9

Consolidation
Ownership
Issues

© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin
 General Overview

• The following topics are discussed in this

chapter:
1. Subsidiary preferred stock outstanding
2. Changes in the parent’s ownership interest in the
subsidiary
3. Multiple ownership levels
4. Reciprocal or mutual ownership
5. Subsidiary stock dividends

9-2
Subsidiary Preferred Stock Outstanding

• Preferred stockholders normally have

preference over common shareholders with
respect to dividends and the distribution of
assets in a liquidation
– The right to vote usually is withheld
– Special attention must be given to the claim of a
subsidiary’s preferred shareholders on the net
assets of the subsidiary

9-3
Subsidiary Preferred Stock Outstanding

• Consolidation with subsidiary preferred stock

outstanding
– The amount of subsidiary stockholders’ equity
accruing to preferred shareholders must be
determined before dealing with the elimination
of the intercompany common stock ownership
– If the parent holds some of the subsidiary’s
preferred stock, its portion of the preferred
stock interest must be eliminated
– Any portion of the subsidiary’s preferred stock
interest not held by the parent is assigned to
the noncontrolling interest
9-4
Subsidiary Preferred Stock Outstanding
- Illustration
1. Peerless Products acquires 80 percent of Special Foods’ common stock on
January 1, 20X1, at its book value of $240,000 and accounts for the
investment using the basic equity method. At the date of combination, the
fair value of Special Foods’ common stock held by the noncontrolling
shareholders is equal to its book value of $60,000.

2. Peerless earns income from its own operations of $140,000 in 20X1 and
declares dividends of $60,000.

3. Special Foods reports net income of $50,000 in 20X1 and declares

common dividends of $30,000.

4. On January 1, 20X1, immediately after the combination, Special Foods

issues $100,000 of 12 percent preferred stock at par value, none of which
is purchased by Peerless. The regular $12,000 preferred dividend is paid in
20X1.

9-5
Subsidiary Preferred Stock Outstanding
- Illustration
• Allocation of Special Foods’ net income
Of the total $50,000 of net income reported by Special Foods for 20X1,
$12,000 ($100,000 x .12) is assigned to the preferred shareholders as their
current dividend. Peerless records its share of the remaining amount:

Special Foods’ net income, 20X1 $50,000

Less: Preferred dividends ($100,000 x .12) (12,000)
Special Foods’ income accruing to common shareholders 38,000
Peerless’s proportionate share X 0.80
Peerless’s income from Special Foods $30,400

Income assigned to the noncontrolling interest for 20X1:

Preferred dividends of Special Foods $12,000

In come assigned to Special Foods’ noncontrolling
common shareholders ($38,000 x .20) 7,600
Income to noncontrolling interest $19,600
9-6
Subsidiary Preferred Stock Outstanding
- Illustration
Computation and allocation of consolidated net income:

Peerless’s separate operating income $140,000

Special Foods’ net income 50,000
Consolidated net income $190,000
Income to the noncontrolling interest (19,600)
Income attributed to the controlling interest $170,400

The workpaper to prepare consolidated financial statements at the end of

20X1 appears in Figure 9–1 in the text.

9-7
Subsidiary Preferred Stock Outstanding
- Illustration
Elimination entries:
E(1) Income from Subsidiary 30,400
Dividends Declared—Common 24,000
Investment in Special Foods Common 6,400
Eliminate income from subsidiary.
E(2) Income to Noncontrolling Interest 19,600
Dividends Declared—Preferred 12,000
Dividends Declared—Common 6,000
Noncontrolling Interest 1,600
Assign income to noncontrolling interest.
E(3) Common Stock—Special Foods 200,000
Retained Earnings, January 1 100,000
Investment in Special Foods Common 240,000
Noncontrolling Interest 60,000
Eliminate beginning investment in common stock.
E(4) Preferred Stock—Special Foods 100,000
Noncontrolling Interest 100,000
Eliminate subsidiary preferred stock.

9-8
Subsidiary Preferred Stock Outstanding

• Subsidiary preferred stock held by parent

– Because the preferred stock held by the parent
is within the consolidated entity, it must be
eliminated when consolidated financial
statements are prepared
– Any income from the preferred stock recorded
by the parent also must be eliminated

9-9
Subsidiary Preferred Stock Outstanding
- Illustration
Peerless acquires 60 percent of Special Foods’ $100,000 par value, 12
percent preferred stock for $60,000 when issued on January 1, 20X1. During
20X1 dividends of $12,000 are declared on the preferred stock. Peerless
recognizes $7,200 of dividend income from its investment in preferred stock,
and the remaining $4,800 is paid to the holders of the other preferred shares.
Noncontrolling interest’s share of preferred dividends ($12,000 x .40) $4,800
In come assigned to Special Foods’ noncontrolling common shareholders
($38,000 x .20) 7,600
Income to noncontrolling interest $12,400
Elimination entries:
E(5) Income from Subsidiary 30,400
Dividends Declared—Common 24,000
Investment in Special Foods Common 6,400
Eliminate income from subsidiary:
$30,400 = ($50,000 - $12,000) x .80

