1 - Topic 7 - Heading 2 - Parent Forms Subsidiary - Heading Chapter 7: Miscellaneous Topics Subsidiary sells stock to Outsiders as well as to Parent 3 - Parent Forms Subsidiary - #1 4 - Parent Forms Subsidiary - #2 P forms S & P buys 100% of S s stock Price of Stock = all of assets of S Price of Stock = FMV of all of S s Net Assets No excess purchase price to allocate P may not buy 100% of stock of S Employees & professionals (e.g., lawyers/accountants) want piece of action (e.g., Enron) So, P may buy large % of S s stock and Others buy small % 1
5 - Parent Forms Subsidiary - #3 6 - Parent Forms Subsidiary - #4 If Others pay same price as P P s price for stock = P s % of FMV of S Net Assets No real problem E.g., P buys 90K shares at $10 and Others buys 10K shares at $10: S has raised $1,000K: (P) 90K x $10 = $900K (O) 10K x $10 = $100K P paid = 90% of S s Net Assets ($1,000K) $900K = $900K If Others pay different price for S s stock Then P s Price for S s stock FMV of P s % of S s Net Assets We have to deal with this We use rules that we learned in Chapters 1&2 7 - Parent Forms Subsidiary - #5 8 - Parent Forms Subsidiary - #6 If Others pay higher price Then P s % of S s Net Assets > Price P paid E.g., P buys 90K shares for $10 & others buy 10K shares for $20 S has raised $1,100K: (P) 90K x $10 = $900K (O) 10K x $20 = $200K P paid < 90% of S s Net Assets ($1,100K total) $900K < $990K What do you do when P pays less than FMV of P s share of S s assets? P paid $900K for 90% of S s assets which are worth $990K P gets gain 2
9 - Parent Forms Subsidiary - #7 10 - Parent Forms Subsidiary - #8 If Others pay lower price. Then Price P paid > P s 90% of Net Assets of the S E.g., P buys 90K shares for $10 & Others buy 10K shares for $5 S has raised $950K: (P) 90K x $10 = $900K (O) 10K x $5 = $50K P paid > 90% of S s Net Assets ($950K total) $900K > $855K What do you do? P paid $900K for share of S s assets worth $855K This is a GW situation The example in the book is bad It talks about buying a corporation with an NCI Not these situations at all There will be no exam questions on insiders paying a different price for stock. 11 - Parent Buys Stock in Stages - Heading 12 - Parent Buys 1 st Block of Sub W/O Control & Later Gets Control - Heading Parent Buys Stock of Subsidiary in Stages Parent Buys 1 st Block of Subsidiary s Stock Without Getting Control of S ---------------------------------------------------- Later Parent Gets Control of Subsidiary (This was discussed at the end of Chapter 2) 3
13 - Parent Buys 1 st Block of Sub W/O Control & Later Gets Control - #1 When P buys less than 50% of S with 1 st block & then gets control Reevaluate 1 st block to FMV Book a gain 14 - Parent Buys 1 st Block of Sub W/O Control & Later Gets Control E.g. - #1 Assume: P bought 20% of S P paid $100K P later buy another 40% of S paying $250K The $250K price implies total FMV of $625K ($250K/.4) Implied value of 20% = $125K (.2 x $625K) On P s books: P takes a gain of $25K on its 1st block P then combines both blocks D. Investment in Company S $100,000 C. Cash $100,000 D. Investment in Company S $25,000 C. Unrealized Gain on Revaluation of Investments $25,000 D. Investment in Subsidiary $375,000 C. Investment in Company S (20% block) $125,000 Cash (40% block) $250,000 15 - Parent Buys Stock in Stages - Heading Parent Buys Stock of Subsidiary in Stages ----------------------------------------- Parent gets control with 1 st block & then buys 2 nd block 16 - Parent Buys S s Stock in Stages - #2 Assume P buys S s stock in stages & P gets control of S with 1 st block of S s stock P buys second block Purchase of 2 nd block treated as retirement of stock It is not a purchase of another block There is no reevaluation You retire the NCI You calculate whether you have a gain or loss from the retirement 4
