Consolidated FS-Income Taxes, Cash flows, and Installment ...

Chapter 9

Consolidated Financial Statements: Income Taxes,

Cash Flows, and Installment Acquisitions

ACCT 501 (All examples are from the

textbook by Larsen)

Income Taxes and Cash Flows2

Objectives of the Chapter

1. To learn the accounting treatment of income taxes for a purchase-type business combination.

2. To learn the preparation of consolidated statement of cash flows.

3. To study the accounting for installment acquisitions of a subsidiary in a purchase-type business combination.


Income Taxes in Business Combinations and ConsolidationsThe discussion of the accounting for income taxes in business combinations and consolidated financial statements are subdivided in three sections:

a. Income taxes attributable to current fair values excess of purchased identifiable net assets;

b. Income taxes attributable to undistributed earnings of subsidiaries;

c. Income taxes attributable to unrealized and realized intercompany profits (gains).


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets When a purchase-type business

combination is qualified as a "tax-free corporate reorganization" under the IRC, a new income tax basis (i.e., based on the current fair value)is Not required for the combinee's net assets.

In this situation, a temporary difference may result between provisions for deprecation and amortization in the combinee's financial statements and income tax returns.


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)The other situation which can also result in temporary difference is in the pooling-type business combination, in which there is no revaluation of combinee's net assets.When the pooling-type business combination is not qualified as a "tax free corporation reorganization" under the IRC, the income tax basis of the combinee's net assets may be changed.


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)In recognition of this problem, the FASB requires the following:

a deferred tax liability or asset be recognized in accordance with the requirements for differences between the assigned value (i.e., the current value at the business combination) and the tax bases (I.e., the carrying amount) of the assets and liabilities.


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)Example: assume that the purchase-type business combination of Regal Corp. and the combinee,Thorne Company, completed on 6/1/1999, met the requirements for a "tax-free corporation reorganization" for income tax purposes.

Regal paid $800,000 for all of Thornes' identifiable net assets except cash.


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)The current fair values of Thorne's identifiable net assets were equal to their carrying amounts, except for the following assets:


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

Assets Current Fair

Values

Tax/ Bases

Carrying Amounts

Current Fair

Values Excess

Economic Life

Inventories $ 100,000 $ 80,000 $ 20,000

Land 250,000 220,000 30,000

Building 640,000 500,000 140,000 20 yearsMachinery 120,000 100,000 20,000 5 years

Totals $1,110,000 $900,000 $210,000


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)If the carrying amounts (equal to current fair values) of Thorne's other identifiable assets and liabilities were $390,000 and $650,000, respectively, and the income tax rate is 40%, Regal's journal entry to record the business combination with Thorne Company on 6/1/1999, would be as follows:


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)Investment in Net Assetsa 800,000

Cash 800,000Inventoriesb 100,000 Land 250,000 Building 640,000 Machinery 120,000 Other Identifiable Assets 390,000 Goodwill 34,000 Deferred Income Tax Lia. 84,000c

Other Liability 650,000Investment in Net Assets 800,000


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)Notes for the above journal entries:a. To record acquisition of net assets of

Thorne Company except cash.b. To allocate cost of Thorne's net assets to

identifiable net assets; to establish liability for deferred income tax attributable to differences between current fair values and tax bases of assets; and to allocate remainder of cost to goodwill.

c. Current fair value excess of assets *tax rate = $210,000 *40% = $84,000


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)The deferred income liability ($84,000) will be extinguished when the temporary differences reverse through sale or deprecation.

