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88

Changes in
Ownership Interest

Advanced Accounting, Fifth Edition

Slide
8-1
Learning
Learning Objectives
Objectives
1. Identify the types of transactions that change the parent company’s
ownership interest in a subsidiary.
2. Describe the process needed when the parent acquires subsidiary shares
through multiple open market purchases.
3. Explain how the parent reports the difference between selling price and
book value when shares are sold subsequent to acquisition.
4. Compute the controlling interest in income after the parent sells some
shares of the subsidiary company.
5. Describe the effect on the eliminating process when the subsidiary issues
new shares entirely to the parent, and the parent pays either more or less
than the book value of the subsidiary shares.
6. Describe the impact on the parent’s investment account when the
subsidiary issues new shares and either the new shares are purchased
ratably by the parent and noncontrolling shareholders or entirely by the
noncontrolling shareholders.
Slide
8-2
Changes
Changes in
in Ownership
Ownership Interest
Interest
Parent company can increase its ownership interest in a
subsidiary by either
1. buying additional subsidiary shares directly from third
parties or
2. having a subsidiary purchase its (subsidiary’s) shares from
third parties.

Parent company can decrease its ownership interest in a


subsidiary by either
1. selling some subsidiary shares directly to third parties or
2. having a subsidiary sell additional shares (including treasury
shares) to third parties.
Slide LO 1 Changes in ownership and differences
8-3 between current and proposed GAAP.
Changes
Changes in
in Ownership
Ownership Interest
Interest

Prior GAAP:

Acquisitions of additional shares are handled in a step-


by-step manner.

Sales of shares are handled the same as any sale of an


asset.

The difference between the selling price and the


basis of the shares sold is shown as a gain or loss in
income.

Slide LO 1 Changes in ownership and differences


8-4 between current and proposed GAAP.
Changes
Changes in
in Ownership
Ownership Interest
Interest
Current GAAP:
Acquisitions that take place in stages or partial sales:
a. Measure and recognize acquiree’s identifiable assets and
liabilities at 100% of their fair values on date the
acquirer obtains control, and
b. Recognize all acquiree’s goodwill (not just parent’s share),
measured as difference between fair value of acquiree on
acquisition date and fair value of identifiable net assets.

(Continued)

Slide LO 1 Changes in ownership and differences


8-5 between current and proposed GAAP.
Changes
Changes in
in Ownership
Ownership Interest
Interest
Current GAAP:
Acquisitions that take place in stages or partial sales:
c. Any previously held noncontrolling equity interests should
be remeasured to fair value, with resulting adjustment
recognized in income.
d. After control is achieved, subsequent adjustments due to
increased ownership are shown as Additional Contributed
Capital, not as income.
e. If parent loses control, retained investment should be
remeasured to fair value with adjustments recognized in
net income.
Slide LO 1 Changes in ownership and differences
8-6 between current and proposed GAAP.
Parent
Parent Acquires
Acquires Subsidiary
Subsidiary Stock
Stock Through
Through
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

Current GAAP FASB ASC paragraph 805-10-25-9:


Previously held noncontrolling equity interest should be
remeasured to fair value when control is achieved, and
the resulting adjustment should be recognized in net
income.
If a parent loses control but retains a noncontrolling
interest, the portion retained should be remeasured to
fair value on the date control is surrendered and the
adjustment reflected in the income statement.

LO 2 Parent acquires subsidiary shares


Slide through multiple open market
8-7
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

Illustration: S Company had 10,000 shares of $10 par value


common stock outstanding during 2010–2013 and retained earnings
as follows:

January 1, 2010 (1st stock purchase) $ 40,000


January 1, 2012 (control achieved) 120,000
January 1, 2013 185,000
December 31, 2013 265,000

P Co. purchased S Co. common stock on the open market for cash:
January 1, 2010 1,500 shares (15%) $ 24,000
January 1, 2012 7,500 shares (75%) 187,500
Total 9,000 shares (90%) $211,500

Slide
LO 2 Parent acquires subsidiary shares
8-8 through multiple open market
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

Thus on P’s books, the following entries are made:


January 1, 2010

January 1, 2012

Assumptions:
1. Any difference between implied and book values of the purchases
relates solely to goodwill and is, therefore, not subject to
amortization or depreciation but is reviewed periodically for
impairment.

2. S Company distributes no dividends during the periods under


consideration. Solution on
LO 2 Parent acquires subsidiary shares
Slide
note page through multiple open market
8-9
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

Calculation of IMPLIED Value of S Company:

Slide
Solution on LO 2 Parent acquires subsidiary shares
8-10 note page through multiple open market
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

Because P Company has owned a percentage of S Company (15%)


since January 1, 2010, an entry is needed on P’s books to revalue
the 1,500 shares purchased in 2010 to their fair value as of the
date of control ( January 1, 2012).

