Advanced Financial Accounting 7e (Baker Lembre King).Chap009

8/7/2019 Advanced Financial Accounting 7e (Baker Lembre King).Chap009

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McGraw-Hill/Irwin 2008 The McGraw-Hill Companies, Inc. All rights reserved.

9

Consolidation Ownership Issues


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Only simple ownership situations have beenpresented in the preceding chapters.

In practice, however, relatively complexownership structures are often found.


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For example, a subsidiary may have preferredstock outstanding in addition to its commonstock, and in some cases a parent mayacquire shares of both the common and thepreferred stock of the subsidiary.


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Additionally, one or more subsidiaries mayacquire stock of the parent or of other relatedcompanies.

Further, the parents ownership claim on asubsidiary may change through its purchaseor sale of subsidiary shares or through stocktransactions of the subsidiary.


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The discussion in this chapter is intended toprovide a basic understanding of some of theconsolidation problems arising from complexownership situations commonly encounteredin practice.


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Specifically, the following topics are discussed:S ubsidiary preferred stock outstanding.

Change in the parents ownership interest in thesubsidiary.Multiple ownership levels.Reciprocal or mutual ownership.S ubsidiary stock dividends.


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Subsidiary Preferred Stock Outstanding

Many companies have more than one type of stock outstanding.

Each type of security typically serves a particular

function, and each has a different set of rightsand features.


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Because preferred shareholders of a subsidiarydo have a claim on the net assets of thesubsidiary, special attention must be given tothat claim in the preparation of consolidatedfinancial statements.


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Preferred stockholders normally havepreference over common shareholders withrespect to dividends and the distribution of assets in a liquidation.


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The right to vote usually is withheld frompreferred shareholders, so preferred stockownership normally does not convey control,regardless of the number of shares owned.


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Many other features of preferred stocks arefound in practice.

For example, most preferred stocks arecumulative, a few are participating, and manyare callable at some price other than par value.


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Occasionally a parent company will holdpreferred stock of a subsidiary in addition to itsinvestment in the subsidiarys common stock.

Because the preferred stock held by the parentis within the consolidated entity, it must beeliminated when consolidated financialstatements are prepared.


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Likewise, any income from the preferred stockrecorded by the parent also must be eliminated.

Any portion of the subsidiarys preferred stockinterest not held by the parent is assigned to thenoncontrolling interest.


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When a subsidiary with preferred stockoutstanding is consolidated, the provisionsof the preferred stock agreement must beexamined to determine the portion of thesubsidiarys stockholders equity to beassigned to the preferred stock interest.


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A cumulative dividend provision provides somedegree of protection for preferred shareholdersby requiring the company to pay both currentand omitted past preferred dividends before anydividend can be given to common shareholders.


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If a subsidiary has cumulative preferred stockoutstanding, an amount of income equal to thecurrent years preferred dividend is assigned tothe preferred stock interest in consolidationwhether of not the preferred dividend isdeclared.


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When dividends are in arrears on a subsidiaryscumulative preferred stock, recognition is givenin consolidation to the claim of the preferredshareholders by assigning to the preferredstock interest an amount of subsidiary retainedearnings equal to the passed dividends.


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No special consolidation procedures areneeded with respect to undeclared dividendson noncumulative subsidiary preferred stock.


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Preferred stock participation features allow thepreferred stockholders to receive a share of income distributions that exceed the preferredstock base dividend rate.


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Although few preferred stocks are participating,many different types of participationarrangements are possible. Once the degree of participation has been determined, theappropriate share of subsidiary income and netassets is assigned to the preferred stock interestin the consolidated financial statements.


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Many preferred stocks are callable, often atprices that exceed the par value.The amount to be paid to retire a subsidiaryscallable preferred stock under the preferred

stock agreement is viewed as the preferredstockholders claim on the subsidiarys assets.


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That amount of subsidiary stockholders equity isassigned to the preferred stock interest inpreparing the consolidated balance sheet.


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Changes in Parent Company Ownership

Although preceding chapters have treated theparent companys subsidiary ownership interestas remaining constant over time, in actualityownership levels sometimes vary.

Changes in ownership levels may result fromactions of either the parent or the subsidiary.


