Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE, AND CONSOLIDATED INCOME TAXATION Answers to Questions Par’s investment income Sam’s net income Less: Preferred income ($500,000  10%) Income to common stockholders Par’s percentage owned Investment income Par’s investment account balance (equal to book value): Sam’s stockholders’ equity Less: Preferred equity (no arrearages or call premiums) Common equity Par’s percentage ownership Investment account balance $ $ 300,000 (50,000) 250,000 60% 150,000 $2,500,000 (500,000) 2,000,000 60% $1,200,000 The payment of two years preferred dividend requirements would not have affected Par’s investment income Since the preferred stock is cumulative, the preferred dividend requirements are deducted from net income each year regardless of whether preferred dividends are declared The preferred stock of a subsidiary does not appear in a consolidated balance sheet If there is a noncontrolling interest in the preferred stock, it is reported as a noncontrolling interest in the consolidated balance sheet In part a, the investment in preferred is eliminated against the preferred equity and there is no noncontrolling interest in preferred When 50 percent of the stock is held by the parent (part b), the investment in preferred is eliminated against 50 percent of the preferred equity and the other 50 percent is reported as a noncontrolling interest In part c, all of the preferred stock is reported as a noncontrolling interest Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated to preferred plus 20 percent of the income allocated to common There is no difference between the controlling share of consolidated EPS and parent company EPS An investor company’s EPS computations must reflect the potential dilution of an equity investee’s common stock equivalents and other potentially dilutive securities if the effect is material Procedures applied in computing a parent company’s EPS computations are the same as those for a corporation without equity investments except when the subsidiary has outstanding common stock equivalents or other potentially dilutive securities Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and then it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary common stock If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in subsidiary diluted EPS Alternatively, when subsidiary securities are convertible into the parent’s common stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities had been issued by the parent © 2011 Pearson Education, Inc publishing as Prentice Hall 10-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-2 10 The replacement computation does not involve unrealized profits from downstream sales because these items relate solely to parent operations and not affect the noncontrolling interest In the case of unrealized profits from upstream sales, however, unrealized profits are deducted in the replacement computation which involves subtracting the parent’s equity in subsidiary realized income and adding back the parent’s equity in subsidiary diluted EPS (also based on subsidiary realized income) 11 Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that qualifies as an “affiliated group” may elect to file consolidated tax returns Once consolidated returns are elected, it may be difficult to obtain IRS permission to file separate returns 12 Yes Consolidated entities that meet the requirements of an affiliated group can and often elect to file separate income tax returns 13 The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against gains of other members of the affiliated group, (2) intercompany profits between group members are eliminated from taxable income until realized, and (3) intercorporate dividends are fully excluded from taxable income (But note that is not a unique advantage of filing a consolidated return.) 14 Dividends received by a member of an affiliated group from other group members are excluded from federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns 15 Temporary differences result because investors that are not members of an affiliated group record income from equity investments as it is earned, but pay taxes only when dividends are actually received 16 In providing for income taxes on undistributed earnings of equity investees, the parent/investor debits income tax expense and credits deferred tax liability as part of the determination of all income taxes for the period The investment and investment income accounts are not affected 17 Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated entity is a member of an affiliated group and elects to file consolidated tax returns SOLUTIONS TO EXERCISES