Initial purchase price (1,500 shares at $16/share) $24,000


Change in retained earnings of S since acquisition 15%:
[.15 x ($120,000 - $40,000)] 12,000
Carrying value (implied) of initial investment $36,000

Thus the gain on revaluation of the initial shares is computed as:


Implied value ($25/share 1,500) $37,500
Implied carrying value of initial shares 36,000
Revaluation gain $ 1,500

Slide LO 2 Parent acquires subsidiary shares


8-11 through multiple open market
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

The following entry is made on P company books.

Investment in S Company 1,500


Gain on revaluation 1,500

A workpaper entry is needed on December 31, 2012, to convert to


equity (establish reciprocity) from 2010 to the beginning of 2012.

Investment in S Company 12,000


1/1 Retained Earnings—P Company 12,000
[.15 x ($120,000 - $40,000) change in retained earnings
from 1/1/10 to 1/1/12]

Slide
LO 2 Parent acquires subsidiary shares
8-12 through multiple open market purchases
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

On the workpaper, the investment is eliminated by the following


entry:

Common Stock—S Company 100,000


1/1 Retained Earnings—S Company 120,000
Difference between Implied and Book Value 30,000
Investment in S Company ($187,500 + $37,500) 225,000
Noncontrolling Interest in Equity 25,000

LO 2 Parent acquires subsidiary shares


through multiple open market purchases

Slide
8-13
Several
Several Open-Market
Open-Market Purchases—Cost
Purchases—Cost Method
Method

Comparison to IFRS

IFRS 3, Business Combinations, provides the guidance


for step acquisitions under international standards.
Under IFRS 3, all previous ownership interests are
adjusted to fair value, with any gain or loss recorded in
earnings. This is similar to the rules issued by the FASB.

LO 2 Parent acquires subsidiary shares


through multiple open market purchases

Slide
8-14
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

Control Maintained
Under FASB ASC paragraphs 810–10–45–22 and 24 the
treatment of the sale of a portion of its investment by a
parent company depends on whether or not the sale results in
the loss of effective control of the subsidiary.

 If control is maintained, no gain or loss is recognized in


the income statement.

 If control is lost, the entire interest is adjusted to fair


value, and a gain or loss recorded in income on all shares
owned prior to sale.
LO 3 Shares sold subsequent to acquisition
Slide
8-15
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

Illustration: P Company owns 9,000 shares of S Company that


were revalued to $25 a share on the date of acquisition, or
$225,000. Assume that P Company sold 1,800 shares of the
9,000 shares of S Company stock on July 1, 2013, for $84,600
($47/share). The cost of the 1,800 shares sold equals
$45,000 (or 20% of $225,000). After the sale, P Company
retains control with a 72% ((9,000 x 80%)/10,000) interest.
It should be noted that the 1,800 shares sold represent 18%
of total S Company shares.

Slide
LO 3 Shares sold subsequent to acquisition
8-16
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

Illustration: To record the sale of the shares, P Company


makes the following entry in its books on July 1, 2013.

Cash 84,600
Investment in S Company (20% x $225,000) 45,000
Additional Contributed Capital—P Company 39,600

After this entry, the balance in the investment in S Company


account on P Company books will be $168,000 (or $24,000
$187,500 $1,500 $45,000).

Slide LO 3 Shares sold subsequent to acquisition


8-17
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

From a consolidated standpoint, the cost of the shares sold


($45,000) needs to be adjusted for 18% of the undistributed
earnings since the date of acquisition.

Slide LO 3 Shares sold subsequent to acquisition


8-18
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

The correct consolidated amount of additional contributed


capital on is:

An adjustment is needed on the workpapers to reduce


additional contributed capital:

Slide LO 3 Shares sold subsequent to acquisition


8-19
Slide
8-20
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock

When more than one purchase is made before control is


obtained, the acquisition date is defined as the date at
which control is achieved.

To illustrate the procedures followed for open-market


purchases and sales of subsidiary stock under the equity
method, the previous cost method example will be used.

Slide LO 3 Shares sold subsequent to acquisition


8-21
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock

Illustration: S Company had 10,000 shares of $10 par value


common stock outstanding during 2010–2013 and retained earnings
as follows:

January 1, 2010 (1st stock purchase) $ 40,000


January 1, 2012 (control achieved) 120,000
January 1, 2013 185,000
December 31, 2013 265,000

P Co. purchased S Co. common stock on the open market for cash:
January 1, 2010 1,500 shares (15%) $ 24,000
January 1, 2012 7,500 shares (75%) 187,500
Total 9,000 shares (90%) $211,500

Slide LO 3 Shares sold subsequent to acquisition


8-22
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock
Assumptions:
1. Any difference between implied and book value of net assets acquired
relates to goodwill.