(E(6) Dividend Income—Preferred 7,200

Dividends Declared—Preferred 7,200
Eliminate dividend income from subsidiary preferred:
$12,000 x .60
9-10
Subsidiary Preferred Stock Outstanding
- Illustration
Elimination entries (continued):
E(7) Income to Noncontrolling Interest 12,400
Dividends Declared—Preferred 4,800
Dividends Declared—Common 6,000
Noncontrolling Interest 1,600
Assign income to noncontrolling interest:
$12,400 = $4,800 + $7,600
$4,800 = $12,000 x .40

E(8) Common Stock—Special Foods 200,000

Retained Earnings, January 1 100,000
Investment in Special Foods Common 240,000
Noncontrolling Interest 60,000
Eliminate beginning investment in common stock.

E(9) Preferred Stock—Special Foods 100,000

Investment in Special Foods Preferred 60,000
Noncontrolling Interest 40,000
Eliminate subsidiary preferred stock.

9-11
Subsidiary Preferred Stock Outstanding

• Subsidiary preferred stock with special

provisions
– The provisions of the preferred stock
agreement must be examined to determine the
portion of the subsidiary’s stockholders’ equity
to be assigned to the preferred stock interest
• Cumulative dividend provision
• Noncumulative preferred stock
• Preferred stock participation features
• Preferred stocks that are callable

9-12
 Illustration of Subsidiary Preferred
Stock with Special Features
1. Special Foods issues $100,000 par value 12 percent preferred stock on
January 1, 20X0. It is cumulative, nonparticipating, and callable at 105.
2. No dividends are declared on the preferred stock during 20X0.
3. On January 1, 20X1, Peerless Products acquires 80 percent of Special
Foods’ common stock for $240,000, when the fair value of the
noncontrolling interest in Special Foods’ common stock is $60,000.
4. On January 1, 20X1, Peerless acqiures 60 percent of the preferred stock
for $61,000.
5. Stockholders’ equity accounts of Special Foods on January 1, 20X1 follow:

Preferred Stock $100,000

Common Stock 200,000
Retained Earnings 100,000
Total Stockholders’ Equity $400,000

9-13
 Illustration of Subsidiary Preferred
Stock with Special Features
Peerless acquires 60 percent of Special Foods’ $100,000 par value, 12
percent preferred stock for $60,000 when issued on January 1, 20X1. During
20X1 dividends of $12,000 are declared on the preferred stock. Peerless
recognizes $7,200 of dividend income from its investment in preferred stock,
and the remaining $4,800 is paid to the holders of the other preferred shares.

Par value of Special Foods’ preferred stock $100,000

Call premium 5,000
Dividends in arrears for 20X0 12,000
Total preferred stock interest, January 1, 20X1 $117,000

This amount is apportioned between Peerless and the noncontrolling

shareholders:

Peerless’s share of preferred stock interest ($117,000 x .60) $70,200

Noncontrolling stockholders’ share of preferred stock interest ($117,000 x .40) 46,800
Total preferred stock interest, January 1, 20X1 $117,000

9-14
 Illustration of Subsidiary Preferred
Stock with Special Features
Because the preferred stock interest exceeds the par value by $17,000, the
portion of Special Foods’ retained earnings accruing to the common
shareholders is reduced by that amount. Therefore, Special Foods’ common
stockholders have a total claim on the company’s net assets as follows:

Common stock $200,000

Retained earnings ($100,000 - $17,000) 83,000
Total common stock interest, January 1, 20X1 $283,000

Because the book value of Special Foods’ common stock is only $283,000 on
January 1, 20X1, a differential arises:

Consideration given by Peerless Products $240,000

Fair value of noncontrolling interest in Special Foods’ common stock 60,000
$300,000
Book value of Special Foods’ common stock (283,000)
Differential $17,000

9-15
Illustration of Subsidiary Preferred
Stock with Special Features
Eliminating entries:
E(10) Common Stock—Special Foods 200,000
Retained Earnings 83,000
Differential 17,000
Investment in Special Foods Common 240,000
Noncontrolling Interest 60,000
Eliminate investment in common stock:
$83,000 = $100,000 - $17,000
$17,000 = $300,000 - $283,000
E(11) Preferred Stock—Special Foods 100,000
Retained Earnings 17,000
Investment in Special Foods Preferred 61,000
Additional Paid-In Capital 9,200
Noncontrolling Interest 46,800
Eliminate subsidiary preferred stock:
$17,000 = $117,000 - $100,000
$9,200 = ($117,000 x .60) - $61,000
$46,800 = $117,000 x .40