Solution E10-1 [AICPA adapted] a Sob income to preferred $ 4,000 $20,000  20% owned 80,000 Sob income to common $100,000  80% owned Income from Sob $ 84,000 a ($180,000- $30,000)  20% taxable  30% tax rate d All dividend income is excluded from a consolidated group d Intercompany profit is deferred in the consolidated tax return until realized through sale to an outside entity © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-3 Solution E10-2 [Preferred stock](in thousands) Cost/fair value differential Total stockholders’ equity January 1, 2012 Less: Preferred equity (20,000 shares  $115) Common equity $16,000 2,300 $13,700 Cost $16,200 Implied total fair ($16,200 / 90%) Book value of investment Excess fair over book value – Goodwill $18,000 13,700 $ 4,300 Income from Sir for 2012 Sir’s net income Less: Preferred dividends for 2012 Income to common Income from Sir ($2,200  90%) $2,400 200 $2,200 $1,980 Investment in Sir at December 31, 2012 Investment cost January 1, 2012 Add: Income from Sir Less: Dividends ($1,200 - $400 preferred)  90% Investment in Sir $16,200 1,980 (720) $17,460 Noncontrolling interest for 2012 Beginning stockholders’ equity Add: Net income Less: Dividends Stockholders’ equity December 31, 2012 $16,000 2,400 (1,200) $17,200 Preferred equity ($105  10,000) Common noncontroling interest ($17,200,000 + $4,300,000 (Goodwill)-$2,100,000)  10% Noncontrolling interest December 31, 2012 Solution E10-3 $2,100 1,940 $4,040 [Preferred stock] Fair value — book value differential Cost of 80% interest $1,536,000 Implied total fair value ($1,536,000 / 80%) Less: Book value ($2,500,000 total equity $630,000 preferred equity) Excess fair value over book value - Goodwill $1,920,000 (1,870,000) $ 50,000 Loss from Sol — 2011 Sol’s net loss Add: Income to preferred stockholders Loss to common stockholders Percent owned Loss on investment in Sol $ $ © 2011 Pearson Education, Inc publishing as Prentice Hall 100,000 72,000 172,000 80% 137,600 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-4 Solution E10-3 (continued) Income from Sol — 2012 Net income Less: Income to preferred stockholders Income to common stockholders Percent owned Income from investment in Sol Total stockholders’ equity at December 31, 2012 ($2,500,000 - $100,000 loss in 2011 + $500,000 income in 2012 - $344,000 dividends in 2012) Less: Preferred equity Common equity Percent owned Underlying equity Add: 80% of Goodwill Investment in Sol at December 31, 2012 $2,556,000 (630,000) 1,926,000 80% 1,540,800 40,000 $1,580,800 Check: Cost of investment Loss — 2011 Income — 2012 Dividends 2012 ($344,000 - $144,000)  80% Investment in Sol at December 31, 2012 $1,536,000 (137,600) 342,400 (160,000) $1,580,800 [Preferred stock] Investment cost (fair value equals book value) Total stockholders’ equity of San Less: Preferred equity 10,000 shares  ($100 + $5 + $12) Common equity Percent owned Investment cost (fair value and book value) $ 500,000 (72,000) 428,000 80% 342,400 Par’s investment in Sol account Solution E10-4 $ $4,000,000 1,170,000 2,830,000 80% $2,264,000 Consolidated net income and noncontrolling interest share Pen separate income Add: Income from San ($500,000 - $120,000)  80% Consolidated net income $3,000,000 304,000 $3,304,000 Noncontrolling interest share ($380,000 common income  20%) + $120,000 preferred income $ 196,000 Underlying book value Total stockholders’ equity Less: Preferred equity (10,000 shares  $105 call price) Common equity Percent owned Underlying book value December 31, 2012 $4,200,000 1,050,000 3,150,000 80% $2,520,000 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-5 Solution E10-5 Preliminary computations Total equity of Son at December 31, 2011 Less: Preferred equity (10,000 shares  $115) Common equity December 31, 2011 $3,500,000 (1,150,000) $2,350,000 Entries to record preferred stock investment 600,000 Investment in Son — preferred Cash To record purchase of 50% of Son’s preferred stock 600,000 25,000 Additional paid-in capital 25,000 Investment in Son — preferred To adjust investment in preferred account to underlying equity: $600,000 cost - ($1,150,000 underlying equity  50%) = $25,000 Excess of fair value over book value from common stock investment Cost of 80% investment in common stock $2,000,000 Implied total fair value ($2,000,000 / 80%) Book value Excess fair value over book value $2,500,000 (2,350,000) $ 150,000 Pam’s income from Son preferred — 2012 $1,000,000 par  15%  50% owned $ 75,000 Pam’s income from Son common — 2012 Equity in Son’s common income ($400,000 income $150,000 preferred dividends)  80% owned Income from Son common $ $ 200,000 200,000 Noncontrolling interest at December 