2. S Company distributed no dividends during the periods under


consideration. Since no dividends were declared, the change in
retained earnings represents the net income for that year.

3. P Company sold 1,800 shares of S Company stock on July 1, 2013, for


$84,600.
P Company’s Books:
1/1/10 1/1/12
Investment in S 24,000 Investment in S 187,500
Cash 24,000 Cash 187,500

Slide
8-23 LO 3 Shares sold subsequent to acquisition
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock

Since P Company now has a 90% interest in S Company and intends


to apply the equity method, the investment account must be
restated to recognize P Company’s share (15%) of the increase in S
Company’s retained earnings from January 1, 2010, to January 1,
2012.

Investment in S Company 12,000

1/1 Retained Earnings—P Company 12,000


[.15 x ($120,000 x $40,000) or the change in retained earnings from
1/1/10 to 1/1/12].

Slide LO 3 Shares sold subsequent to acquisition


8-24
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock

To adjust the investment to fair value as of the date of


acquisition, the gain on revaluation of the initial shares is
computed as:

P Company’s Books

Investment in S Company 1,500

Gain on revaluation 1,500

Slide
8-25 LO 3 Shares sold subsequent to acquisition
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock

P Company will recognize its share of S Company income for 2012


as follows:

Investment in S Company 58,500

Equity in Subsidiary Income 58,500


[90% x ($185,000 - $120,000)]

Slide LO 3 Shares sold subsequent to acquisition


8-26
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock
Assuming P Company received a six month interim income
statement from S Company reporting $40,000 of net income, the
following entry will be made by P Company on June 30, 2013.

Investment in S Company 36,000


Equity in Subsidiary Income 36,000
(90% x $40,000)

Investment in 1/1/10 Purchase (15%) $ 24,000


S Company 1/1/12 Adjustment of 15% to fair value 1,500
1/1/12 Purchase (75%) 187,500
1/1/12 Adjustment 12,000
12/31/12 Subsidiary Income 58,500
6/30/13 Subsidiary Income 36,000
Slide
Balance $319,500
8-27
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock

To record the sale of the S Company shares on July 1, 2013, P


Company will make the following entry (recall that P Company is
selling 20% of its shares):

Cash 84,600
Investment in S Company* 63,900
Additional contributed capital 20,700
* $63,900 = 20% of $319,500, the carrying value of the
investment.

Slide LO 3 Shares sold subsequent to acquisition


8-28
Equity
Equity Method—Purchase
Method—Purchase and
and Sale
Sale of
of Stock
Stock

After the sale of the 1,800 shares, P Company holds a 72%


interest in S Company. For the second six months of 2013 (and for
subsequent periods), P Company will recognize 72% of the
reported income and dividends received from S Company. The
December 31, 2013, book entry by P Company is:

Investment in S Company 28,800


Equity in Subsidiary Income 28,800
($40,000 X 72%)

Slide LO 3 Shares sold subsequent to acquisition


8-29
Slide
8-30
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

Loss of Control
Under FASB ASC paragraphs 810–10–45–22 and 24 the
treatment of the sale of a portion of its investment by a
parent company depends on whether or not the sale results in
the loss of effective control of the subsidiary.

 If control is maintained, no gain or loss is recognized in


the income statement.

 If control is lost, the entire interest is adjusted to fair


value, and a gain or loss recorded in income on all shares
owned prior to sale.

Slide LO 4 Controlling interest in income


8-31
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

The parent accounts for the deconsolidation by recognizing a gain


or loss in net income attributable to the parent, measured as the
difference between:

1. The carrying value of S Company

2. The sum of the following:

a. The fair value of the consideration received

b. The fair value of the retained noncontrolling interest


(at the date of deconsolidation)
c. The carrying value of the former noncontrolling
interest (at the date of deconsolidation). This amount also
includes any accumulated other comprehensive income attributable
to the noncontrolling interest.
Slide LO 4 Controlling interest in income
8-32
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

Illustration: Suppose P Company owns 9,000 shares of S Company


(90% of S Company) that were acquired at $25 a share (or
$225,000) on January 1, 2012. During 2012, S Company reported
$60,000 of income and did not pay any dividends.