Example: assume that the inventories were sold during the year ended 5/31/2000, the deferred tax liability would be reduced by $12,400, computed as follows:


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)Cost of goods sold (inventories current fair value excess $20,000Building depreciation attributable to current fair value excess (140,000 / 20) 7,000 Machinery depreciation attributable to current fair value excess ($20,000 / 5) 4,000Total reversing temporary differences $31,000Income tax effect ($31,000 X 0.40) $12,400


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)Assuming Regal Corp. had pre-tax financial income of $420,000 (net of tax-deductible goodwill amortization of $2,267) for the year ended May 31, 2000,and there were no temporary difference between pre-tax financial income and taxable income other than those resulting from the business combination with Thorne Company,Regal's journal entry for income taxes on May 31, 2000, is as follows:


Income Taxes Attributable to Undistributed Earnings of Subsidiaries

The FASB requires that a deferred income tax liability be recognized for an excess of the reported investment income in a subsidiary over its tax basis(i.e., cash dividends received from the subsidiary) if this excess is temporary and will be reverted in the future.a


Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)Income Taxes Expensec 168,000 Deferred Income Tax Liability 12,400

Income Taxes Payable b 180,400

a. Income tax effect of the temporary difference reversion = > $31,000 X 0.40 = $12,400. b.Taxable income x 40% = >($420,000 + $31,000) X 40% c. $180,400 – $12,400 = $168,000 d. The tax-deductible goodwill amortization expense of $2,267

is included in the measurement of both pre-tax financial income and taxable income. It is based on the 15-year amortization period. If the excess is permanent in duration, no deferred income tax liability is recognized for the excess. a. Applies to the excess arose in fiscal years beginning after 12/15/1992.


Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.) Example: Pinkley Corp. owns 75% of the outstanding

common stock of Seabright Company, which it acquired for cash on 4/1/1999. Goodwill acquired by Pinkley in the purchase-type business combination was $30,000 and was to be amortized over 15 years.

Seabright's identifiable net assets were fairly priced at their carrying amounts.


Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.) For the year ended 3/1/2000, Pinkley had

pre-tax financial income, exclusive of goodwill amortization and intercompany investment income under the equity method, of $100,000.

Seabright's pre-tax financial income was $50,000, and dividends declared and paid by Seabright during fiscal year 2000 totaled $10,000.

The income tax rate for both companies is 40%.


Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.) Income tax laws provide for a dividend-

received deduction rate of 80% on dividends from less-than-80%-owned domestic corporations.

Neither Pinkley nor Seabright had an temporary differences.

Neither had any income subject to preference income tax rates.

There were no intercompany profits resulting from transactions between Pinkley and Seabright.


Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)Seabright's journal entry to accrue income taxes on 3/31/2000 is as follows:Income Taxes Expense 20,000

Income Taxes Payable 20,000To record income taxes expense for Fiscal Year 2000 => $50,000 X 40%.

•On 3/31, 2000, Pinkley Corp. prepares the following journal entries for income taxes payable, the subsidiary's operating results, and deferred income tax liability:


Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

Amortization Expense 2,000Investment in Seabright Cop. 2,000To record amortization of goodwill for Fiscal Year 2000 ($30,000 / 15 = $2,000)

Income Taxes Expense 39,200

Income Taxes Payable 39,200

To record income taxes expense for Fiscal Year 2000 on income exclusive of intercompary investment income = > ($100,000 - $2,000) X 40% = $39,200.



Cash 7,500 Investment in Seabright 7,500

To record div. declared and paid by sub.$10,000 X 0.75 = $7,500

Investment in Seabright 22,500 Intercompany Investment Income 22,500To accrue share of subsidiary’s net income for Fiscal Year 2000 ($30,000* X 0.75 = $22,500) *$50,000 - $20,000 = $30,000



Income Taxes Expense 1,800 Income Taxes Payable

600 Deferred Income Tax Liability 1,200

To provide for income taxes on intercompany investment income from subsidiary as follows:



Net income of subsidiary $ 30,000 Less: Depre. and amor. attributable to differences between current fair values and carrying amounts of subsidiary’s net assets 0 Income of subsidiary subject to income taxes $30,000 Parent company’s share ($30,000 X 0.75) $22,500 Less: Dividend-received deduction ($22,500 X 0.80) $18,000 Amount subject to income taxes $ 4,500 Income taxes expense ($4,500 X 0.40) $ 1,800



Taxes currently payable based on dividend received ($7,500 X 0.20 X 0.40 ) $ 600 Taxes deferred until earnings remitted by subsidiary $ 1,200 Income Taxes expense $ 1,800


Income Taxes Attributable to Intercompany Profits (Gains)

The IRC permits an affiliated groupa of corporation to file a consolidated income tax return rather than separate returns.Intercompany profits and losses are eliminated in a consolidated income tax return just as they are in consolidated financial statements.