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The parent company can change ownershipratios by purchasing or selling shares of thesubsidiary in transactions with unaffiliatedcompanies.


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A subsidiary can change the ownershippercentage of the parent by selling additionalshared to or repurchasing shares fromunaffiliated parties, or through stock transactionswith the parent (if the subsidiary is less thanwholly owned).


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Parents Purchase of Additional

Shares from Nonaffiliate

A parent company may purchase the commonstock of a subsidiary at different points in time.

When consolidated statements are prepared,the cost of each block of stock purchased is

compared with the stocks book value at thedate of purchase and the difference is treatedas part of the purchase differential to beassigned.


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Parents Purchase of Additional


In the event a purchase of additional shares ismade during the period, the eliminating entrieswill be altered so that consolidated net incomewill include only the earnings accruing to theparent company for the portion of the period inwhich the additional shares are owned by theparent.Consolidation procedures for interim acquisitionsare illustrated in Chapter 10.


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Parents Sale of Subsidiary

Shares to Nonaffiliate

A gain or loss normally occurs and is recordedon the books of the seller when a companydisposes of all or part of an investment.

APB 18 deals explicitly with sales of stock of an

investee, requiring recognition of a gain or losson the difference between selling price and thecarrying amount of the stock.


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A question arises, however, when the sharessold are those of a subsidiary and the subsidiarycontinues to qualify for consolidation.


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When a parent sells some of the shares of a

subsidiary but continues to hold a controllinginterest, the question is whether the gain or losson the sale of shares should be carried to theconsolidated income statement or eliminated inconsolidation.


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Recognizing a gain or loss in the consolidatedincome statement on a sale of subsidiary shareswhile continuing to consolidate the subsidiaryseems inconsistent with the concept of a singleeconomic entity.


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From a consolidated viewpoint, the subsidiaryshares become part of the noncontrollinginterest outstanding at the point they are sold toa nonaffiliate.


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This has been the FASBs view for the pastdecade, although it has yet to be incorporatedinto an official pronouncement. However, thistreatment is required in the FASBs proposednew standard for consolidated financialstatements.


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If recognition of the gain on the sale of the stockis considered appropriate in the consolidatedincome statement, no adjustment is needed inpreparing consolidated statements, or in theperiods that follow.


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On the other hand, excluding the gain from theconsolidated income statement is moreconsistent with the view of a single economicentity. In that case, the gain is eliminated andadditional paid-in capital is established.


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Subsidiarys Sale of Additional


Additional funds are generated for theconsolidated enterprise when a subsidiary sellsnew shares to parties outside the economicentity.


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A sale of additional shares to an unaffiliated

party increases the total shares of the subsidiaryoutstanding and, consequently, reduces thepercentage ownership held by the parentcompany.


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At the same time, the dollar amount assigned tothe noncontrolling interest in the consolidatedfinancial statements increases.


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The resulting amounts of the controlling andnoncontrolling interests are affected by twofactors:

The number of shares sold to nonaffiliates.The price at which the shares are sold tononaffiliates.


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Shares to Parent

A sale of additional shares directly from a lessthan wholly owned subsidiary to its parentincreases the parents ownership percentage.


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Shares to Parent

If the sale is at a price equal to the book value

of the existing shares, the increase in theinvestment account of the parent equals theincrease in the stockholders equity of thesubsidiary. The net book value assigned to thenoncontrolling interest remains unchanged.


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Shares to ParentIn preparing consolidated financial statements,the normal elimination entries are made based

on the parents new ownership percentage.

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Shares to Parent

When the parent purchases sharesdirectly from a subsidiary at an amountother than the book value of thesubsidiarys shares already outstanding.

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Shares to Parent

A differential is measured as the differencebetween the price paid and the resultingincrease in the total underlying book valueof all shares owned by the parent.

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Shares to Parent

This increase in book value includes boththe amount assigned to the new shares

just acquired from the subsidiary and theincrease or decrease in the book value of shares previously held by the parent.

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Shares to Parent

Once determined, the differential is treated inpreparing consolidated financial statements inthe same manner as a differential arising on apurchase from a nonaffiliate.

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Shares to Parent

However, because the parent may be ableto influence the purchase price of theshares in this case.