17 1 st, lets assume that P buys all of the NCI just to simplify the numbers 18 - Parent Buys S s Stock in Stages - #3 Assume P bought 60% of S for $126K BV of S is $160K Implied value is $210K ($126/.6) Implied Value BV = $50K Excess attributable to: Equipment: $30K This is depreciated $6/year ($30/5years) GW: $20K NCI got 40% of these adjustments $12K (Equipment) and $8K (GW) = $20K D. Equipment $30K Goodwill $20K C Investment in Sub $30K Retained Earnings, Sub (NCI) $20K 19 - Parent Buys S s Stock in Stages - #5 2 years later, BV = $200K Increase in S s RE P buys the 40% NCI for $100K This $100K will increase Investment in S D. Investment in Subsidiary $100,000 C. Cash $100,000 20 - Parent Buys S s Stock in Stages - #5 You need to calculate the Worksheet value (WSV) of the 40%NCI (the value of the NCI in the Consolidation) This is the vale that the 40% NCI was given after P took control of the S Then you calculate gain or loss Compare: (i) what P paid for the NCI to (ii) 40% NCI s WSV WSV OF 40% NCI: Trial Balance (BV) + D entry (Extra Value added) A entry (Value lost from depreciation) 5
21 22 What is the WSV of the 40% NCI position acquired? BV (On S s books) of 40% NCI position is $80 (total BV of $200K x.4 = $80K) 40% NCI position was increased when P took control of S NCI s was given extra value of $20K ($50K x.4) D. Equipment $30K Goodwill $20K C Investment in Sub $30K Retained Earnings, Sub (NCI) $20K 40% NCI WSV before depreciating the equipment is $100K ($80K + $20K) We depreciate the Equipment ($30K/5years) $6K a year x 2 years = $12K in the A entry D. Retained Earnings, Parent (60%) $7,200 Retained Earnings, Subsidiary (40%) $4,800 C Accumulated Depreciation $12K 40% NCI is reduced by the $4,800 of depreciation in the A entries 40% NCI WSV = $95,200 ($100K - $4,800) 23 - Parent Buys S s Stock in Stages - #5 Now, Compare: (i) what P paid to (ii) the WSV of the NCI interest bought P paid $100,000 WSV is $95,200: 100,000 95,200 = $4,800 P lost $4,800 when it bought the 40% NCI interest. 24 - Parent Buys S s Stock in Stages - #5 Remember that you don t book gains or losses when you trade in your own stock Trading in Stock of S is treated as trading in Stock of P Corporations never book a gain or loss when they trade in their own stock Same rule applies to Treasury Stock 6
25 - Parent Buys S s Stock in Stages - #5 If P paid more than the WSV of NCI position purchased: Reduce any APIC Retirement If no APIC, reduce RE, Parent If P paid less than the WSV of the NCI position purchased: Increase APIC Retirement This is all done on WS $4,800 will cause a reduction in P s RE Because there is no APIC Retirement exists 26 Now we will redo this example assuming that P bought half of the NCI. 27 - Parent Buys S s Stock in Stages - #5 2 years later, BV = $200K Increase in S s RE P buys another 20% for $50K This $50K will increase Investment in S, 28 - Parent Buys S s Stock in Stages - #5 You need to calculate the WSV of the 20% NCI interest purchased WSV of 20% NCI: Trial Balance (BV) + D entry (value added) A entry (value lost from depreciation) D. Investment in Subsidiary $50,000 C. Cash $50,000 7
29 What is the WSV of the 20% NCI position acquired? BV (On S s books) of 20% NCI position is $40 (total BV of $200K x.2 = $40K) 20% NCI position was increased in the Consolidation when P took control of S NCI s was given extra value of $10K ($50K x.2) D. Equipment $30K Goodwill $20K C Investment in Sub $30K Retained Earnings, Sub (NCI) $20K Remember that P is buy ½ of NCI in this example. 30 20% NCI WSV before depreciation is $50K ($40K + $10K) The Equipment is depreciated ($30K/5years) $6K a year x 2 years = $12K D. Retained Earnings, Parent (60%) $7,200 Retained Earnings, Subsidiary (40%) $4,800 C Accumulated Depreciation $12K 20% NCI gets $2,400 of depreciation in the A entries (1/2 of depreciation) 20% NCI WSV = $47,600 ($50K - $2,400) 31 - Parent Buys S s Stock in Stages - #5 Now, Compare what P paid to the WSV of the NCI interest bought P paid $50,000 WSV is $47,600: P lost $2,400 when it bought the 20% NCI interest. $2,400 will cause a reduction in P s RE 32 - Parent Buys S s Stock in Stages - #5 Now, let s focus on the retirement of the 20% NCI position that P bought. First, we have to create the WSV of the NCI This creates assets Do the D and A entries just as before Give the 20% NCI position, the value that it is entitled to Then, we eliminate the 20% NCI equity. So, the NET effect is that P bought the WSV of the NCI, it takes over the 20% NCI equity. If you create the assets and eliminate the NCI equity, then the equity belongs to the CI. 8