Income Taxes Attributable to Intercompany Profits (Gains) (contd.)

Note a: An "affiliated group" for tax purposes is defined as a group of corporations connected through stock ownership with a common parent corp. which owns directly at least 80% of the voting power of all subsidiaries and at least 80% of each class of the nonvoting stock of at least one of the other affiliates.


Income Taxes Attributable to Intercompany Profits (Gains) (contd.)

If a parent company and its subsidiaries do not qualify for the "affiliated group" status, or if they elect to file separate tax returns, the provisions of SFAS No. 109, "Accounting for Income Taxes" for the recognition of deferred tax assets and liabilities will be applied.


Income Taxes Attributable to Intercompany Profits in Inventory

For unrealized intercompany profits in inventory at the end of the first year for an affiliated group's operation, return to the working paper elimination on page 354 of the textbook for Post Corp. and Sage Company (a 95% partially owned subsidiary of Post) on 12/31/2001, which is as follows:


Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

Intercomany Sales—Sage 120,000

Intercompany CGS—Sage 96,000 CGS—Post 16,000 Inventories—Post 8,000

To eliminate intercompany sales, cost of goods sold (CGS), and unrealized intercomany profit in inventories



If Post and Sage file separate income tax returns for year 2001, the following additional working paper elimination is required on 12/31/2001:

Deferred Income Tax Asset—Sage 3,200 Income Taxes Expense—Sage 3,200To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany profits in parent company’s inventories on Dec. 31, 2001 ($8,000 X 0.40 = $3,200)



Note: the $3,200 reduction in income tax expense should be considered in the computation for the minority interest in net income of the subsidiary for the year ended 12/31/2001. For the unrealized intercompany profits in beginning and ending inventories, return to the working paper elimination on p356 of the textbook for the year ended 12/31/2002, which follows:



Retained Earnings—Sagea 7,600 Minority Interest in NA of Sub. 400 Intercompary Sales—Sage 150,000 Intercompany CGS—Sage 120,000 CGS—Post 26,000 Inventories—Post 12,000 a. $8,000X0.95To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories.



If the affiliated group file income separately, the following additional working paper eliminations are required on 12/31/2002:Deferred Income Tax Asset—Sage 4,800 Income Taxes Expense—Sage 4,800

To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany profits in parent company’s inventories on Dec. 31, 2002 ($12,000X0.40=$4,800).



Income Taxes Expense—Sage 3,200 Retained Earning—Sage a 3,040 Minority Interest in Net Assetsb&c 160

To provide for income taxes attributable to realized intercompany profits in parent company’s inventories on Dec. 31, 2001. ($8,000X0.40=$3,200)

a. $3,200X0.95; or $7,600X0.40. b. $3,200X0.05; or $400X0.40. c. This elimination reflects the income tax effects of the realization by the consolidated group, on a FIFO basis,of the intercompnay profits in the parent company's beginning inventories.



Note to the working paper elimination of year 2002:

The decrease on the subsidiary's I/T expense of $4,800 and the increase on subsidiary's the I/T expense of $3,200 are included in the computation of the minority interest in subsidiary's net income.


Income Taxes Attributable to Unrealized Intercompany Gain in Land

Return to the working paper elimination on p65 of chapter 8 notes for the intercompany gain resulting from an intercompany sale of land by the parent company on 12/31/2001(Post):

Intercompany Gain on Saleof Land—Post 50,000

Land—Sage 50,000

To eliminate unrealized intercompany gain on sale of land.


