© The McGraw-Hill Companies, Inc., 2001 Slide 7-1 McGraw-Hill/Irwin 7 C H A P T E R Ownership...

© The McGraw-Hill Companies, Inc., 2001

Slide 7-1

McGraw-Hill/Irwin

7

C H A P T E R

Ownership Patterns and Income Taxes

Updated Sixth Edition


Slide 7-2

McGraw-Hill/Irwin

Indirect Subsidiary ControlIndirect Subsidiary Control

Father-Son-Grandson relationships occur

when the parent controls a subsidiary

that controls other subsidiaries.

80% OwnershipFather

Son

Grandson

70% Ownership


Slide 7-3

McGraw-Hill/Irwin

Indirect Subsidiary ControlIndirect Subsidiary Control

In effect, the Father company

indirectly controls ALL of the

subsidiaries in the chain.

80% OwnershipFather

Son

Grandson

70% Ownership


Slide 7-4

McGraw-Hill/Irwin

Be sure to always start from the bottom

and work up to the parent company.

Be sure to always start from the bottom

and work up to the parent company.

Consolidation When Indirect Control Is Present

Consolidation When Indirect Control Is Present

Compute realized income for the “grandson”.

Compute consolidated income for the “son” and “grandson”.

Compute consolidated income for the “father” and the “son”.

Let’s look at an example from your

text.

Let’s look at an example from your

text.


Slide 7-5

McGraw-Hill/Irwin

Determine consolidated income for the business combination by:

Combining Midway and Bottom to determine Midway’s realized income.

Combining Top with the realized income from Midway.

Determine consolidated income for the business combination by:

Combining Midway and Bottom to determine Midway’s realized income.

Combining Top with the realized income from Midway.

Indirect ControlExample


70% OwnershipTop Co.

Midway Co.

Bottom Co.

60% Ownership


Slide 7-6

McGraw-Hill/Irwin

2000 Income Figures For Each Company



After adjusting for intercompany income, Bottom Co.’s realized

income is $80,000.

Midway gets 60% of $80,000.

After adjusting for intercompany income, Bottom Co.’s realized

income is $80,000.

Midway gets 60% of $80,000.


Slide 7-7

McGraw-Hill/Irwin





Slide 7-8

McGraw-Hill/Irwin





Slide 7-9

McGraw-Hill/Irwin

Consolidation ProcessIndirect Control


The consolidation process requires making the consolidation entries for:

each son/grandson relationship, and then

each father/son relationship.


Slide 7-10

McGraw-Hill/Irwin



Using the consolidation entries previously described is sufficient to complete the father-son-grandson combination.

Essentially, the entries are duplicated for each relationship.


Slide 7-11

McGraw-Hill/Irwin

Indirect Subsidiary ControlConnecting Affiliation


Low Company

Side Company

70% owned

30% owned

45% owned

The combination of the parent’s

DIRECT ownership and

INDIRECT ownership can

result in control of a subsidiary.

The combination of the parent’s

DIRECT ownership and

INDIRECT ownership can

result in control of a subsidiary.

High Company


Slide 7-12

McGraw-Hill/Irwin



In this case, High controls Side directly

with 70% ownership, and Low indirectly

with 61.5% effective

ownership.




ownership. Low Company

Side Company

70% owned

30% owned

45% owned

High Company


Slide 7-13

McGraw-Hill/Irwin




ownership.




ownership.



Basic Consolidation Rules Still Hold:

Eliminate effects of intercompany transfers.

Eliminate sub’s beginning equity balances.

Adjust for unamortized FMV adjustments.

Record Amortization Expense. Remove intercompany income

and dividends. Record noncontrolling

interest.


Slide 7-14

McGraw-Hill/Irwin

Up Company

Down Company

90% owned

20% owned

Mutual OwnershipMutual Ownership

Occurs when the subsidiary owns shares of the parent.

Two methods can be used to account for the mutually owned shares: Treasury Stock

Approach Conventional

Approach


Slide 7-15

McGraw-Hill/Irwin

Mutual OwnershipTreasury Stock Approach

Mutual OwnershipTreasury Stock Approach

The predominant approach in practice.