31, 2012 Total equity at December 31 ($3,500,000 + $400,000 income - $300,000 dividends) Less: Preferred equity Common equity Plus goodwill Common equity plus excess fair value $3,600,000 (1,000,000) $2,600,000 150,000 $2,750,000 Noncontrol Int — preferred ($1,000,000  50%) $500,000 Noncontrol interest — common ($2,750,000  20%) 550,000 Total noncontrolling interest December 31 $1,050,000 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-6 Solution E10-6 [Preferred stock] (in thousands) Fair value — book value differentials Cost of preferred stock Book value of preferred 60,000 shares  ($100 par + $5 call premium + $10 dividend arrearage) Excess book value of preferred stock over cost $ 6,500 Cost of common stock $35,000 Implied total fair value ($35,000 / 70%) Book value of common ($60,000 total equity $11,500 preferred equity) Excess fair value over book value of common $50,000 (6,900) $ (400) 48,500 $ 1,500 The $400,000 negative differential should be treated as an increase in the preferred investment and other paid-in capital accounts on Pay’s books Pay will record its investment in Set preferred as follows: Investment in Set preferred 6,500 Cash To record purchase of 60% of Set’s preferred stock 6,500 400 Investment in Set preferred Other paid-in capital 400 To adjust other paid-in capital for the constructive retirement of 60% of Set’s preferred shares Solution E10-7 [EPS] d c d Solution E10-8 [EPS] a Sod’s diluted earnings for consolidated EPS purposes Pal’s equity in Sod’s income $176,000/.8 c Sod’s outstanding shares Add: Incremental shares 10,000 shares - ($100,000 assumed proceeds/$20 average market price) Sod’s common shares and common share equivalents b Pal’s net income Less: Equity in Sod’s income Add: Equity in Sod’s diluted earnings (40,000 shares  Sod’s $4 diluted EPS) Pal’s diluted earnings $ 220,000 50,000 shares 5,000 shares 55,000 shares $ $ 316,000 (176,000) 160,000 300,000 d Pal’s diluted earnings $300,000/300,000 Pal outstanding common shares = $1 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-7 Solution E10-9 [EPS] San’s basic and diluted EPS Income to common (equal to San’s net income) = a Common shares and common share equivalents: Outstanding shares Additional shares using treasury stock method: 1,000 - (1,000  $9)/$15 Common shares and common share equivalents = b San’s EPS = a/b Basic $18,000 Diluted $18,000 5,000 5,000 5,000 $ 3.60 400 5,400 $ 3.33 Put’s basic and diluted EPS Income to common (equal to Put’s net income) Replacement of Put’s equity in San’s realized income with Put’s equity in San’s diluted earnings: Equity in San’s income to common ($18,000  80%) Equity in San’s diluted earnings (4,000 shares  $3.33) Put’s basic and diluted earnings = a Outstanding common shares = b Put’s EPS = a/b Solution E10-10 $20,000 $20,000 (14,400) 13,320 $20,000 $18,920 8,000 8,000 $ 2.50 $ 2.37 [EPS] Basic a b Sal’s earnings per share Net income Sal’s common shares outstanding Incremental shares from warrants Diluted: 5,000 — ($120,000 assumed proceeds/$30 average price) Common shares and equivalents Earnings per share Pin’s basic and diluted EPS Pin’s income to common ($80,467 - $12,000 to preferred) Replacement computation: Equity in Sal’s realized income Equity in Sal’s diluted EPS 16,000 shares  $1.26 $26,400 20,000 Diluted $26,400 20,000 1,000 20,000 $ 1.32 21,000 $ 1.26 $68,467 $68,467 (21,120) 20,160 a b Earnings Pin’s common shares outstanding $68,467 10,000 $67,507 10,000 a/b Earnings per share $ $ 6.85 © 2011 Pearson Education, Inc publishing as Prentice Hall 6.75 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-8 Solution E10-11 [EPS] Diluted a Soy’s earnings per share Soy’s earnings: Income to Soy common (equals net income) Soy’s outstanding shares Incremental shares from warrants Diluted: 10,000 — ($240,000 assumed proceeds/$40 average price) b Common and equivalent shares a/b Soy’s earnings per share a Consolidated earnings per share Pow’s income to common (equals net income) Replacement: 80% of Soy’s income Equity in diluted earnings 40,000 shares  $11.67 diluted EPS Pow’s earnings b Pow’s outstanding shares a/b Consolidated earnings per share Solution E10-12 [Tax] c b Solution E10-13 c $630,000 50,000 4,000 54,000 $ 11.67 Basic Diluted $1,480,000 $1,480,000 (504,000) $1,480,000 466,800 $1,442,800 1,000,000 1,000,000 $ 1.48 $ 1.44 b [Tax] c Assigned value of equipment Related deferred tax liability ($6,000,000 - $4,000,000 tax basis)  34% tax rate $6,000,000 $ 680,000 c Income tax expense = $500,000 investment income  20% taxable  34% tax rate c Income taxes currently payable: $30,000 dividends  20% taxable  34% tax rate = $2,040 Income tax expense: $60,000 