33 - Parent Buys S s Stock in Stages - #5 34 - Parent Buys S s Stock in Stages - #5 WS entries 1 st Do EL entry with new percentages 2 nd - Do First D entry with old percentages (60% vs. 40% NCI) D. Common Stock, S (80%) $80,000 RE, S (80%) $80,000 C. Investment in S $160,000 This wipes out the portion of the 20% NCI that goes with the BV. D. Equipment $30,000 Goodwill $20,000 C. Investment in S $30,000 RE, S (40%) 20,000 This creates the assets that go with the 20% NCI 35 - Parent Buys S s Stock in Stages - #5 What about the depreciation? With the Simple Equity Method, A Entry: Depreciation for 1 st & 2 nd years were split 60:40 Depreciation for 3 rd and later years will be split 80:20 D. RE, S (40%) $4,800 RE, P (60%) 7,200 Depreciation Expense (Current Year) 6,000 C. Accumulated Depreciation $18,000 This reduces the assets that go with the 20% NCI for the depreciation taken earlier. 36 - Parent Buys S s Stock in Stages - #5 3 rd - Do new D entry to wipe out the 20% NCI position Remaining BV: $10K (D entry) - $2,400 (A entry) Remaining BV = $7,600 D. RE, S (transfer 20% NCI position) $7,600 RE, P (amount paid over 20% NCI position) $2,400 C. Investment in S (amount paid over 20% BV) $10,000 This wipes out the extra WSV over the BV that was creates in the A and D entries It also books the gain or loss on retirement of the 20% NCI 9
37 - Parent Sells All of its Stock in Sub - Heading 38 - Parent Sells All of its Stock in Sub - #1 Parent Sells All of Its Interest in Subsidiary If P sells its entire interest in S: Gain/loss recognized by P on its books S will no longer be part of Consolidation Amount of gain has to be consistent with results reported in Consolidated FS Consolidated FS have reported: S s income Mark Up/Down of Assets Depreciation on the Mark Ups/Downs 39 - Parent Sells All of its Stock in Sub - #1 40 - Parent Sells All of its Stock in Sub - #1 E.g. Assume that: P bought 100% of S for $1,000K 20 years ago Every year S loses $50,000 which shows up on Consolidated IS After 19 years, S is only worth $50K P uses Cost Method With no adjustment P sells S for $50K with $1,000K BV = $950K loss This loss will show up on Consolidated IS This loss has already shown up over last 19 years This double counting There is no real loss Gain is calculated by: Price Paid BV of Asset Sold BV of S should reflect (S s income, div & extra depreciation) If Sophisticated Equity Method was used BV has all of this If Simple Equity Method was used BV doesn t reflect depreciation on Mark Ups/Downs If Cost Method was used BV doesn t reflect: S s income, S s dividends, & depreciation expense on Mark Ups/Downs Basically, you need to change Inv in Sub acct balance to what it would have been had you used Sophisticated Equity Method 10
41 - Parent Sells All of its Stock in Sub - #6 42 - Parent Sells All of its Stock in Sub - #7 If Simple Equity Method were used by P You need to add depreciation (from A entries) to Inv in Sub so BV will be correct This makes it same as Sophisticated Equity Method If Cost Method had been used, you need to adjust Inv in S account for: Depreciation taken in A entries Income/Loss From S Dividends From S This makes it same as Sophisticated Equity Method 43 - Parent Sells All of its Stock in Sub E.g., - #1 44 - Parent Sells All of its Stock in Sub E.g., - #2 E.g., Assume: P bought 100% of S for $100,000 There was excess asset of $10,000 depreciated S/L for 10 years ($1K per year) S had $5K income each year P sells S after 5 years If P uses Sophisticated Equity Method then Inv in S account is $120,000 $100,000 + [5 x ($5,000 -$1,000) ] = $120,000 If P uses simple Equity Method then Inv in S account is $125,000 $100,000 + [5 x $5,000 ] = $125,000 We need to adjust Inv in S account to reflect $1,000/ year depreciation from A entries On P s books, you make the following entry: D. Retained Earnings $5,000 C. Investment in Subsidiary $5,000 11
