Kế toán, kiểm toán - Chapter seven: Consolidated financial statements – ownership patterns and income taxes

Chapter SevenConsolidated Financial Statements – Ownership Patterns and Income TaxesCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Learning Objective 7-1Demonstrate the consolidation process when indirect control is present in a grandfather-father-sonownership configuration.7-2Indirect Subsidiary ControlThe presence of an indirect ownership does not change most consolidation procedures; however, a calculation of each subsidiary’s accrual-based income does pose some difficulty.Appropriate income determination is essential for calculating (1) equity income accruals and (2) the noncontrolling interest’s share of consolidated net income.7-3Indirect Subsidiary ControlAssume three companies form a business combination: Top Company owns 70% of Midway Company, which owns 60% of Bottom Company. Top controls both subsidiaries, although the parent’s relationship with Bottom is only of an indirect nature.7-4Indirect Control -ExampleThe following data is from the individual company financial records:7-5Indirect Control – ExampleFollowing the consolidation steps to determine Midway’s realized income:7-6Indirect Control - ExampleThen combine Top Company’s income with Midway’s realized income:Midway’s realized income as previously calculated.7-7Indirect Control - ExampleUsing the income from the previous calculations, determine noncontrolling interest. (Bottom and Midway’s individual incomes as calculated).Use the standard consolidation entries to complete the father-son-grandson combination. The entries are essentially duplicated for each relationship.7-8Indirect Control - ExampleIf appropriate equity accruals are recognized, the sum of the parent’s accrual-based income and the noncontrolling interest income share serves as a “proof figure” for the consolidated total. Thus, if the consolidation process is performed correctly, the earnings this entire organization reports should equal $735,000.7-9Learning Objective 7-2Demonstrate the consolidation process when a corporate ownership structure is characterized by a connecting affiliation.7-10Indirect Subsidiary Control – Connecting AffiliationA connecting affiliation exists when two or more companies within a business combination own an interest in another member of the organization. 7-11Indirect Subsidiary Control – Connecting AffiliationAssume High, Side, and Low have separate internal operating incomes of $300,000, $200,000, and $100,000, respectively. Each has a $30,000 net intra-entity gain in its current income. Annual amortization expense is $10,000 for acquisition-date excess fair value over book value for each subsidiary.Both High company and Side Company own Low Company’s stock, a connecting affiliation. Neither owns enough stock to establish direct control over Low’s operations, but they hold a total of 75% of the outstanding shares. Control lies within the single consolidated entity and Low’s financial information must be included in the consolidated statements.7-12Indirect Subsidiary Control –Connecting AffiliationBasic Consolidation Rules Still Hold:Eliminate effects of intra-entity transfers.Adjust parent’s beginning R/E to recognize prior period ownership.Eliminate sub’s beginning equity balances.Adjust for unamortized FV adjustments.Record Amortization Expense.Remove intra-entity income and dividends.Compute and record noncontrolling interest in subsidiaries’ net income.7-13Indirect Subsidiary Control –Connecting AffiliationThe combination of the parent’s DIRECT ownership and INDIRECT ownership results in control of the subsidiary. Accrual-based income figures for the three companies in this combination are derived as seen on the following slide.In the same manner as a father-son-grandson organization, determining accrual-based earnings begins with any companies solely in a subsidiary position (Low). Next companies that are both parents and subsidiaries (Side) compute their accrual- based income. Finally, this same calculation is made for the one company (High) that has ultimate control over the entire combination.7-14Indirect Subsidiary Control –Connecting Affiliation7-15Learning Objective 7-3Demonstrate the consolidation process when a corporate ownership structure is characterized by mutual ownership.7-16Mutual OwnershipMutual ownership occurs when two companies within a business combination hold an equity interest in each other. GAAP recommends that “shares of the parent held by the subsidiary should be eliminated in consolidated financial statements.” The shares are