income from Sap  20% taxable  34% tax rate = $4,080 Deferred tax liability: $30,000 undistributed earnings  20% taxable  34% tax rate = $2,040 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-9 Solution E10-13 (continued) d Income taxes currently payable: $17,500 dividends  20% taxable  34% tax rate = $1,190 Deferred income taxes: $17,500 share of undistributed earnings  20% taxable  34% tax rate = $1,190 a No income tax is assessed on dividends received from a 100% owned domestic subsidiary in an affiliated group Solution E10-14 [Tax] Separate company tax returns Pit’s income taxes currently payable: Pretax accounting income $300,000  34% tax rate = Sol’s income taxes currently payable: Pretax accounting income $100,000  34% tax rate = Income taxes currently payable Less: Increase in deferred tax asset ($200,000  34%) Consolidated income tax expense 34,000 136,000 (68,000) $ 68,000 Consolidated tax return Combined pretax accounting income Less: Unrealized gain on downstream sale of land Taxable income Tax rate Consolidated income tax expense $400,000 (200,000) 200,000 34% $ 68,000 Separate tax Pit’s income Pretax Sol’s income Pretax Income taxes returns taxes currently payable: accounting income $300,000  34% tax rate = taxes currently payable: accounting income $100,000  34% tax rate = currently payable Consolidated tax return Combined pretax accounting income Less: Unrealized gain on downstream sale of land Taxable income Tax rate Income taxes currently payable $102,000 $102,000 34,000 136,000 $400,000 (200,000) 200,000 34% $ 68,000 Note: No tax is paid on intercompany profits when consolidated returns are filed © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-10 Solution E10-15 [Tax] Preliminary computations — Because there is only one tax rate, a schedule approach to this solution is not necessary Sales Gain on equipment Cost of sales Other expenses(includes $50,000 patent amortization) Pretax operating income Income taxes payable on operating income at 34% income tax rate Income taxes payable on dividends ($400,000 paid  70% interest  20% taxable  34%) Income taxes currently payable Increase in deferred tax asset* Income tax expense Separate incomes Add: Income from Sum ($528,000  70% owned - $160,000 unrealized gain) Net income * Sum Pan $8,000,000 $4,000,000 200,000 (5,000,000) (2,000,000) (1,850,000) (1,200,000) 1,350,000 800,000 (459,000) (272,000) (19,040) _ (478,040) (272,000) 48,307 _ (429,733) (272,000) 920,267 528,000 209,600 $1,129,867 $ 528,000 Deferred tax asset ($160,000 unrealized gain  34%) - ($128,000 future dividends  70% owned  20% taxable  34% enacted tax rate) = $48,307 Pan Corporation and Subsidiary Consolidated Income Statement for the year 2011 Consolidated sales $12,000,000 (7,000,000) Less: Cost of sales Less: Other expenses ($3,000,000 + $50,000 - $40,000) (3,010,000) Income before income taxes and noncontrolling interest share 1,990,000 (701,733) Income tax expense** Total consolidated income 1,288,267 Noncontrolling interest share (158,400) Controlling share of onsolidated net income $ 1,129,867 ** Taxes currently payable of $478,040 for Pan + $272,000 for Sum - $48,307 increase in deferred tax asset = $701,733 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-15 Solution P10-3 [Preferred stock](in thousands) Preliminary computations Cost of 70% interest in Sal January 1, 2010 Implied total fair value of Sal ($490 / 70%) Book value acquired of common equity Excess of fair value over book value $490 $700 700 $ Cost of 20% interest in Sal April 1, 2011 $152 Implied total fair value of Sal ($152 / 20%) Book value of Sal($850 + $22.5 - $12.5 - $100) Excess of fair value over book value $760 760 $ Pat’s investment income from Sal for 2011 Sal’s net income Less: Preferred income ($100  10%) Income to common Income from Sal($80  70%  year)+($80  20%  3/4 year) $ 90 10 $ 80 $ 68 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-16 Solution P10-3 (continued) Pat Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 (in thousands) Pat Income Statement Sales Income from Sal Cost of sales Other expenses Preacquisition income Noncontrolling int share Controlling share of NI $1,233 68 610* 390* Adjustments and Eliminations Sal $ 700 $1,933 a 301 $ 501 68 400* 210* b d $ $ 90 $ 200 Consolidated Statements 1,010* 600* 4* 18* $ 301 18 Retained Earnings Retained earnings — Pat Retained earnings — Sal Net income Dividends Retained earnings December 31 Balance Sheet Cash Other current assets Plant assets Investment in Sal** Current liabilities $10 preferred stock Common stock Other paid-in capital Retained earnings $ 301 200* 301 90 50* a d b 34 14 602 $ 240 $ $ 191 200 900 