9-16
 Changes in Parent Company
Ownership
• Parent’s purchase of additional shares from
nonaffiliate
– Effects of multiple purchases of a subsidiary’s
stock on the consolidation process are
illustrated in the following example:
Assume that on January 1, 20X0, Special Foods has $200,000 of common
stock outstanding and retained earnings of $60,000. During 20X0, 20X1, and
20X2, Special Foods reports the following information:

9-17
 Changes in Parent Company
Ownership - Illustration
Peerless Products purchases its 80 percent interest in Special Foods in
several blocks, as follows:

All of the differential relates to land held by Special Foods. Note that Peerless
does not gain control of Special Foods until January 1, 20X2.

9-18
 Changes in Parent Company
Ownership - Illustration
The investment account on Peerless’s books includes the following amounts
through 20X1:

9-19
 Changes in Parent Company
Ownership - Illustration
When Peerless gains control of Special Foods on January 1, 20X2, assume
that the fair value of the 30 percent equity interest it already holds in Special
Foods is $111,000, and the fair value of Special Foods’ 20 percent remaining
noncontrolling interest is $74,000. The book value of Special Foods as a whole
on that date is $320,000. Under FASB 141R, the differential at the date of
combination is computed as follows:

Because all of the differential relates to land, it is not amortized or written off
either on Peerless’s books or for consolidation.
9-20
 Changes in Parent Company
Ownership - Illustration
Under FASB 141R, Peerless must remeasure the equity interest it already
held in Special Foods to its fair value at the date of combination and recognize
a gain or loss for the difference between the fair value and its carrying amount:

The total balance of the investment account on Peerless’s books immediately

after the combination is:

9-21
 Changes in Parent Company
Ownership - Illustration
Because Peerless Products gains control of Special Foods on January 1,
20X2, consolidated statements are prepared for the year 20X2.
Eliminating entries:
E(12) Income from Subsidiary 60,000
Dividends Declared 32,000
Investment in Special Foods Stock 28,000
Eliminate income from subsidiary.
E(13) Income to Noncontrolling Interest 15,000
Dividends Declared 8,000
Noncontrolling Interest 7,000
Assign income to noncontrolling shareholders:
$15,000 = $75,000 x .20
$8,000 = $40,000 x .20
$7,000 = $15,000 - $8,000
E(14) Common Stock—Special Foods 200,000
Retained Earnings, January 1 120,000
Land 50,000
Investment in Special Foods Stock 296,000
Noncontrolling Interest 74,000
Eliminate beginning investment balance:

9-22
 Changes in Parent Company
Ownership
• Parent’s sale of subsidiary shares to
nonaffiliate
– When a parent sells some shares of a
subsidiary but continues to hold a controlling
interest, FASB 160 makes clear that this is
considered to be an equity transaction and no
gain or loss may be recognized in consolidated
net income
– An adjustment is required to the amount
assigned to the noncontrolling interest to reflect
its change in ownership of the subsidiary
9-23
 Changes in Parent Company
Ownership
– The difference between the fair value of the
consideration exchanged and the adjustment to
the noncontrolling interest results in an
adjustment to the stockholders’ equity
attributable to the controlling interest
– Some parent companies might choose to
recognize a gain on their separate books
• A better alternative is to avoid recognizing a gain
that later will have to be eliminated and instead
recognize an increase in additional paid-in capital

9-24
 Changes in Parent Company
Ownership
• Subsidiary’s sale of additional shares to
nonaffiliate
– Increases the total stockholders’ equity of the
consolidated entity by the amount received by
the subsidiary from the sale
– Increases the subsidiary’s total shares
outstanding and reduces the percentage
ownership held by the parent
– The dollar amount assigned to the
noncontrolling interest in the consolidated
financial statements increases
9-25
 Changes in Parent Company
Ownership
• The resulting amounts of the controlling and
noncontrolling interests are affected by two
factors:
1. The number of shares sold to nonaffiliates
2. The price at which the shares are sold to
nonaffiliates

9-26
 Changes in Parent Company
Ownership
• Difference between book value and sale
price of subsidiary shares
– If the sale price of new shares equals the book
value of outstanding shares, there is no change
in the existing shareholders’ claim
– The consolidation eliminating entries are
changed to recognize the increase in the claim
of the noncontrolling shareholders and the
corresponding increase in the stockholders’
equity balances of the subsidiary

