Beams11 Ppt10 EDIT

Chapter 10
Subsidiary Preferred
Stock, Consolidated
Earnings Per Share, and
Consolidated Income
Taxation
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright ©2012 Pearson Education,

10-1
Inc. Publishing as Prentice Hall
Subsidiary Preferred Stock, Consolidated Earnings
Per Share, and Consolidated Income Taxation
1: PREFERRED STOCK

10-2
Subsidiary Preferred Stock
Subsidiary preferred stock
 Doesn't change consolidation in principle
 Does impact calculations
 Common stockholders' equity = total equity
less preferred stock at book value
 Income of subsidiary is first allocated to
preferred shareholders, then CI and NCI
 Subsidiary dividend payments must consider
payments to preferred shareholders before
common shareholders

10-3
Who Holds Preferred Stock?
Preferred stock is held by outsiders
 Preferred stock is a noncontrolling interest
Preferred stock is held by parent

May choose between:
 Constructive retirement
 Cost basis

10-4
Review of Preferred Stock
Characteristics Income allocated to PS is:
Callable, redeemable Current period dividend
Cumulative or irrespective of amount
noncumulative declared, if cumulative
Participative or non- Declared amount if
participative noncumulative
Limited voting rights
Most is cumulative and Potentially more if
nonparticipating participative
Book Value of PS is: Preferred stock dividend
Call or redemption price is:
(par value if neither) Face value x dividend rate
Plus Dividends in arrears Also consider:
(if cumulative) Arrearage
Participation

10-5
Example: PS Held by Outsiders
Poe buys 90% of Sol for $396 when Sol's equity
consists of $100 preferred stock, $200 common
stock, $40 other paid in capital and $160
retained earnings.
 The preferred stock is cumulative,
nonparticipating, carries a 10% dividend and is
callable at 105% of par value. There is no
arrearage.
During the year, Sol earns $50 and pays $30 in

dividends.
10-6
Calculations for Preferred Stock
Cost of 90% of Sol $396
Implied value of Sol $440
Sol's total equity $500
Less book value of preferred stock (105)
Book value of common 395
Excess, goodwill $45
The book value of preferred is its call price (no

arrearage), 105% x $100 PS par value.
Dividends are cumulative, so the current
dividend is $10 = 10% x $100 PS par value.
10-7
Allocations
NCI share –
Income allocation: (preferred)
Sol's net income $50 NCI share
$10 income (10%
Amortizations 0 common)
Income to allocate 50 $10 dividend
$4 income
Allocated to preferred (10)
Allocated to common $40 CI share $2 dividend
(90%)
Dividends $30 $36 income
Allocated to preferred (10)
$18 dividend
Allocated to common $20

10-8
Income from Sol (-R, -SE) 36
Dividends (+SE) 18
Investment in Sol (-A) 18
Noncontrolling interest share, CS (-SE) 4
Worksheet Dividends (+SE) 2
Entries with Noncontrolling interest, CS (+SE) 2
Preferred Stock Noncontrolling interest share, PS (-SE) 10
Held by Dividends (+SE) 10
Outsiders Preferred Stock (-SE) 100
Retained earnings (-SE) 5
There is an Noncontrolling interests, PS (+SE) 105
entry for NCI Common stock (-SE) 200
share, PS that
Other paid in capital (-SE) 40
parallels the
entry for NCI
share, CS. Goodwill (+A) 45
Preferred Stock Investment in Sol (-A) 396
is eliminated. Noncontrolling interest, CS (+SE) 44
10-9
Parent Uses Constructive Retirement
Parent acquires subsidiary's preferred stock
 Investment in subsidiary, PS is recorded at its book
value
 Any difference between book value and cost of the
stock is an adjustment of other paid in capital
 This is an owner transaction; no gain or loss is
recorded
Investment is carried at the book value of the
PS
 Increase for dividends in arrears
 Decrease later when declared
10-10
Parent Uses Cost Basis
Parent acquires subsidiary's preferred stock
 Use cost method
 Investment in subsidiary, PS is at cost
 Dividends are recorded as income
Di laporan konsolidasi
 Preferred stock is eliminated at its book value
 Noncontrolling interest, PS is recorded at book
value of the preferred stock held by others
 Investment is removed at its cost and any
difference from book value is charged or credited
to other paid in capital
10-11
Example: Parent Acquires PS
Poe owns 90% of Sol acquired at fair value
plus implied goodwill of $45.
On 1/1/14 Poe acquires 80% of Sol's
outstanding preferred stock for $80.
Sol's equity at 1/1/14:

$10 Preferred stock, $100 par, callable at
$105, cumulative, 1 year in arrears $100
Common stock $10 par 200
Other paid-in capital 40
Retained earnings 140
Total equity $480
10-12
Calculations at 1/1/14
Book value of preferred stock
($105 call price + $10 arrearage) x
($100 total PS / $100 par) shares
= $115
Book value of Sol's common stock
$480 total equity – $115 = $365
Sol's total value with goodwill

$480 total equity + $45 goodwill = $525
Investment in Sol, CS (90%) = $369

Noncontrolling interest, CS (10%) = $41
Noncontrolling interest, PS (20%) = $115
10-13
Acquisition of PS by Poe
Poe acquires 80% of Sol's PS for $80 on 1/1/14
Poe may use the constructive retirement or

cost basis
Investment in Sol, PS (at book value)
80% x 115 = $92
Or
Investment in Sol, PS (at cost)
= $80
The difference, $12 = $92 - $80, increases the parent's
other paid-in capital for the constructive retirement method.

10-14
Sol’s 2014 Income and Dividends
For 2014, Sol had $20 in income and paid no
dividends.
Totals CI NCI
Sol’s net income $20
Allocated to preferred
(10) $8 $2
shareholders
To common
$10 $9 $1
shareholders

10-15
Constructive Retirement Entries
POE'S ACQUISITION ENTRY 1/1/14:
Investment in Sol, preferred (+A) 92
Cash (-A) 80
Other paid-in capital (+SE) 12
CONSOLIDATION WORKSHEET ENTRY 12/31/14:
Income from Sol, preferred (-R, -SE) 8
Investment in Sol, preferred (+SE) 8
NCI share, preferred (-SE) 2
NCI, preferred (+SE) 2
Income from Sol, common (-R, -SE) 9
Investment in Sol, common 9
10-16
Constructive Retirement Entries (cont.)
NCI share, common (-SE) 1
NCI, common (+SE) 1
Preferred stock (-SE) 100
Investment in Sol, preferred (+SE) 92
NCI, preferred (+SE) (20% x 115) 23
Common stock (-SE) 200
Goodwill (+A) 45
Investment in Sol, common (-A) 369
Noncontrolling interest, common (20%) 41
10-17
Cost Basis Entries
PARENT'S ACQUISITION ENTRY 1/1/14:
Investment in Sol, preferred (+A) 80
Cash (-A) 80
CONSOLIDATION WORKSHEET ENTRIES 12/31/14:
Income from Sol, preferred (-R, -SE) 8
Investment in Sol, preferred (-A) 8
NCI share, preferred (-SE) 2
Income from Sol, common (-R, -SE) 9
NCI share, common (-SE) 1
NCI, common (+SE) 1
10-18
Cost Basis Entries (cont.)
Preferred stock (-SE) 100
Investment in Sol, preferred (-A) 80
Other paid-in capital (+SE) 12
Common stock (-SE) 200
Goodwill 45
Noncontrolling interest, common (+SE) 41
10-19
Comparison of Methods
Both result in the same consolidated amounts
Constructive retirement
 Records the Other paid in capital (parent's) at
acquisition
 Investment is at book value
 Simplifies consolidation process!
Cost basis
 Records the Other paid in capital (parent's) as part
of the consolidation process
 Investment is at cost
10-20
2: EARNINGS PER SHARE

10-21
EPS Requirements
GAAP meminta perusahaan menyertakan basic
dan diluted EPS
 EPS is disclosed on a consolidated basis
Main issue: Subsidiary's capital structure

 Subsidiary potentially dilutive securities
convertible into subsidiary common stock
 Subsidiary potentially dilutive securities
convertible into parent common stock

10-22
Review Basic EPS
Numerator:
Net income – preferred stock dividends*
* current dividends if cumulative, otherwise
declared dividends
Denominator:
Weighted average shares of common stock

10-23
Review Diluted EPS
Numerator:
(Net income – PS dividends)
+ adjustments for dilutive securities
Denominator:
Weighted average shares outstanding
+ shares represented by dilutive securities
Dilution:
 Dilutive securities reduce EPS
 Non-dilutive securities are excluded