711 $ 50 300 600 $ $2,002 $ 950 $ $ 60 100 500 50 240 950 a 34 b 677 1,200 602 $2,002 602 241 500 1,500 $ $2,241 $ c 100 b 500 b 50 260 1,200 602 Noncontrolling interest — common b Noncontrolling interest — preferred Noncontrolling interest December 31 c 100 * 200* $ 200 501 b 200 d 75 179 $2,241 Deduct ** Common equity of Sal = $790 x 90% = $711 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-17 Solution P10-4 [Preferred stock] Preliminary computations Fair value — book value differential Investment cost Implied total fair value of Sam ($240,000 / 80%) Less: Book value acquired Sam’s stockholders’ equity January 1, 2010 Less: Preferred equity Sam’s common equity Excess fair value over book value = Goodwill Income from Sam for 2011 Equity in Sam’s income ($60,000 - $10,000 pf)  80% Add: Intercompany profits beginning inventory ($50,000  40%  3/5) Less: Intercompany profits ending inventory ($60,000  40%  4/6) Add: Realization of 80% of $10,000 profit deferred on land from 2010 Add: Constructive gain on bonds ($9,000  80%) Less: Piecemeal recognition of gain ($9,000/3 years  1/2 year  80%) Income from Sam Investment in Sam December 31, 2011 Underlying book value ($390,000 - $100,000)  80% Add: 80% of Goodwill Less: Unrealized inventory profit Add: Constructive gain less 1/2 year piecemeal recognition ($9,000 - $1,500)  80% Investment in Sak December 31 Noncontrolling interest share — common Sam’s reported income less income to preferred ($60,000 - $10,000) Recognition of previously deferred gain on land Constructive gain on bonds less 1/2 year piecemeal recognition of gain ($9,000 - $1,500) Sam’s realized income to common Noncontrolling interest percentage Noncontrolling interest share — common $240,000 $300,000 $325,000 100,000 225,000 $ 75,000 $ 40,000 12,000 (16,000) 8,000 7,200 (1,200) $ 50,000 $232,000 60,000 (16,000) 6,000 $282,000 $ 50,000 10,000 7,500 67,500 20% $ 13,500 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-18 Solution P10-4 (continued) Par Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2011 Par Income Statement Sales Gain on land Interest income Gain on bonds Income from Sam Cost of sales $ 900,000 10,000 6,500 $ 50,000 600,000* Operating expenses Interest expense Consolidated net income Noncontrolling share Preferred 300,000 140,000* 208,500* Noncontrol Share — common Controlling share of NI Adjustments and Eliminations Sam 80% a e 6,500 f c 50,000 16,000 90,000* 10,000* i i $ 158,000 $ 132,000 60,000 $ 60,000 $ 50,000 Consolidated Statements d 10,000 $1,140,000 20,000 e 9,000 9,000 a b 60,000 12,000 e 5,000 684,000* 298,500* 5,000* 181,500 10,000 13,500 10,000* 13,500* $ 158,000 $ 132,000 Retained Earnings Retained earnings — Par Retained earnings — Sam Controlling share of NI 158,000 100,000* Dividends Retained earnings December 31 — Sam Investment — Sam Investment 190,000 $ 90,000 $ $ 15,000 20,000 60,000 5,000 30,000 420,000 bonds 5,500 26,000 80,000 100,000 160,000 268,000 92,500 stock 282,000 $1,014,000 $ 550,000 $ $ 15,000 100,000 45,000 200,000 100,000 24,000 100,000 700,000 190,000 $1,014,000 Noncontrolling interest — common 158,000 f i b d h Goodwill Accounts payable 10% bonds payable Other liabilities Capital stock 10% preferred stock Retained earnings 50,000 60,000 20,000* $ Balance Sheet Cash Accounts receivable Inventories Other current assets Land Plant and equipment h 12,000 8,000 75,000 8,000 12,000 j c 5,000 16,000 e 92,500 $ 190,000 $ 20,500 41,000 124,000 105,000 190,000 688,000 f 42,000 h 260,000 75,000 $1,243,500 j 5,000 e 100,000 $ 34,000 145,000 700,000 h 200,000 g 100,000 190,000 90,000 $ 100,000* 550,000 (beginning) Noncontrolling interest — preferred (beginning) Noncontrolling interest December 31 d 2,000 h 65,000 g 100,000 i 11,500 174,500 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-19 $1,243,500 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 10-20 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation Solution P10-5 [EPS](in thousands) Requirement Requirement Diluted Diluted Sir’s EPS Sir’s net income (equal to income to common stockholders) Add: Net-of-tax interest on convertible bonds Sir’s earnings = a $ 60 $ 66 $ 60 NA $ 60 Sir’s outstanding common shares Add: Shares from assumed conversion of bonds Common shares and common share equivalents = b Sir’s EPS = a/b 50 10 60 $1.10 50 NA 50 $1.20 $150 $150 Pal’s EPS Pal’s net income (equal to income to common stockholders) Add: Net-of-tax interest on convertible bonds of Sir Replacement of Pal’s equity in Sir’s income with Pal’s equity in Sir’s diluted EPS (35,000 shares  $1.10) and convertible to Pal securities (35,000 shares  $1.20) Pal’s earnings = a Pal’s outstanding common