45 - Parent Sells All of its Stock in Sub E.g., - #3 If P uses Cost Method then Inv in S account is $100,000 (orig cost) We need to adjust Inv in S account to reflect $5,000/ year income of S $1,000/ year depreciation from A entries On P s books, you make the following entry: D. Investment in Subsidiary $20,000 C. Retained Earnings $20,000 46 - Parent Sells All of its Stock in Sub During Year - #1 If sale occurs during year you do everything we just discussed That brings you current up to the 1 st of the year You have to adjust Inv in S account for the current year Income/Loss of S for current year (up to sale) Dividends of S for current year (up to sale) Depreciation from A entries for current year (up to sale) The current year s adjustment is same for all methods Inv in S was not adjusted for the current year s operations under any of the methods 47 - Parent Sells All of its Stock in Sub During Year E.g. - #1 48 - Parent Sells Part of its Stock in Sub - Heading E.g., Assume sale occurred in middle of 6 th year in prior example Then you have to adjust Inv in Sub for ½ year s income ($2,500) and depreciation ($500): Parent Sells Part of Its Interest in Subsidiary D. Investment in Subsidiary $2,000 C. Subsidiary Income $2,000 12
49 - Parent Sells Part of its Stock in Sub - #1 50 - Parent Sells Part of its Stock in Sub - #2 When P sells part of S & loses control of S You still have to bring P s Inv in S account to amount indicated by Sophisticated Equity Method This is done on the P s books When S leaves consolidation, it should have BV equal to value indicated in consolidation Do same journal entries that we discussed previously When P sells part of S & maintains control of S Don t need to bring all of Investment in S to Sophisticated Equity Method BV Only need to adjust BV of part (%) sold P still has control, so free to use any method it wishes for its remaining Inv in Sub acct 51 - Parent Sells Part of its Stock in Sub E.g., - #1 52 - Parent Sells Part of its Stock in Sub - #3 E.g., Assume: P bought 100% of S for $100,000 There was excess asset of $10,000 depreciated S/L for 10 years ($1K per year) S had $5K income each year P sells 10% of S after 5 years No adjustment for Sophisticated Equity Method Simple Equity Method needs to reflect depreciation for 5 years (10%) $500 decrease in Inv in S Cost Method needs to reflect depreciation & income for 5 years (10%) $2,000 increase in Inv in S How do you treat gain from sale of S shares? If P loses control gain/loss Selling Investment If P doesn t lose control No gain/loss Use APIC instead Like Treasury Stock Because P still controls S GAAP says not really selling Investment you are selling your own stock Can t have gain/loss from sale of your own stock Remember, done on P s books Not WS 13
53 Subsidiary Has Preferred Stock - Heading 54 Subsidiary Has Preferred Stock - #1 Subsidiary Has Preferred Stock --------------------------------------- Parent Doesn t Own Preferred Stock (NOT ON TEST) PS has claim on RE of S Claim liquidation preference (what PS gets on liquidation of S) Liquidation preference includes: Par value of PS If PS is cumulative preference will include arrearages Unpaid dividends May include a bonus PS s claim on RE comes before P s ownership of S (S s RE) 55 Subsidiary Has Preferred Stock - #2 Assuming that P doesn t own PS PS affects: WS entries P s recognition of P s share of S s Net Income NCI s share of Consolidation Income 56 Subsidiary Has Preferred Stock - #3 When doing analysis of purchase price remember that P didn t buy PS s Equity PS affects D entry Price Paid $187,500 Less: Interest Acquired Common Stock $100,000 Retained Earnings Balance, January 1, 2003 $80,000 Less preferred dividends in arrears (2 years x $6,000) ($12,000) Retained Earnings applicable to common stock $68,000 Total Equity applicable to common stock ($168,000) Goodwill $15,600 14