Income Taxes Attributable to Unrealized Intercompany Gain in Land(contd.)

Assuming a 40% income tax, the following working paper elimination is needed if Post and Sage filed separate income tax returns for year the year ended 12/31/2001:

Deferred Income Tax Asset—Post 20,000

Income Taxes Expense—Posta 20,000

a. This decrease in the expense has no impact on the minority interest in subsidiary's net income.



The purposes of the working paper elimination on 12/31/01:To defer income taxes provided on separate income tax returns of parent company applicable to unrealized intercompany gain in subsidiary's land on Dec. 31, 2001 ($50,000X0.04=$20,000).


Income Taxes Attributable to Unrealized Intercompany Gain in Land(contd.) The following working paper elimination

applies to all subsequent years for this intercompany sale of land as long as Sage does not sell the land to an outsider:

Retained Earnings—Post 50,000

Land—Sage 50,000To eliminate unrealized intercompany gain in land.



In years subsequent to year 2001, as long as the subsidiary owns the land, the following tax related working paper elimination is also required at the end of the year:Deferred Income Tax Asset—Post 20,000

Retained Earnings—post 20,000To defer income taxes attributable to unrealized intercompany gain in subsidiary’s land ($50,000x 40%).This elimination has no impact on the minority interest in subsidiary's net income.



When Sage sold the land, the following elimination would be prepareda:

Income Tax Expense-Postb 20,000 Retained Earnings- Post 20,000

a. This is due to the intercompany gain is realized by Sage on behave of Post

b. No impact on the minority interest in subsidiary's net income


Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets

Return to the working paper elimination on p76 of chapter 8 note for illustration: 12/31/2001

Intercompany Gain on Sale of Machinery—Sage 23,800 Machinery—Post 23,800

To eliminate unrealized intercompany gain of $23,800 on sale of Post's machinery to Sage on 12/31/3001.This intercompany gain will be realized through the periodic depreciation of the asset.


Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.) Assuming separate income tax (I/T) returns and an I/T tax rate of 40%, the following additional working paper elimination is required on 12/31/2001:

Deferred I/T Asset—Sage 9,520 I/T Expense—Sage a 9,520

To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany gain in parent company’s machinery on Dec. 31, 2001 (23,800X0.40=$9,520).


Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.) a. The $9,520 increase in the Sage's net income should be included in the computation of minority interest in the subsidiary's net income for year 2001.

For the year ended 12/31/2002, the working paper elimination of the intercompany gain is as follows:


Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.)

12/31/2002 Retained Earning—Sagea 22,610 Minority Interest in Net Assets of Subsidiaryb

1,190 Accu. Depre.—Post 4,760

Machinery—Post 23,800Depre. Expense—Post 4,760

a. $23,800X0.95 b.$23,800X0.05To eliminate unrealized intercompary gain in machinery and in related depreciation. Gain element in depreciation company is 23,800X0.20=$4,760 based on five-year economic life.



The elimination for income taxes attributable to the intercompany gain for the year ended 12/31/2002 is as follows:

I/T Expense—Sagea 1,904 Deferred I/T Asset—Sageb 7,616

Retained Earning—Sagec 9,044 Minority Interest in NA of Sub.d 476

a.$4,760 x 40% b. 9,520-$1,904 c.$9,520X0.95; or $22,610X40% d. $9,520X0.05; or $1,190X40%



The purposes of the above working paper elimination are:

1. To provide income taxes expense on intercompany gain realized through parent company’s depreciation (4,760X0.40=$1,904);

2. To defer income taxes attributable to the remainder of unrealized gain.



Comments to the above working paper elimination:

1. The decrease in the subsidiary's net income is included in the computation of the minority interest in the subsidiary's net income for year 2002.

2. Comparable working paper eliminations to the above elimination are necessary on December 31, years 2003, 2004,2005 and 2006.


Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds

Return to the 12/31/2001 working paper elimination on p131 of Chapter 8 notes for illustration:

Intercompany Bonds Payable— Sage 300,000

Discount on Intercompany Bonds Payable-Sage 18,224 Investment in Sage Company Bonds-Post 257,175 Gain on Extinguishment of Bonds-Sage 24,601

To eliminate subsidiary’s bonds acquired by parent and to recognize gain on the extinguishment of the bonds.(Income tax effects are disregarded.)


Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

The following working paper elimination is required on 12/31/2001 to accompany the above working paper elimination assuming a separate income tax return filing, a 40% income tax rate and the gain on extinguishment of debt is not material:

Income Taxes Expense –Sage a 9,840 Deferred Income Tax Lia.-Sage 9,840

To provide for income taxes attributable to subsidiary's realized gain on parent company's acquisition of the subsidiary's bonds ($24,601*40%)



The purpose of the elimination on 12/31/2001:

To provide for income taxes attributable to subsidiary's realized gain on parent company's acquisition of the subsidiary's bonds ($24,601*40%).



Note to the elimination on 12/31/2001:

The increase in expense of the subsidiary ($9,840) in the above elimination should be included in the computation of the minority interest in net income of the subsidiary for year 2001.


Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.) The working paper elimination for the bonds

and interest on 12/31/2002 is as follows: Intercompany Interest Revenue-Post 38,576 Intercompany Bonds Payable-Sage 300,000

Discount on Intercompany Bonds Payable- Sage 14,411Investment in Sage Company Bonds- Post 265,751Intercompany Interest Expense-Sage 33,813Retained Earnings-Sage($24,601 x 0.95) 23,371Minority Interest in Net Assets of Subsidiary

1,230

To eliminate subsidiary’s bonds owned by parent company, and related interest revenue and expense; and to increase subsidiary’s beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.



The following I/T related working paper elimination is necessary to accompany the above elimination:

12/31/02 Retained Earnings – Sagea 9,348

Minority Interest in NA of Sub.b 492 I/T Expense – Sage c 1,905 Deferred I/T Lia.d 7,935

a. $9,840x 0.95 or $23,371 x 40% b. $9,840x 0.05 c. $38,576-$33,813) x 40% d. $9,840-$1,905



The purposes of the I/T related working paper elimination prepared on 12/31/02:

1. To reduce the subsidiary’s income taxes expense for amount attributable to recorded intercompany gain (for consolidation purposes) on subsidiary’s bond;

2. To provide for remaining deferred income taxes on unrecorded portion of gain.



Note to the I/T related working paper elimination on 12/31/2002:

The $1,905 decrease in expense (increase in the subsidiary's net income is included in the computation of the minority interest in the subsidiary's net income for the year ended 12/31/2002


Summary: Income Taxes Attributable to Intercompany Profits (Gains)

The unrealized intercompany profits (gains) resulting from intercompany transactions of affiliated companies required interperiod tax allocation when the affiliated companies file separate income tax returns.The elimination of unrealized intercompany profits causes a temporary difference.


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-contd.

The elimination of unrealized intercompany gains for consolidation purposes will result in a taxable income exceeding a pre-tax financial income.Thus, a deferred income tax assets must be accounted for in the working paper eliminations that accompany the profit (gain) eliminations.


Summary: Income Taxes Attributable to Intercompany Profits (Gains)- contd.

In the case of intercompany bonds, pre-tax financial income exceeds taxable income of the accounting period of the realized gain.Thus, a deferred income tax liability must be provided in a working paper elimination.


Summary: Income Taxes Attributable to Intercompany Profits (Gains) – contd.

The following pages summarize the working paper eliminations for the intercompany transactions on inventory, land, depreciable plant assets and extinguishment of bonds for the year ended 12/31/2002.