shares Add: Shares from assumed conversion of bonds Common shares and common share equivalents = b Pal’s EPS = a/b a (42) 38.5 $146.5 100 100 $1.47 (42)a 42a $156 100 10 110 $1.42 When subsidiary securities are convertible into parent common stock, the replacement calculation is not needed The replacement is included in this solution only to show that it has no effect on the calculation © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-21 Solution P10-6 [EPS] Diluted Basic a b a b a She’s earnings per share Income to common Income to preferred assumed converted Earnings Common shares and common share equivalents: Common shares outstanding Add: Common shares issuable on preferred Add: Incremental shares issuable on options 2,000 - [($2,000  $15)/$30] Common and common equivalent shares EPS a/b Pen’s earnings per share Income to common Replacement calculation Equity in She’s income to common ($45,000  80%) Equity in She’s EPS 8,000  $4.50 basic EPS 8,000  $3.93 diluted EPS Earnings Common shares EPS a/b $ 45,000 $ 45,000 $ 45,000 10,000 $ 55,000 10,000 10,000 3,000 1,000 10,000 14,000 $ 4.50 $ 3.93 $150,000 (36,000)a $150,000 (36,000) 36,000a 31,440 $150,000 $145,440 20,000 20,000 $ 7.50 $ 7.27 A replacement calculation is never needed when calculating basic earnings per share It is only included here to illustrate the point that the replacement will have no impact on the earnings per share calculation © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-22 Solution P10-7 [EPS] a b Common and common equivalent shares a b $ Consolidated earnings per share Net income to Pro Replacement calculation for diluted EPS $36,000  80% share of realized income $5.00 diluted EPS  4,800 shares Earnings Outstanding common shares EPS a/b Net income of Pro Add: Income to preferred Earnings Common stock of Pro Common shares from conversion of Preferred Common and common share equivalents EPS a/b Solution P10-8 $ 36,000 14,000 $ 50,000 6,000 4,000 6,000 EPS a/b a b Diluted Basic Sit’s earnings per share Income to common $50,000 - $14,000 $36,000 Add: Income to preferred assumed converted Earnings $36,000 Common shares outstanding 6,000 Common shares from conversion of preferred 10,000 6.00 $ 5.00 $93,800 $ 93,800 $93,800 20,000 $ 4.69 (28,800) 24,000 $ 89,000 20,000 $ 4.45 $93,800 $93,800 20,000 $ 93,800 14,000 $107,800 20,000 20,000 $ 4.69 5,000 25,000 $ 4.312 [EPS] Pin’s net income Replacement calculation: Pin’s equity in Sum’s realized income ($500,000 - $60,000)  80% Pin’s equity in Sum’s diluted EPS (40,000 shares  $7.44) Consolidated diluted earnings = a Pin’s outstanding common shares = b Consolidated diluted EPS = a/b $1,262,000 $352,000 297,600 54,400 $1,207,600 100,000 $ 12.08 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-23 Solution P10-9 [EPS](in thousands) a b a b Sim’s earnings per share Income to common Less: Unrealized profit — upstream sale Add: Income to preferred Earnings Common shares outstanding Add: Shares from conversion of preferred Add: Incremental shares from warrants 10,000 - ($150,000/$20) Common and common equivalent shares EPS a/b Basic Diluted $200 (20) $200 (20) 100 $280 50 30 $180 50 Consolidated (and Pit’s) earnings per share Pit’s income to common Replacement calculation Equity in Sim’s realized income ($200,000 - $20,000)  80% Equity in Sim’s diluted EPS 40,000  $3.39 Earnings Outstanding common shares EPS a/b 50 $3.60 2.5 82.5 $3.3939 $450 $450 $450 100 $4.50 (144) 135.6 $441.6 100 $4.42 Solution P10-10 [Tax] Par Corporation Income Statement for the current year (in thousands) (a) Assuming Separate Tax Returns Sales $2,400 Gain on sale of land 100 98 Income from Sama Cost of sales (1,200) (700) Operating expenses Income before income taxes 698 (170) Income tax expenseb Net income $ 528 (b) Assuming Consolidated Tax Return $2,400 100 98 (1,200) (700) 698 (170) $ 528 Supporting computations a b Income from Sam Equity in Sam’s income ($300 - $102 income taxes)  100% Less: Unrealized profit Income from Sam Income tax expense Income tax currently payable: Par’s $600 taxable income  34% Consolidated taxable income of $800  34%  $500/$800 Deferred income taxes: Deferred tax asset ($100  34%) Income tax expense $ 198 (100) $ 98 $198 (100) $ 98 $204 $170 (34) $ 170 $170 Note: There is no tax on undistributed income because Par and Sam are an affiliated group © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-24 Solution P10-11 [Tax] Preliminary computations Investment cost $577,500 Implied total fair value of Sir($577,500 / 70%) Less: Book value of Sir Excess fair value over book value = Goodwill $825,000 800,000 $ 25,000 Income tax expense (separate tax returns required) Pan Tax on