Investment (9,000 x $25) 225,000


Cash 225,000

Slide LO 4 Controlling interest in income


8-33
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

On January 1, 2013, P Company sold two-thirds of its investment


(6,000 shares) of S Company stock, for $180,000 ($30/share).
After the sale, P Company has lost control and now only maintains a
30% ((9,000 - 6,000)/10,000) interest. The carrying value of S
company, on January 1, 2013, is computed as follows:

Slide
8-34
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

The gain or loss in net income attributable to P Company is


computed as follows:

Slide LO 4 Controlling interest in income


8-35
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

To record the sale of the shares, P Company makes the following


entry in its books on January 1, 2013.

Slide
8-36 LO 4 Controlling interest in income
Sell
Sell Investment
Investment on
on Open-Market—Cost
Open-Market—Cost Method
Method

Because P Company now holds a 30% (not controlling) interest in S


Company, the investment must be carried on the books using the
equity method.

Thus the investment account must be adjusted for previous


earnings of S Company (i.e., the reciprocity entry usually made on
the consolidated workpaper).

Investment in S Company (60,000 x .90) 54,000


1/1 Retained Earnings-P Company 54,000

Slide LO 4 Controlling interest in income


8-37
Subsidiary
Subsidiary Issues
Issues Stock
Stock

The newly issued shares may be purchased

1. entirely by the parent company,

2. partly by the parent company and partly by the noncontrolling


stockholders, or

3. entirely by the noncontrolling stockholders.

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-38
Subsidiary
Subsidiary Issues
Issues Stock
Stock

New Shares Issued above Existing Carrying Value


per Share

Illustration: P Company purchased 14,000 shares (70%) of S


Company’s $10 par value common stock on January 1, 2006, for
$210,000, which included a $20,000 excess of implied over book
value; the excess cost was assigned to land. S Company’s retained
earnings on January 1, 2006, were $50,000.

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-39
Subsidiary
Subsidiary Issues
Issues Stock
Stock

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-40
Subsidiary
Subsidiary Issues
Issues Stock
Stock
On January 1, 2014, P Company purchased 4,000 additional shares
of S Company stock directly from S Company at its current market
price of $22 per share ($88,000). This price is greater than the
existing book value per share of S Company. Noncontrolling
stockholders elected not to participate in the new issue. S
Company’s stockholders equity on January 1, 2014, was:

Slide
8-41
Subsidiary
Subsidiary Issues
Issues Stock
Stock

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-42
Subsidiary
Subsidiary Issues
Issues Stock
Stock

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-43
Subsidiary
Subsidiary Issues
Issues Stock
Stock
If a workpaper were prepared immediately after the purchase of
the new shares, the workpaper entries to establish reciprocity
(convert to equity) and eliminate the investment account would be:

Slide
8-44
Subsidiary
Subsidiary Issues
Issues Stock
Stock

New Shares Issued at or below the Existing


Carrying Value per Share

Illustration: The shares are issued at their book value of


$17.50 per share (or $70,000), the computation is as follows:

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-45
Subsidiary
Subsidiary Issues
Issues Stock
Stock

Although the noncontrolling stockholders’ percentage of


ownership decreases from 30% to 25%, their share of the net
assets of S Company decreased only by the land value
transferred, as shown here:

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-46
Subsidiary
Subsidiary Issues
Issues Stock
Stock
Assume the new shares were issued at $14 per share (or $56,000).
The excess of book value over cost is computed as follows:

Slide
8-47
Subsidiary
Subsidiary Issues
Issues Stock
Stock
Journal entry by P Company to record the purchase of the new
shares is:

P Company’s Books
Investment in S company 56,000
Cash 56,000

LO 5 Subsidiary issues new shares entirely


Slide to parent
8-48
Subsidiary
Subsidiary Issues
Issues Stock
Stock
Workpaper entries:

Slide
LO 5 Subsidiary issues new shares entirely
8-49 to parent
Subsidiary
Subsidiary Issues
Issues Stock
Stock
New Shares Purchased Ratably by Parent and
Noncontrolling Stockholders

If the noncontrolling stockholders had elected to exercise their


rights, the percentage of stock owned by the parent and
noncontrolling stockholders after the new issue would be the same
as their respective interests prior to the new issue.

LO 6 Noncontrolling shareholders acquire


Slide new shares issued by subsidiary
8-50
Subsidiary
Subsidiary Issues
Issues Stock
Stock
New Shares Purchased Entirely by Noncontrolling
Stockholders

As long as the number of new shares issued is not so large that it


reduces the parent’s percentage of ownership below that needed
for control, new financing can be made available and control
retained.

 Issuance of new shares to noncontrolling stockholders


reduces the parent’s percentage of ownership.

 Economic substance of the transaction is a sale of interest by


P Company.

LO 6 Noncontrolling shareholders acquire


Slide new shares issued by subsidiary
8-51
Copyright
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Slide
8-52