not “outstanding” because they are not held by parties outside the combination.The Treasury Stock Approach is used to account for the mutually owned shares.7-17Mutual OwnershipThere is no accounting distinction between a parent owning stock of a subsidiary, or a subsidiary owning stock of a parent; they are both intra-entity stock ownership. The cost of the parent shares held by the subsidiary is reclassified on the worksheet into Treasury Stock.Intra-entity dividends on shares of the parent owned by the subsidiary are eliminated as an intra- entity cash transfer.Example: Pop Co owns 70% of Sun Co. Sun owns 10% of Pop Co, purchased for $120,000, and records the investment under the Fair Value Method. Pop declares dividends of $8,000 to Sun, and Sun records dividend income.7-18Mutual Ownership –Treasury Stock Approach ExampleThe following entries are recorded in the consolidation worksheet:(*C) Conversion of initial value method to equity method. Recognizes 70% of increase in Sun Company’s book value less previous year’s amortization expense [70% ($25,000  -  $3,000)]. (S) Elimination of subsidiary’s stockholders’ equity and recognition of January 1, noncontrolling interest. (TS) Reclassification of Sun’s ownership in Pop into a treasury stock account. (A) Allocation to franchises, unamortized balance recognized as of January 1. (I) Elimination of intra-entity dividend income for the period. (E) Recognition of amortization expense for the current year.(Note: Parentheses indicate a credit balance.)7-19Mutual Ownership –Treasury Stock Approach Example7-20Learning Objective 7-4List the criteria for being amember of an affiliated groupfor income tax filing purposes.7-21Income Tax Accounting for a Business CombinationBusiness combinations may elect to file a consolidated federal tax return for all companies of an affiliated group.The affiliated group (as defined by the IRS) will likely exclude some members of the business combination.7-22Income Tax Accounting for a Business CombinationAffiliated Group = The parent company + Any domestic subsidiary where the parent owns 80% or more of the voting stock AND 80% of each class of nonvoting stock (direct or indirect ownership).All others must file separately (including any foreign subsidiaries.)7-23Income Tax Accounting for a Business CombinationThere is a distinction between business combinations as identified for financial reporting and affiliated groups as defined for tax purposes. A business combination comprises all subsidiaries controlled by a parent company unless control is only temporary.The IRS’s 80 percent rule creates a smaller circle of companies qualifying for inclusion in an affiliated group.7-24Income Tax Accounting for a Business CombinationA parent company is not required to file a consolidated return, but there are benefits for doing so.Intra-entity profits are not taxed until realized.Losses of one affiliated group member can be used to offset taxable income earned by another group member.7-25Learning Objective 7-5Compute taxable incomeand deferred tax amounts foran affiliated group based oninformation presented in aconsolidated set of financialstatements.7-26Income Tax Accounting – Deferred Income TaxesTax consequences are often dependent on whether separate or consolidated returns are filed. Transactions affected:Intra-entity DividendsGoodwillUnrealized Intra-entity Gains7-27Income Tax Accounting –Deferred Income TaxesIntra-entity DividendsFor accounting purposes, all intra-entity dividends are eliminated.For tax purposes, dividends are removed from income if at least 80 percent of the subsidiary’s stock is held. (20% is taxable.)If less than 80 percent of a subsidiary’s stock is held, tax recognition is necessary. A deferred tax liability is created for any of sub’s income not paid currently as a dividend.7-28Income Tax Accounting –Deferred Income TaxesAmortization of GoodwillCurrent tax law permits the amortization of Goodwill and other purchased Intangible Assets over 15 years.GAAP does not systematically amortize Goodwill for financial reporting purposes, but instead reviews it annually for impairment.Timing differences between the amortization and write-off creates a temporary difference that results in deferred income taxes.7-29Income Tax Accounting –Deferred Income TaxesUnrealized Intra-Entity GainsIf consolidated returns are filed, intra-entity gains are deferred until realized and no timing difference is created.