The cost of the parent shares held by the subsidiary are reclassified on the worksheet to Treasury Stock.


Slide 7-16

McGraw-Hill/Irwin

Mutual OwnershipConventional Approach

Mutual OwnershipConventional Approach

Treats each investment independently.

Applies the equity accounting rules.

Requires the use of simultaneous equations to compute realized income for the parent and the sub.


Slide 7-17

McGraw-Hill/Irwin

Income Tax Accounting for a Business Combination


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.

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.


Slide 7-18

McGraw-Hill/Irwin



Affiliated Group

= The parent company

+ Any subsidiary where the parent owns 80% of the voting stock AND 80% of each class of nonvoting stock.

All others must file separately.

Affiliated Group

= The parent company

+ Any subsidiary where the parent owns 80% of the voting stock AND 80% of each class of nonvoting stock.

All others must file separately.


Slide 7-19

McGraw-Hill/Irwin

Benefits of Using an Affiliated Group

Benefits of Using an Affiliated Group

Intercompany profits are not taxed until realized.

Intercompany dividends are non-taxable.

Losses of one affiliated group member can be used to offset income earned by another group member.

Intercompany profits are not taxed until realized.

Intercompany dividends are non-taxable.

Losses of one affiliated group member can be used to offset income earned by another group member.


Slide 7-20

McGraw-Hill/Irwin

Income Tax AccountingDeferred Income Taxes


The tax consequences are often dependent on whether separate or consolidated returns are filed.

Transactions affected:

Intercompany Dividends

Intercompany Dividends

GoodwillGoodwill

Unrealized Intercompany

Gains

Unrealized Intercompany

Gains


Slide 7-21

McGraw-Hill/Irwin



Intercompany Dividends For accounting purposes, all

intercompany dividends are eliminated.

For tax purposes, dividends are NOT eliminated if ownership is < 80%.

A deferred tax liability is created based on the uneliminated difference.


Slide 7-22

McGraw-Hill/Irwin



Amortization of Goodwill The Revenue Reconciliation

Act of 1993 allows amortization of Goodwill over 15 years for tax purposes.

SFAS No. 142 prohibits amortization of Goodwill for financial reporting purposes.

A permanent deferred tax liability must be recognized.

Amortization of Goodwill The Revenue Reconciliation

Act of 1993 allows amortization of Goodwill over 15 years for tax purposes.

SFAS No. 142 prohibits amortization of Goodwill for financial reporting purposes.

A permanent deferred tax liability must be recognized.


Slide 7-23

McGraw-Hill/Irwin



Unrealized Intercompany Gains If separate returns are filed,

the gains must be reported in the period of transfer.

The “prepayment” of taxes on the unrealized gains creates a deferred income tax asset.

Unrealized Intercompany Gains If separate returns are filed,

the gains must be reported in the period of transfer.

The “prepayment” of taxes on the unrealized gains creates a deferred income tax asset.


Slide 7-24

McGraw-Hill/Irwin

Assigning Income Tax ExpenseAssigning Income Tax Expense

1. For the subsidiary’s separate tax return

(if not part ofan affiliated group)

2. T o determ inethe noncontrolling

interest's share of thesub's net incom e.

W hen a consolidated return is filed, incom etax expense m ust be allocated to the

separate parties for a couple of reasons.


Slide 7-25

McGraw-Hill/Irwin

Assigning Income Tax ExpenseAssigning Income Tax Expense

Assign Tax Expensebased on relative

net incom es of thecom panies.

PercentageAllocation M ethod

Allocation based onrelative tax expense

IF they had filedseparate returns.

SeparateReturn M ethod

T w o Methods


Slide 7-26

McGraw-Hill/Irwin

Our grandson is Our grandson is so good to send so good to send us dividends on us dividends on our share of his our share of his company each company each

year!year!

End of Chapter 7End of Chapter 7

© The McGraw-Hill Companies, Inc., 2001 Slide 7-1 McGraw-Hill/Irwin 7 C H A P T E R Ownership...

Documents

Transcript of © The McGraw-Hill Companies, Inc., 2001 Slide 7-1 McGraw-Hill/Irwin 7 C H A P T E R Ownership...