Summary: Income Taxes Attributable to Intercompany Profits (Gains) – Inventory

b) Retained Earnings—Sage 7,600

Minority Interest in NA of Sub. 400

Intercompany Sale—Sage 150,000

Intercompany CGS-Sage 120,000

CGS—Post 26,000

Inventories—Post 12,000

POST CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations

December 31, 2002

To eliminate intercompany sales, cost of goods, and unrealized intercompany profits in inventories.


Summary: Income Taxes Attributable to Intercompany Profits (Gains) –Inventory

c) Deferred Income Tax Asset--Sage

4,800

Income Taxes Expense--Sage

4,800

To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany profits in parent company’s inventories on Dec. 31, 2002 ($12,000X0.40=$4,800).


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Inventory

c) Income Taxes Expense—Sage 3,200

Retained Earnings—Sage ($3,200X0.95; or $7,600X0.40)

4,800

Minority interest in Net Assets of Subsidiary($3,200X0.05; or $400X0.40)

160

To provide for income taxes attributable to realized intercompany profits parent company’s inventories on Dec. 31, 2001($8,000X0.40=$3,200).


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Land

d) Retained Earning—Post 500,000

Land--Sage 500,000To eliminate unrealized intercompany in land.

e) Deferred Income Tax Asset– Post

20,000

Retained Earnings--post 20,000

To defer income taxes attributable to unrealized intercompany gain in subsidiary’s land ($50,000X0.40=$20,000).


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Plant Assets

f) Retained Earning—Sage ($23,800X0.95)

22,610

Minority Interest in Net Assets of Subsidiary ($23,800X0.05)

1,190

Accumulated Depreciation—Post

4,760

Machinery—Post 23,800

Depreciation Expense—Post 4,760To eliminate unrealized intercompany gain in machinery and in related depreciation. Gain element in depreciation computed as $23,800X0.20=$4,760, based on five-year economic life.


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Plant Assets

g) Income Taxes Expense--Sage 1,904

Deferred Income Tax Asset—Sage ($9,520-$1,904)

7,616

Retained Earnings—Sage ($9,520X0.95; or $22,610X0.40)

9,044

Minority Interest in Net Assets of Subsidiary ($9,520X0.05; or $1,190X0.40)

476

To provide for income taxes expense on intercompany gain realized through parent company’s depreciation ($4,760X0.40=$1,904); and to defer income taxes attributable to remainder of unrealized gain.


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Bonds

h) Intercompany Interest Revenue—Post 38,576

Intercompany Bond Payable—Sage 300,000

Discount on Intercompany B/P-Sage 14,411

Invest. in Sage Company -Post 265,751

Intercompany Interest Expense--Sage 33,813

Retained Earnings—Sage ($24,601X0.95) 23,371

Minority Interest in NA of Sub. 1,230

To eliminate subsidiary’s bonds owned by parent company, and related interest revenue and expense; and to increase subsidiary’s beginning retained earning by amount of unamortized realized gain on the extinguishment of the bond.


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Bonds

i) Retained Earning—Sage ($9,840X0.95; or $23,371X0.40)

9,348

Minority interest in Net Assets of Subsidiary ($9,840X0.05; or $1,230X0.40)

492

Income Taxes Expense—Sage [($38,576-$33,813)X0.40]

1,905

Deferred Income Tax Liability– Sage ($9,840-$1,905)

7,935

To reduce the subsidiary’s income taxes expense for amount attributable to recorded intercompany gain (for consolidation purposes) on subsidiary’s bonds; and to provide for remaining deferred income taxes on unrecorded portion of gain


Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Comments

All the forgoing eliminations except (d) and (e) affect the net income of Sage Company.The corresponding amount of those eliminations are included in the computation of minority interest in net income of subsidiary for year 2002


Consolidated Statement of Cash Flows – General Comments

The consolidated statement of cash flows is prepared as described in intermediate accounting textbooks with a few points deserves special attention: The depreciation and amortization expense added (when using the indirect method) to total consolidated income is the consolidated deprecation and amortization expense.


Consolidated Statement of Cash Flows-General Comments (contd.)