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.7-30Assigning Income Tax Expense – Consolidated ReturnConsolidated 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. Used as a basis for calculating noncontrolling interest’s share of consolidated income.7-31Assigning Income Tax Expense MethodsThe Percentage Allocation Method attributes the GAAP tax expense based on the relative contribution of each affiliate to taxable income. The Separate Return Method, an alternative technique, uses the taxable income that results from filing separate tax returns.7-32Learning Objective 7-6Compute taxable incomeand deferred tax amounts tobe recognized when separatetax returns are filed by anyof the affiliates of a businesscombination.7-33Filing Separate Tax ReturnsSeparate returns are mandatory for foreign subsidiaries and for domestic corporations not meeting the 80 percent ownership rule. Canadian and Mexican subsidiaries can qualify for treatment as domestic companies for purposes of filing a consolidated return. A company may still elect to file separately even if it meets the conditions for inclusion within an affiliated group. If all companies in an affiliated group are profitable and few intra-entity transactions occur, they may prefer separate returns to give the companies more flexibility in their choice of accounting methods and fiscal tax years. 7-34Filing Separate Tax ReturnsTax laws do not allow a company to switch back and forth between consolidated and separate returns. Obtaining Internal Revenue Service permission to file separately can be difficult once consolidation is selected. When members of a business combination file separate tax returns, temporary differences often emerge for income recognized for consolidated financial reporting and for income tax reporting. 7-35Filing Separate Tax ReturnsDifferences in the timing of income recognition across consolidated reporting and income tax purposes create deferred tax assets and/or liabilities. These temporary differences may occur due to(1) the immediate taxation of unrealized intra-entity gains (and losses) and(2) possible future tax effects of subsidiary income in excess of dividend payments.7-36Learning Objective 7-7Determine the deferred taxconsequences for temporarydifferences generated when abusiness combination iscreated.7-37Temporary Differences Generated by Business CombinationsA business combination can create temporary differences due to differences in tax bases and book value stemming from the takeover.In most purchases, resulting book values of acquired company’s assets and liabilities differ from their tax bases because:Subsidiary’s cost is retained for tax purposes (in tax-free exchanges). Allocations for tax purposes vary from those used for financial reporting (found in taxable transactions).7-38Learning Objective 7-8Explain the impact that a netoperating loss of an acquiredaffiliate has on consolidatedfigures.7-39Business Combinations and Operating Loss CarryforwardsNet operating losses for companies may be carried back for two years and/or forward for twenty years. Because some acquisitions appeared to be done primarily 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.)7-40Business Combinations and Operating Loss Carryforwards FASB ASC Topic 740, Income Taxes, requires an acquiring firm to recognize a deferred income tax asset for any NOL carryforward. However, a valuation allowance also must be recognized if it is more likely than not (based on available evidence) that some or all of the deferred tax asset will not be realized.7-41Operating Loss Carryforwards - ExampleAssume a parent purchased a company (sub) for $640,000. The sub has one asset, a building, worth $500,000.Due to recent losses, the sub has a $200,000 NOL carryforward. The assumed tax rate is 30 % so the parent can derive $60,000 in future tax savings if it earns future income.The parent anticipates the sub will utilize some or all of the NOL carryforward. 7-42Operating Loss Carryforwards - ExampleIf it is more likely than not that the benefit will be realized, goodwill of $80,000 results.If chances are 50% or less that the sub will use the NOL carryforward, the parent records a valuation allowance and $140,000 of consolidated goodwill.7-43IFRS and U.S. GAAP DifferencesU.S. GAAP prohibits the recognition of unrealizedintra-entity profits on asset transfers; therefore, the selling firm defers any related current tax effects until the asset is sold to a third party.International Accounting Standard (IAS) 12 requires taxes paid by a selling firm on intra-entity profits to be recognized as incurred and allows tax deferral on differences between the tax bases of assets transferred across entities that remain within the consolidated group.7-44