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7-2
Son 80 % ownership
Grandsons
7-3
Start from the bottom of the pyramid and work upwards Recognize realized income of the grandson(s) Use this to consolidate the son and grandson(s) financial information, taking care to calculate any noncontrolling interest Finally, consolidate the son(s) and parent in the same manner
7-4
Bottom Co.
7-5
7-6
7-7
7-8
7-9
Using the consolidation entries previously described is sufficient to complete the fatherson-grandson combination. Essentially, the entries are duplicated for each relationship.
7-10
The combination of the parents DIRECT ownership and INDIRECT ownership can result in control of a subsidiary.
High Company
70% owned
30% owned
Side Company
45% owned
Low Company
7-11
In this case, High controls Side directly with 70% 70% owned ownership, and Low indirectly with 61.5% effective ownership.
( 30% + [ 70% x 45% ])
High Company
30% owned
Side Company
45% owned
Low Company
7-12
In this case, High controls Side directly with 70% ownership, and Low indirectly with 61.5% effective ownership.
( 30% + [ 70% x 45% ])
Eliminate effects of intercompany transfers. Eliminate subs beginning equity balances. Adjust for unamortized FV adjustments. Record amortization Expense. Remove intercompany income and dividends. Compute and record noncontrolling interest in subsidiaries net income.
7-13
Mutual Ownership
Occurs when the subsidiary owns shares of the parent. SFAS 160 requires the treasury stock approach to account for mutual ownership.
Down Company
Mutual Ownership
SFAS 160, Noncontrolling Interests in Consolidated Financial Statements. Shares of the parent held by a subsidiary shall not be treated as outstanding shares in the consolidated statement of financial position and, therefore, shall be eliminated in the consolidated financial statements and reflected as treasury shares. (paragraph 13)
7-15
7-16
Business combinations may elect to file a consolidated federal tax return for all companies composing an affiliated group. The affiliated group will likely exclude some members of the business combination.
7-17
7-18
Intercompany profits are not taxed until realized. Intercompany dividends are nontaxable. Losses of one affiliated group member can be used to offset taxable income earned by another group member.
7-19
The tax consequences are often dependent on whether separate or consolidated returns are filed. Transactions affected: Unrealized Intercompany Gains Goodwill Intercompany Dividends
7-20
Intercompany Dividends For accounting purposes, all intercompany dividends are eliminated. For tax purposes, dividends are NOT eliminated if ownership is < 80%. (They are currently taxed at a rate of 20 percent.) A deferred tax liability is created based on the difference.
7-21
Amortization of Goodwill The Revenue Reconciliation Act of 1993 allowed amortization of Goodwill over 15 years for tax purposes. SFAS No. 142 eliminated amortization of Goodwill for financial reporting purposes. However, goodwill can be written off if it is impaired or if there is disposal of the related business A deferred tax liability must therefore be recognized.
7-22
Unrealized Intercompany Gains If separate returns are filed, taxable gains must be reported in the period of transfer. The prepayment of taxes on the unrealized gains creates a deferred income tax asset.
7-23
7-24
Net operating losses for companies may be carried back for two years and/or forward for 20 Because some acquisitions were designed in part to take advantage of this situation, US law has been changed to require operating loss carryforwards to be used only by the company incurring the loss (in most situations.)
7-25
SFAS 109 requires deferred tax assets to be recorded for any net operating loss carryforwards Valuation allowances must be recognized if it is more likely than not (based on available evidence) that some portion or all of the deferred tax asset will not be realized. (The valuation
allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized.)
7-26
Consolidated tax returns require allocation of tax expense between the parties Important for the subsidiary
If separate financial statements are
needed for loans or equity issues As a basis for calculating noncontrolling interests share of consolidated income
7-27
Allocation based on relative tax expense IF they had filed separate returns.
7-28
Summary
Control may be indirect Consolidation of pyramid structures is conceptually identical to that for direct ownership, but requires a systematic bottom-to-top approach Mutual affiliation occurs when a subsidiary owns shares of the parent. Beginning in 2009, the treasury stock approach must be used to produce consolidated information for this situation. The treasury stock approach also dominated past practice. Affiliated groups, which may differ from the consolidated entity due to IRS restrictions, are permitted to file consolidated returns
7-29
Possible Criticisms
Affiliated groups are often different from the consolidated entity due to IRS restrictions. This can create a variety of differences in reporting financial statement income versus taxable income for the combination. Some critics contend that indirect ownership creates a different control environment than direct ownership, and that this difference should be disclosed.