operating income ($500,000  34%) ($200,000  34%) Tax on dividends received ($50,000  70%)  20% taxable  34% tax rate Income taxes currently payable Deferred tax on undistributed income ($49,000*  70%)  20% taxable  34% tax rate Deferred tax asset on unrealized inventory profit ($50,000  34%) Income tax expense $174,712 * Sir $170,000 $ 68,000 2,380 172,380 68,000 2,332 (17,000) $ 51,000 Undistributed income (Sir’s operating income of $200,000 - $51,000 tax $50,000 unrealized profit - $50,000 dividends paid) = $49,000 Income from Sir Equity in Sir’s net income ($200,000 - $51,000 tax)  70% Unrealized inventory profit ($50,000  70%) Income from Sir $104,300 (35,000) $ 69,300 Pan Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales ($5,000,000 - $120,000) Cost of sales ($2,550,000 + $50,000 - $120,000) Gross profit Operating expenses Income before income taxes and noncontrolling interest Less: Income taxes ($174,712 + $51,000) Total consolidated income Less: Noncontrolling interest share ($149,000 net income - $50,000 unrealized)  30% $4,880,000 2,480,000 2,400,000 1,750,000 650,000 225,712 424,288 Controlling share of NI $ 394,588 $ 325,288 69,300 394,588 Check: Pan’s separate income ($500,000 - $174,712) Income from Sir Pan’s and Controlling share of NI 29,700 $ © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-25 Solution P10-12 [Tax] Pub Corporation and Subsidiary Partial Consolidation Working Papers for the year ended December 31, 2011 Pub Income Statement $500,000 Sales Dividends received from Sew 28,000 Cost of sales 250,000* Operating expenses 78,000* Income tax expense 58,222* Noncont Share** Control Share - NI $141,778 70% Sew $300,000 120,000* 80,000* 34,000* Adjustments and Eliminations Noncont Interest a 90,000 c 28,000 b 10,000 Consolidated Statements $ 710,000 $ 290,000* 158,000* 92,222* 19,800* 149,978 a 90,000 $19,800 $ 66,000 Note: The offsetting credits to entries b and c are to inventory and dividend accounts, respectively * ** Deduct Noncontrolling interest share = $66,000  30% Supporting computations Pub Income taxes currently payable Taxes on operating income ($172,000  34%) ($100,000  34%) Tax on dividends received ($40,000  70%)  20% taxable  34% tax rate Tax on undistributed income ($26,000  70%)  20% taxable  34% tax rate Less: Deferred tax on inventory profit $10,000  34% tax rate Income tax expense Consolidated net income check Sew’s net income of $66,000  70% Less: Unrealized inventory profit Income from Sew — equity basis Less: Sew’s income — cost basis Cost — equity method difference Add: Pub’s reported net income Controlling share of NI Sew $58,480 $ 34,000 1,904 60,384 34,000 1,238 (3,400) $58,222 $ 34,000 $ 46,200 (10,000) 36,200 (28,000) 8,200 141,778 $149,978 © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 10-26 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation Solution P10-13 [Tax] Preliminary computations Investment cost $900,000 Implied total fair value of Soo($900,000 / 90%) Less: Book value of Soo Excess fair value over book value = Goodwill $1,000,000 900,000 $ 100,000 Sales Gain on land sale Income from Soo Cost of sales Expenses Income tax expense Noncontrolling share Controlling share of NI Pen $800,000 20,000 36,430 (400,000) (150,000) (85,000)a Soo $200,000 $221,430 $ 62,700 Adjustments and Eliminations Consolidated $1,000,000 a 20,000 b 36,430 (75,000) (30,000) (32,300) (475,000) (180,000) (117,300) (6,270) $ 221,430 a Pen’s income tax expense is calculated: Sales 800,000 Cost of Sales (400,000) Expenses (150,000) Pretax income 250,000 34 Tax rate Income tax expense 85,000 Preliminary computations Income from Soo for 2011 $ 56,430 Share of Soo’s net income ($62,700  90%) Less: Unrealized profit on intercompany sale of land (20,000) Income from Soo $ 36,430 Investment in Soo account December 31, 2011 $900,000 Cost of 90% interest in Soo January Add: Income from Soo 36,430 (45,000) Less: Dividends from Soo Investment December 31 $891,430 a Gain on sale of land 20,000 Land 20,000 To eliminate unrealized intercompany profit from downstream sale of land 36,430 b Income from Soo 8,570 Investment in Soo Dividends from Soo 45,000 To eliminate investment income and dividends and return the investment in Soo account to its beginning of the period balance 500,000 c Capital stock — Soo 400,000 Retained earnings — Soo Goodwill 100,000 900,000 Investment in Soo Noncontrolling interest January 100,000 6,270 Noncontrolling interest share Dividends 5,000 1,270 Noncontrolling interest To eliminate reciprocal beginning of the period investment and equity balances, establish beginning noncontrolling interest, and enter goodwill © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-27 