9-27
 Changes in Parent Company
Ownership
• When the sale price and book value are not
the same:
– All common shareholders are assigned a pro
rata portion of the difference
– The book value of the subsidiary’s shares held
by the parent changes
– This change is recognized by the parent by
adjusting the carrying amount of its investment
in the subsidiary and additional paid-in capital
– The parent’s additional paid-in capital is then
carried to the workpaper in consolidation
9-28
 Changes in Parent Company
Ownership
• Subsidiary’s sale of additional shares to parent at a
price equal to the book value of the existing shares
– A sale of additional shares directly from a less-than-
wholly owned subsidiary to its parent increases the
parent’s ownership percentage
– The increase in the parent’s investment account equals
the increase in the stockholders’ equity of the subsidiary
– The net book value assigned to the noncontrolling
interest remains unchanged
– Normal elimination entries are made based on the
parent’s new ownership percentage

9-29
 Changes in Parent Company
Ownership
• Subsidiary’s sale of additional shares to parent at an
amount other than book value
– It increases the carrying amount of its investment by the
fair value of the consideration given
– In consolidation, the amount of the noncontrolling
interest must be adjusted to reflect the change in its
interest in the subsidiary
– FASB 160 then requires an adjustment to consolidated
additional paid-in capital for the difference between any
consideration given or received by the consolidated
entity and the amount of the adjustment to the
noncontrolling interest
9-30
 Changes in Parent Company
Ownership
• Subsidiary’s purchase of shares from
nonaffiliate
– Sometimes a subsidiary purchases treasury
shares from noncontrolling shareholders, who
may be willing sellers
– The parent’s equity in the net assets of the
subsidiary may change as a result of the
transaction
– When this occurs, the amount of the change
must be recognized in preparing the
consolidated statements
9-31
 Changes in Parent Company
Ownership
• Subsidiary’s purchase of shares from parent
– When this happens, the parent has traditionally
recognized a gain or loss on the difference
between the selling price and the change in the
carrying amount of its investment
– From a consolidated viewpoint, the transaction
represents an internal transfer and does not
give rise to a gain or loss
– A better approach is for the parent to adjust
additional paid-in capital
9-32
Complex Ownership Structures

9-33
 Complex Ownership Structures

• Direct ownership: The parent has

controlling interest in each of the subsidiaries
• Multilevel ownership: The parent has only
indirect control over the company controlled
by its subsidiary
– The eliminating entries used are similar to those
used in a simple ownership situation, but
careful attention must be given to the sequence
in which the data are brought together

9-34
 Complex Ownership Structures

• Reciprocal ownership or mutual holdings:

– The parent owns a majority of the subsidiary’s
common stock and the subsidiary holds some
of the parent’s common shares
– If mutual shareholdings are ignored in
consolidation, some reported amounts may be
materially overstated

9-35
 Complex Ownership Structures

• Multilevel ownership and control

– When consolidated statements are prepared, they
include companies in which the parent has only an
indirect investment along with those in which it holds
direct ownership
– The complexity of the consolidation process increases
as additional ownership levels are included
– The amount of income and net assets to be assigned to
the controlling and noncontrolling shareholders, and the
amount of unrealized profits and losses to be
eliminated, must be determined at each level of
ownership

9-36
 Complex Ownership Structures

– When a number of different levels of ownership

exist, the first step normally is to consolidate
the bottom, or most remote, subsidiaries with
the companies at the next higher level
– This sequence is continued up through the
ownership structure until the subsidiaries
owned directly by the parent company are
consolidated with it
– Income is apportioned between the controlling
and noncontrolling shareholders of the
companies at each level
9-37
 Complex Ownership Structures

• Reciprocal or Mutual Ownership

– The treasury stock method is used to deal with
reciprocal relationships
• Purchases of a parent’s stock by a subsidiary are
treated in the same way as if the parent had
repurchased its own stock and was holding it in the
treasury
• The subsidiary normally accounts for the
investment in the parent’s stock using the cost
method

9-38
 Subsidiary Stock Dividends

• Stock dividends are issued proportionally to

all common stockholders
– The relative interests of the controlling and
noncontrolling stockholders do not change
– The investment’s carrying amount on the
parent’s books also is unaffected
– The stockholders’ equity accounts of the
subsidiary do change, although total
stockholders’ equity does not

9-39
 Subsidiary Stock Dividends

• The stock dividend represents a permanent

capitalization of retained earnings, thus:
– Decreasing retained earnings and increasing
capital stock and, perhaps, additional paid-in
capital
– Effect on the preparation of consolidated
financial statements for the period:
• The stock dividend declaration must be eliminated
along with the increased common stock and
increased additional paid-in capital, if any

9-40
 Subsidiary Stock Dividends

– In subsequent years, the balances in the

subsidiary’s stockholders’ equity accounts are
eliminated in the normal manner
– The full balances of all the subsidiary’s
stockholders’ equity accounts must be
eliminated in consolidation, even though
amounts have been shifted from one account to
another

9-41