 1,050 Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) (5,000) Add: Amortization of deferred tax liability allocated to equipment ($5,000 .35) 1,750 Income from Sad $44,800 Solution P10-15 1 Income tax expense Pop Son Income taxes currently payable: Taxes on operating income $1,400,000 34% $476,000 $800,000 34% $272,000 Tax on dividends received: $280,000 20% taxable 34% tax rate 19,040 ________ Income taxes currently payable 495,040 272,000 Tax on undistributed income: $128,000 70% 20% taxable 34% tax rate 6,093 Less: Deferred tax on gain on equipment $400,000 34% tax rate (136,000) ________ Income tax expense $365,133 $272,000 2 Loss from Son Income from Son on an equity basis Son’s net income of $528,000 70% $ 369,600 Less: Unrealized gain ($500,000 - $100,000) (400,000) Income from Son — equity basis (loss) $ (30,400) 3 Pop Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales $12,000,000 Cost of sales (7,000,000) Gross profit 5,000,000 Other expenses ($2,100,000 + $1,200,000 - $100,000) (3,200,000) Income before income taxes 1,800,000 Income tax expense ($365,133 + $272,000) (637,133) Total consolidated income 1,162,867 Less: Noncontrolling interest share ($528,000 30%) (158,400) Controlling share of NI $ 1,004,467
Check: Pop’s pretax income of $1,400,000 - $30,400 loss from Son - $365,133 income taxes = $1,004,467 Controlling share of NI
Solution P10-16 [Tax] 1 Sal’s net income Pretax income $ 430,000 Less: Income tax expense: Taxes currently payable ($430,000 34%) $146,200 Less: Deferred tax asset — land ($30,000 34%) (10,200) (136,000) Sal’s net income $ 294,000 2 Pix’s income from Sal Share of Sal’s net income ($294,000 90%) $ 264,600 Less: Unrealized gain on upstream sale of land ($30,000 90%) (27,000) Less: Unrealized inventory profit (15,000) Income from Sal on an equity basis $ 222,600 3 Pix’s net income Sales $3,815,000 Income from Sal 222,600 Less: Cost of sales and expenses (3,200,000) Income before income taxes 837,600 Income tax expense ($209,100 currently payable less $5,100a deferred tax asset) (204,000) Net income $ 633,600
a The deferred tax asset is $5,100 deferral for the inventory profit.