The minority interest in net income of subsidiary (an expense on the consolidated income statement) should also be added to the consolidated net income in preparing the net cash flows of the operating activities.Only cash dividends paid by the parent company and cash dividends paid by partially owned subsidiary to minority stockholders are reported as cash flows from financing activities.


Consolidated Statement of Cash Flows – General Comments(contd.)

A cash acquisition by the parent company of additional shares of common directly from a subsidiary has no impact on the consolidated cash flows and is not reported in a consolidated statement of cash flows.A cash acquisition by the parent company of additional shares of common directly from minority stockholders reduces consolidated cash and is reported in a consolidated statement of cash flows as an investing activity.


Consolidated Statement of Cash Flows – General Comments(contd.)

A cash acquisition by the parent company of additional shares of common directly from a subsidiary has no impact on the consolidated cash flows and is not reported in a consolidated statement of cash flows.A cash acquisition by the parent company of additional shares of common directly from minority stockholders reduces consolidated cash and is reported in a consolidated statement of cash flows as an investing activity.


Illustration of Consolidated Statement of Cash Flows

Example:Parent Corp. owned 100% of Sub Company for a few years through a purchase-type business combination. Sub has one class of common stock and its total stockholder's equity on 12/31/99 was $500,000.On 1/2/2000, parent sold 30% of its investment in Sub's common stock to outsiders for $205,000, which was $55,000 more than the carrying amount of the investment in Parent's records.


Illustration of Consolidated Statement of Cash Flows (contd.)

Sub had a net income of $100,000 for Year 2000 and paid cash dividends of $60,000 during Year 2000.During Year 2000, Parent issued additional common stock and cash of $290,000 for plant assets which a current fair value of $490,000. The consolidated entity had additional long-term borrowings of $93,000 during Year 2000, and interest payments totaled $62,000 (none was capitalized). Income tax payments totaled $234,000.


Illustration of Consolidated Statement of Cash Flows (contd.)

The followings are the consolidated income statement for Year 2000, the consolidated statement of stockholder's equity for Year 2000, and the comparative consolidated balance sheets on December 31, 1999 and 2000:


Consolidated Income statement for the Year ended 12/31/2000

Sales and other revenue (including gain of $55,000 on sale of investment in Sub Company common stock)

$2,450,000

Costs and expenses:

Costs of goods sold 1,500,000

Depreciation and amortization expense 210,000

Other operating expenses 190,000 190,000

Income before income taxes $550,000

Income taxes expense 250,000

Total consolidated income $300,000

Less: Minority interest in net income of subsidiary

30,000

Net income $270,000

Basic earnings per share of common stock $5.14


Consolidated Statement of Stockholders' Equity For Year Ended 12/31/2000

Common Stock, $10

Par

Additional Paid-in Capital

Retained Earnings

Total

Balances, beginning of year

$500,000 $ 300,00 $ 670,000 $1,470,000

Issuance of 5,000 shares of common stock for plant assets

Net income

50,000 150,000

270,000

200,000

270,000

Cash dividends declared and paid($2.91 a share)

(160,000) (160,000)

Balances, end of year $ 550,000 $ 450,000 $ 780,000 $ 1,780,000


Consolidated Balance Sheets

December 31, 2000 1999

AssetsCash $ 300,000 $ 240,000

Other current assets

Plant assets

Less: Accumulated depreciation of plant asset

900,000

3,000,000

(1,300,000)

660,000

2,510,000

(1,100,000)

Intangible assets (net) 240,000 250,000

Total assets $3,140,000 $2,560,000


Consolidated Balance Sheets(contd.)