10-24
Effect of Dilutive Securities on EPS
Bonds payable convertible into common
 Numerator: after-tax interest expense
 Denominator: common shares bonds represent
Preferred stock convertible into common
 Numerator: preferred stock dividend
 Denominator: common shares the preferred shares
represent
Options or warrants for common stock
 Numerator: none
 Denominator: "treasury stock method" to compute
shares (only if positive, i.e., dilutive)
# shares – (# shares x option price / average market price)
10-25
Subsidiary Securities Convertible into
Subsidiary Common Stock
Compare Parent's equity
 Realized earnings of subsidiary
 Diluted earnings of subsidiary
 If diluted is higher, skip  Non-dilutive
Realized earnings:
 Parent’s share of subsidiary's net income adjusted for
intercompany profits/losses and constructive
gains/losses
 Does not include amortizations of valuation differentials
Diluted earnings:
 Subsidiary's diluted EPS x shares held by parent
Parent's diluted EPS
 Numerator: Reduce by difference
 Denominator: No effect – no parent shares!

10-26
Subsidiary PS Convertible into
Subsidiary CS
Sad has $50 net income and 20 weighted
average shares of common stock. Its preferred
stock has a $10 dividend and is convertible
into 12 shares of Sad common stock.
Sad's basic EPS:
($50 - $10) / 20 = $2.00
Sad's diluted EPS:
($50 - $10) + $10 = $1.5625
20 + 12 .

10-27
Parent's Basic EPS
Sad is 90% owned by Pan. Pan's separate
income is $150. Pan has 200 shares of
common outstanding all year and no dilutive
securities.
Pan’s net income
 Separate income $150
 Income from Sad 90% (50-10) 36
 Pan’s net income $186
Pan's basic EPS:

$186 / 200 = $0.93
10-28
Parent's Diluted EPS
Pan's realized income from Sad
90% x $40 = $36
Pan's share of Sad's diluted earnings:
90% x 20 shares x $1.5625 = $28.125
Since the share of diluted earnings is lower, we
will reduce the numerator by the difference.
Pan's diluted EPS:

$186 – 36 + 28.125 = $0.89
200 .

10-29
Subsidiary Securities Convertible into
Parent Common Stock
Parent's diluted EPS calculation:
 Numerator: Add adjustments for subsidiary
securities convertible into parent common stock
 Preferred stock dividends for shares assumed
converted
 After-tax interest on bonds assumed converted
 Denominator: Add parent common shares
represented by subsidiary's dilutive securities
 Parent common shares to be issued for subsidiary
preferred stock or bonds
 Parent common shares assumed issued for options or
warrants (treasury stock method)
10-30
Use the same assumptions and data as before,
except that Sad’s preferred stock is convertible
into 24 shares of Pan’s common stock.
Sad’s preferred stock dividends on shares

assumed to be converted by Pan is (90% x $10
preferred stock dividend) = $9
Pan's diluted EPS:

$186 + 9 = $0.87
200 + 24 .
10-31
Subsidiary Options and Bonds
Convertible into Parent CS
Syd's net income is $450 and it has 400 shares
of common outstanding all year.
Options: Syd has issued options for 60 shares

of its parent's (Pad) common stock at $10 per
share. The average market price is $15.
Convertible bonds: Syd has $1,000 par bonds

convertible into 80 shares of Pad's common
stock. The bonds were issued at par to yield
7%. The effective tax rate is 34%.
10-32
Parent's Data and Basic EPS
Pad has $1,800 income (including $300 from
Syd) and 1,000 shares of common stock
outstanding all year. It has no preferred stock
or dilutive securities.
Pad's basic EPS:

$1,800 / 1,000 shares = $1.80

10-33
Impact of Syd's options for Pad common:
 Numerator: none
 Denominator: 60 - (60 x $10/$15) = 20 shares
Impact of Syd's bonds convertible to Pad
common:
 Numerator: 7% x $1,000 x (1-34%) = $46.2
 Denominator: 80 shares
Pad's diluted EPS:
$1,800 + 0 + $46.2 = $1.68
1,000 + 20 + 80 .

10-34
3: INCOME TAXES

10-35
Consolidated Tax Return
Advantages
 Offset affiliate losses (excluding preacquisition loss
carry forwards)
 Exclude 100% of intercompany dividends
 Defer intercompany profits until realized (losses are
also deferred)
Disadvantages
 Loss of flexibility
 Difficult to switch back to unconsolidated
 Cannot file as consolidated again for 5 years