57 Subsidiary Has Preferred Stock - #4 58 Subsidiary Has Preferred Stock - #5 Each year, P s share of S s income doesn t include PS s share (preferred dividend): Income of Subsidiary $25,000 Preferred Dividend ($6,000) Income Applicable To Common Shareholders $19,000 Parent's Interest in Subsidiary 80% Parent's Share of the Income of the Subsidiary $15,200 On WS In order to make it easier to eliminate P s share of S s equity We move PS s share of S s RE to another account Recharacterize PS s share of S s RE as RE allocated to PS, S Called PS (Preferred Stock) entry: PS D. Retained Earnings, January 1, 2005 Subsidiary $24,000 C. RE Allocated To Preferred Stock, Subsidiary $24,000 59 Subsidiary Has Preferred Stock - #6 60 Subsidiary Has Preferred Stock - #7 PS affects division of Consolidation Income between NCI & Controlling Interest NCI includes all stock owned by outsiders Both PS & CS E.g., Assume outsiders own 20% of S s common stock & all of S s PS Subsidiary Income Distribution Internally generated net income $25,000 Less preferred cumulative claim to NCI ($6,000) Common stock Income $19,000 NCI Share 20% NCI in common income $3,800 NCI preferred income $6,000 Total NCI $9,800 Parent Income Distribution Internally generated net income $150,000 80% of Subsidiary adjusted income of $19,000 $15,200 Controlling Interest $165,200 15
61 Subsidiary Has Preferred Stock - #8 62 Subsidiary Has Preferred Stock, E.g. - #1 PS can affect calculation of amount in CV entry When P uses Cost Method, you convert Inv in S account to simple Equity Method You can use change in S s RE to calculate the amount BUT only use change in common stock s share of S s RE Take out PS s preference (dividend arrearages) E.g., Assume P has owned 80% of S for 2 years S s RE is $130,000 now & was $80,000 2 years ago PS s dividends are $6,000 per year & PS s dividends were 2 years in arrears when P bought S s stock in 20X1 & they are 4 years in arrears now 63 Subsidiary Has Preferred Stock, E.g. - #2 64 Parent Owns Subsidiary s Preferred Stock - Heading Calculation of amount in CV entry: Parent Owns Subsidiary s Preferred Stock Retained Earnings, Subsidiary, January 1, 2005 $130,000 Less 4 year's arrearage of preferred dividends ($24,000) Retained Earnings applicable to common stock, January 1, 20X5 $106,000 Retained Earnings, Subsidiary, January 1, 2003 $80,000 Less 2 year's arrearage of preferred dividends ($12,000) Retained Earnings applicable to common stock, January 1, 20X3 ($68,000) Increase in common stock portion of retained earnings $38,000 Controlling Interest Share 80% Controlling Interest $30,400 16
65 Parent Owns Subsidiary s Preferred Stock - #1 66 Parent Owns Subsidiary s Preferred Stock - #2 If P owns S s PS P uses Inv in S s PS account That account eliminated just like Inv in S account P is free to use Cost or Equity Methods for Inv in S s PS If P buys outstanding PS of S from outsiders PS treated as being retired Gain/loss on retirement goes to P s APIC This is because P controls the S We do not recognize gains/losses from trading in our own shares WS eliminates income reported by P during the current year for its interest in S s PS Preferred dividends paid to P This is similar to the Date Alignment entry (CY) It is called the CYP entry: CYP D. Subsidiary Income $3,600 C. Investment in Subsidiary s Preferred Stock $3,600 67 Parent Owns Subsidiary s Preferred Stock - #3 68 Parent Owns Subsidiary s Preferred Stock - #4 WS eliminates Inv in S s PS account against S s equity applicable to PS held by P Similar to EL entry Called ELP entry: If P had used the Cost Method to record its Inv in S s PS, Need to convert Inv in S s PS account to balance it would have under simple Equity Method (as of the first of the year) Need to add dividends in arrears Instead of CV entry, called CVP entry: ELP D. Preferred Stock $60,000 RE Allocated to Preferred Stock, Subsidiary $14,400 C. Inv in Subsidiary s Preferred Stock $72,200 APIC, Parent $2,200 CVP D. Investment in Subsidiary Preferred Stock $7,200 C. Retained Earnings, Parent $7,200 17