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Shares to Parent

The amount of differential may or may nothave an obvious connection to changes inthe value of identifiable assets or liabilitiesand must be reviewed carefully in

determining how it is to be assigned.

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Subsidiarys Purchases of


Treasury shares sometimes are purchased bya subsidiary from noncontrolling shareholders.

Noncontrolling shareholders frequently find theyhave little opportunity for input into the activities

and operations of the subsidiary and often arewilling sellers.

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The parent company may prefer not to beconcerned with outside shareholders and maydirect the subsidiary to reacquire any of thenoncontrolling shares that become available.


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When this occurs, the amount of the changemust be recognized in preparing theconsolidated statements.

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Shares from Parent

A subsidiary can reduce the number of shares ithas outstanding through purchases from theparent as well as from noncontrollingshareholders.

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Shares from Parent

In practice, stock repurchases from the parent

occur infrequently. That is, a parent reducing itsownership interest in a subsidiary usually doesso by selling some of its holdings to nonaffiliatesto generate additional funds.

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Shares from Parent

When a subsidiary reacquires some of its sharesfrom its parent, the parent records a gain or losson the difference between the selling price andthe change in the carrying amount of itsinvestment.

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Shares from ParentWhen a subsidiary reacquires some of its sharesfrom its parent, the parent records a gain or loss

on the difference between the selling price andthe change in the carrying amount of itsinvestment.

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Shares from Parent

From a consolidated viewpoint, when asubsidiary requires its shares from the parent,the transaction represents an internal transfer and does not give rise to a gain or loss.

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Complex Ownership Structures

Current reporting standards call for thepreparation of consolidated financialstatements whenever one company hasdirect or indirect control over another.

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The discussion to this point has focusedon a simple, direct parent-subsidiaryrelationship.Many companies, however, havesubstantially more complex organizationalschemes.

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Key concepts for Complex Ownership Structures:

Direct Ownership: the parent has controllinginterest in each of its subsidiaries.

Multilevel Ownership: the parent has indirectcontrol over the company controlled by itssubsidiary.

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Reciprocal Ownership or Mutual Holdings: theparent owns a majority of the subsidiarys

common stock and the subsidiary holds some of the parents common shares.

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Multilevel Ownership and Control

In many cases, companies establish multiplecorporate levels through which they carry outdiversified operations.

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For example, a company may have a number of subsidiaries, one of which is a retailer.

The retail subsidiary may in turn have a finance

subsidiary, a real estate subsidiary, aninsurance subsidiary, and perhaps other subsidiaries.

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This means that when consolidated statementsare prepared, the statements will includecompanies in which the parent has only anindirect investment along with those in whichdirect ownership is held.

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The amount of income and net assets to beassigned to the controlling and noncontrollingshareholders, and the amount of unrealizedprofits and losses to be eliminated, must bedetermined at each level of ownership.

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Consolidation proceeds from the lowest level tothe highest in these cases.

In a relatively few cases, a subsidiary may own

common shares of its parent. Usually thosecommon shares are treated as treasury stock inconsolidated financial statements.

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Subsidiary Stock Dividends

Subsidiary dividends payable in shares of subsidiarys common stock require slightchanges in the elimination entries used inpreparing consolidated financial statements.

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Because stock dividends are issuedproportionally to all common stockholders,the relative interests of the controlling andnoncontrolling stockholders do not changeas a result of the stock dividend.

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While the carrying amount of the investment onthe books of the parent also is unaffected by astock dividend, the stockholders equity accountsof the subsidiary do change, although totalstockholders equity does not.

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The stock dividend represents a permanentcapitalization of retained earnings, thusdecreasing retained earnings and increasingcapital stock and, perhaps, additional paid-incapital.

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In the preparation of consolidated financialstatements for the period in which a stockdividend is declared by the subsidiary, the stockdividend declaration must be eliminated alongwith the increased common stock and increasedadditional paid-in capital, if any.

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The stock dividend declared cannot appear inthe consolidated retained earnings statementbecause only the parents dividends are viewedas dividends of the consolidated entity.

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You Will Survive This Chapter !!!

Chapter 10 is the last chapter dealing specificallywith consolidation topics.


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End of Chapter

Advanced Financial Accounting 7e (Baker Lembre King).Chap009

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