10-36
Income Tax Allocation
Permanent differences
 Dividends from affiliates are excluded from taxable
income
 Dividends from affiliates that are not members of
the affiliated group are allowed an 80% dividends
received deduction
Temporary difference
 Undistributed income from domestic affiliates
[FASB ASC 740-10-05]
 Exception for undistributed earnings of foreign
subsidiaries and foreign joint ventures
10-37
Undistributed Earnings
Par owns 30% of Sea's common stock.
 Sea's income, $600
 Sea's dividends, $200
 Par's applicable tax rate = 34%
Filing separate returns, Par's deferred tax
liability = [30%($600 - $200)] x 20% x 34% = $8.16
Sea's earnings are allowed the 80% deduction, so only
20% is subject to tax.
Filing a consolidated return, Sea’s earnings
would be excluded and Par would have no
deferred tax liability.
10-38
Unrealized Gains and Losses
Separate tax returns
 Unrealized gains (losses) are taxed (deducted) in
the separate returns
 Consolidation procedures
 Remove the unrealized gain (loss)
 Record a deferred tax asset (liability)
 Tax effect impacts the income tax expense of
the selling affiliate
Consolidated tax return
 Unrealized gains (losses) are excluded

10-39
Example
Pal owns 90% of Sal. The tax rate is 34%. Pretax
operating income of Pal and Sal are $150 and $50. Sal
paid dividends of $20 and Sal's dividends are subject
to the 100% exclusion.
During the year, intercompany sales were $40 and

there remains $10 in unrealized profits in ending
inventory.

10-40
Consolidated Tax Return
Downstream sales
Pal's income $150 - $10 unrealized gain = $140
Sal's income $50
Consolidated taxes ($140 + $50) x 34% = $64.6
 Allocate
(140/(140+50)) x $64.6 = $47.6 to Pal
(50/(140+50)) x $64.6 = $17.0 to Sal
Upstream sales
Pal's income $150
Sal's income $50 - $10 = $40
Consolidated taxes ($150 + $40) x 34% = $64.6
 Allocate
(150/(150+40)) x $64.6 = $51.0 to Pal
(40/(150+40)) x $64.6 = $13.6 to Sal

10-41
Entries with Consolidated Return
Pal and Sal would each record their own share
of the income tax expense and income tax
payable.
The unrealized profit does not give rise to any
temporary differences
 Deferred for consolidation purposes
 Deferred for tax purposes
 That is, it is not income now and it is not taxed now!
No special considerations for consolidation
worksheet.

10-42
Separate Tax Returns
Downstream sales
Pal's accounting income $150 - $10 = $140
 Pal's taxes payable $150 x 34% = $51.0
 Pal's deferred tax asset $10 x 34% = $3.4
 Income tax expense $47.6
Sal's income $50
 Sal's taxes $50 x 34% = $17.0
Upstream sales
Pal's income $150
 Pal's taxes $150 x 34% = $51.0
Sal's income $50 - $10 = $40
 Sal's taxes payable $50 x 34% = $17.0
 Sal's deferred tax asset $10 x 34% = $3.4
 Sal's income tax expense $13.6

10-43
Business Combinations
Tax free reorganizations
 Mergers or consolidations
 Exchange of voting stock for another corporation's
stock
 Exchange of voting stock for another corporation's
assets
Purchase acquisitions may be either:
 Tax free
 Taxable

10-44
Tax Free Business Combinations
Tax free business combinations give rise to
differences between book values and tax
values
At acquisition
 Assign assets value based on gross fair value
 Except:
 Goodwill, bargain purchase, deferred taxes,
pension assets, leveraged leases
 Tax bases carry forward from predecessor
 Record deferred tax asset/liability for temporary
differences
10-45
Income Tax Disclosures
Deferred tax assets and liabilities
 Separate into current and non-current
 Based on related asset or liability reporting
Income tax expense
 Separated into its components of expense and
benefits related to:
 Continuing operations
 Discontinued operations
 Extraordinary items
Income tax component of prior-period
adjustments
10-46

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Chapter 10

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Preferred stock is held by parent

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

During the year, Sol earns $50 and pays $30 in

The book value of preferred is its call price (no

Copyright ©2012 Pearson Education,

Sol's equity at 1/1/14:

Sol's total value with goodwill

Investment in Sol, CS (90%) = $369

Poe may use the constructive retirement or

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

2: EARNINGS PER SHARE

Copyright ©2012 Pearson Education,

Main issue: Subsidiary's capital structure

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Pan's basic EPS:

Pan's diluted EPS:

Copyright ©2012 Pearson Education,

Sad’s preferred stock dividends on shares

Pan's diluted EPS:

Options: Syd has issued options for 60 shares

Convertible bonds: Syd has $1,000 par bonds

Pad's basic EPS:

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

During the year, intercompany sales were $40 and

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

Copyright ©2012 Pearson Education,

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