Solution P10-14 [Tax] Allocation schedule Cost of investment = Fair value (100% purchase) Book value Excess fair value over book value Excess allocated Land Buildings — net Equipment — net Goodwill for the remainder Excess fair value over book value $280,000 170,000 $110,000 $ 40,000 30,000 10,000 30,000 $110,000 (10 year life) (2 year life) Note: In a taxable combination transaction there are no deferred tax liabilities since the tax basis and book basis are the same A current tax deduction will affect the future recognized income from Sad Corporation Allocation schedule Cost (fair value) of investment Book value Excess fair value over book value Excess allocated: Land Buildings — net Equipment — net Deferred tax liability ($80,000  35%) Goodwill for the remainder Excess fair value over book value a $280,000 170,000 $110,000 $ 40,000 30,000 10,000 (10 year life) (2 year life) (28,000)a 58,000 $110,000 On a tax-free reorganization a deferred tax liability must be set up for all the tax basis/book basis differentials, other than goodwill Since the transaction is recorded at purchase price on the books but has no change in tax basis from the original books, differences in basis occur and are equal to any fair value write-ups of the assets Par’s income from Sad for 2011 Taxable Sad’s reported income Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) Add: Income tax reductions due to the prior adjustments Income from Sad a $ 50,000 (3,000) (5,000) 2,800a $ 44,800 Since all three items are currently deductible for tax purposes they will reduce the income taxes Par will have to pay © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation 10-28 Solution P10-14 (continued) Tax free Sad’s reported income Less: Depreciation on excess allocated to buildings — net ($30,000/10 years) Add: Amortization of deferred tax liability allocated to buildings ($3,000  35) Less: Depreciation on excess allocated to equipment — net ($10,000/2 years) Add: Amortization of deferred tax liability allocated to equipment ($5,000  35) Income from Sad $50,000 (3,000) 1,050 (5,000) 1,750 $44,800 Solution P10-15 Income tax expense Pop Income taxes currently payable: Taxes on operating income $1,400,000  34% $800,000  34% Tax on dividends received: $280,000  20% taxable  34% tax rate Income taxes currently payable Tax on undistributed income: $128,000  70%  20% taxable  34% tax rate Less: Deferred tax on gain on equipment $400,000  34% tax rate Income tax expense $476,000 $272,000 19,040 495,040 272,000 6,093 (136,000) $365,133 $272,000 Loss from Son Income from Son’s Less: Income from Son Son on an equity basis net income of $528,000  70% Unrealized gain ($500,000 - $100,000) Son — equity basis (loss) $ $ 369,600 (400,000) (30,400) Pop Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2011 Sales Cost of sales Gross profit Other expenses ($2,100,000 + $1,200,000 - $100,000) Income before income taxes Income tax expense ($365,133 + $272,000) Total consolidated income Less: Noncontrolling interest share ($528,000  30%) Controlling share of NI $12,000,000 (7,000,000) 5,000,000 (3,200,000) 1,800,000 (637,133) 1,162,867 (158,400) $ 1,004,467 Check: Pop’s pretax income of $1,400,000 - $30,400 loss from Son $365,133 income taxes = $1,004,467 Controlling share of NI © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-29 Solution P10-16 [Tax] Sal’s net income Pretax income Less: Income tax expense: Taxes currently payable ($430,000  34%) Less: Deferred tax asset — land ($30,000  34%) Sal’s net income 430,000 $ (136,000) 294,000 $ 264,600 $ (27,000) (15,000) 222,600 $146,200 (10,200) Pix’s income from Sal Share of Sal’s net income ($294,000  90%) Less: Unrealized gain on upstream sale of land ($30,000  90%) Less: Unrealized inventory profit Income from Sal on an equity basis $ Pix’s net income Sales Income from Sal Less: Cost of sales and expenses Income before income taxes Income tax expense ($209,100 currently payable less $5,100a deferred tax asset) Net income a $3,815,000 222,600 (3,200,000) 837,600 $ (204,000) 633,600 The deferred tax asset is $5,100 deferral for the inventory profit © 2011 Pearson Education, Inc publishing as Prentice Hall ... ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-5 Solution E10-5 Preliminary computations Total equity of Son at December 31, 2011 Less: Preferred equity (10, 000 shares... publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-13 SOLUTIONS TO PROBLEMS Solution P10-1 [Preferred stock] (amounts in thousands)... includes 10% of Goodwill © 2011 Pearson Education, Inc publishing as Prentice Hall Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 10 10-15 Solution P10-3