December 31, 2000 1999

Liabilities & Stockholder’s EquityCurrent liabilities

Long-term debt

Minority interest in net assets of subsidiary

505,000

693,000

162,000

490,000

600,000

Common stock, $10 per

Additional paid-in capital

Retained Earnings

Total Lia. & stockholders' equity

550,000 450,000 780,000

$3,140,000

500,000 300,000 670,000

$2,560,000


Working Paper for Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (indirect Method)

Balances 12/31/99

Balances 12/31/00

Debit Credit

Cash 240,000 (x) 60,000 300,000

Other current assets less current liabilities

170,000 (5) 225,000 395,000

Plant assets 2,510,000 (6) 290,000 (9) 200,000

3,000,000

Intangible assets (net) 250,000 (2) 10,000 240,000

Totals 3,170,000 3,935,000

Transactions for Year 2000


Working Paper for Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (indirect Method) (contd.)

Balances 12/31/99

Balances 12/31/00

Debit Credit

Accumulated depreciation 1,100,000 (2)200,000 1,300,000

Long-term debt 600,000 (7) 93,000 693,000

Minority interest in net assets of subsidiary

(8) 18,000

(3) 30,000

(4)150,000

162,000

Common stock, $10 par 500,000 (9) 50,000 550,000

Additional paid-in capital 300,000 (9)150,000 450,000

Retained earnings 670,000 (8)160,000 (1)270,000 780,000Totals 3,170,000 953,000 953,000 3,935,000




Balances 12/31/99

Balances 12/31/00

Operating Activities Debit CreditNet IncomeAdd: Depreciation and

amortization expense Minority interest in

net income of subsidiary

Less: Gain on sale of investment in Sub Company common stock

Net increase in net current assets

(1)270,000(2)210,000

(3) 30,000

(4) 55,000

(5)225,000

From operating activities $230,000




Balances 12/31/99

Balances 12/31/00

Investing Activities Debit CreditSale of investment in Sub

Company common Acquisition of plant assets

(4)205,000

(6)290,000

From investing activities ($85,000)




Balances 12/31/99

Balances 12/31/00

Financing Activities Debit CreditLong-term borrowingsPayable of dividends,

including $18,000 to minority stockholders of Sub company

(7) 93,000

(8)178,000

From financing activities ($85,000)

Subtotals 808,000 748,000

Increase in cash (x) 60,000

Totals 808,000 808,000



Consolidated Statement of Cash Flows for Year Ended 12/31/2000

Net cash provided by operating activities (Exhibit 1) $230,000

Cash Flows from Investing Activities:

Disposal of investment in Sub Company common stock

$205,000

Acquisition of plant assets (290,000)

Net cash used in investing activities (85,000)

Cash Flows from Financing Activities:

Long-term borrowings $ 93,000

Dividends paid including $18,000 to minority stockholders of Sub Company

(178,000)Net cash used in financing activitiesNet increase in cashCash, Beginning of yearCash, end of year

(85,000)$60,000240,000

$300,000


Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (contd.)

EXHIBIT 1 Cash flows from operating activities:

Net income $270,000

Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization expense 210,000

Minority interest in net income of subsidiary 30,000

Gain on disposal of investment in Sub Company common stock

(55,000)

Net increase in net current assets (240,000-15,000) (225,000)*

Net cash provided by operating activities $230,000


Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (contd.)

EXHIBIT 2 Supplemental disclosure of cash flow information:

Cash paid during the year for:

Interest (none capitalized) $ 62,000

Income taxes 234,000

EXHIBIT 3 Noncash investing and financing activities:

Common stock issues for plant assets

$200,000


Notes to the Above Consolidated Statement of Cash Flows

1. Net cash provided by operating activities includes the minority interest in net income of Sub Company.

2. Net cash provided by operating activities excludes the gain of $55,000 from sale of the 30% of investment in Sub company. The proceeds received, $205,000, are reported as as a component of investing activity.


Notes to the Above Consolidated Statement of Cash Flows

3. Only the dividends paid to stockholders of the Parent Corp ($160,000) and to minority stockholders of Sub Company ($18,000, Not, $60,000) are reported as cash flows from financing activities.

4. The issuance of common stock by Parent to acquire plant assets is a noncash transaction (a direct exchange).

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