Chapter 9
INDIRECT AND MUTUAL HOLDINGS
Answers to Questions
1 Direct holdings is a result of a direct investments in the voting common stock of one or more investee,
while indirect holdings is a result of investments that enable the investor to control or significantly
influence the decisions of an investee NOT directly owned through an investee directly owned. The
accounting method for both types of holdings are the same, equity method is used for 20% or more
holdings directly or indirectly, and consolidation is used for majority holdings directly or indirectly.
2 There are two types of indirect holding structure:
a. Father-Son-Grandson
PARENT
80%
SUBSIDIARY 60%
A
75%
SUBSIDIARY
B
In the father-son-grandson structure, the parent owns 80% of subsidiary A and subsidiary A
owns 75% of subsidiary B, so the parent indirectly owns 60% (80%*75%) of subsidiary B.
b. Connecting Affiliates
PARENT
70% 20% 42%
SUBSIDIARY 60% SUBSIDIARY
A B
In the connecting affiliates structure, the parent directly owns 70% of subsidiary A and 20% of subsidiary
B. Subsidiary A owns 60% of subsidiary B directly, thus resulting in a 42% (70%*60%) indirect
ownership of subsidiary B by the parent. So, in total, the parent owns 62% (20%+42%) of subsidiary B.
3 An indirect holding involves the ability of one corporation to control another by virtue of its control over
one or more other corporations. A mutual holding affiliation structure is a special type of indirect holding
where affiliates indirectly own themselves.
4 The parent’s direct and indirect ownership of Subsidiary B is 49 percent (70% ´ 70%). However,
consolidation of Subsidiary B is still appropriate because 70 percent of B’s stock is held within the
affiliation structure and only 30 percent is held by the noncontrolling stockholders of B.
5 Approach A
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,9-2 Indirect and Mutual Holdings
Pat
Sam
Stan
Combined separate earnings of Pat, Sam, and Stan
($200,000 + $160,000 + $100,000) $460,000
Less: Noncontrolling interest share computed as follows:
Direct noncontrolling interest in Stan’s income
($100,000 ´ 30%) (30,000)
Indirect noncontrolling interest in Stan’s income
($100,000 ´ 70% ´ 20%) (14,000)
Direct noncontrolling interest in Sam’s income
($160,000 ´ 20%) (32,000)
Pat’s net income and controlling share of consolidated net income $384,000
Approach B
Pat Sam Stan
Separate earnings $200,000 $160,000 $100,000
Allocate Stan’s income to Sam
($100,000 ´ 70%) + 70,000 -70,000
Allocate Sam’s income to Pat
($230,000 ´ 80%) +184,000 -184,000 0
Controlling share $384,000
Noncontrolling interest share $ 46,000 $30,000
6 When the schedule approach for allocating income is used, investment income from the lowest subsidiary
must be added to the separate income of the next subsidiary to determine that subsidiary’s net income
before it can be allocated to the next subsidiary, and so on.
7 P S1 80% S2 70%
Separate earnings $20,000 $10,000 $5,000
Deduct: Unrealized profit - 1,000
Separate realized earnings 20,000 9,000 5,000
Allocate S2’s income + 3,500 -3,500
Allocate S1’s income +10,000 -10,000 0
P’s net income $30,000
Noncontrolling int. share $ 2,500 $1,500
S1’s investment in S2 account was not adjusted for the unrealized profits because this would create a
disparity between S1’s investment in S2 account and S1’s share of S2’s equity.
8 A mutual holding situation exists because two affiliates hold ownership interests in each other.
9 Under the treasury stock approach, parent stock held by subsidiary is considered as treasury stock, hence
the investment account is maintained using the cost basis. The conventional approach, however, viewed
the stock as normal stocks, hence the investment account is maintained using the equity basis. This will
result in different amount of accounts, especially for the consolidated retained earnings and the
noncontrolling interest amount.
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,Chapter 9 9-3
10 In situations in which a subsidiary holds stock in the parent, both the conventional and treasury stock
approaches are acceptable, but they do not result in equivalent consolidated financial statements. The
consolidated retained earnings and noncontrolling interest amounts will usually be different because of
different amounts of investment income. The treasury stock approach is not applicable when the mutually
held stock involves subsidiaries holding the stock of each other.
11 No. Parent dividends paid to the subsidiary are eliminated.
12 The theory is that parent stock purchased by a subsidiary is, in effect, returned to the parent and
constructively retired. By recording the constructive retirement of the parent stock on parent books,
parent equity will reflect the equity of stockholders outside the consolidated entity. Also, recording the
constructive retirement, by reducing parent stock and retained earnings to reflect amounts applicable to
controlling stockholders outside the consolidated entity, will establish consistency between capital stock
and retained earnings for the parent’s outside stockholders and parent net income, dividends, and
earnings per share which also relate to the outside stockholders of the parent.
13 Controlling Share of Consolidated net income is computed as follows:
P = $100,000 + .8S
S = $40,000 + .1P
P = $100,000 + .8($40,000 + .1P)
P = $143,478
Controlling Share of Consolidated net income = $143,478 ´ 90% = $129,130
14 For eliminating the effect of mutually held parent stock, two generally accepted approaches are used—
the treasury stock approach and the conventional approach. But when the mutually held stock involves
subsidiaries holding stock of each other, the treasury stock approach is not applicable.
15 By adding beginning noncontrolling interest and noncontrolling interest share (determined by multiplying
the company’s net income by the noncontrolling interest percentage) and subtracting the noncontrolling
interest’s percentage of dividends, the noncontrolling interest can be determined without use of
simultaneous equations.
SOLUTIONS TO EXERCISES
Solution E9-1
a. In 2013, Pandu Tbk only have indirect holdings of Dewa Tbk through Sunda Tbk, so the structure is the
father-son-grandson. The percentage of ownership is calculated as follows:
Pandu’s ownership of Sunda ´ Sunda’s ownership of Dewa (90% ´ 60%) = 54%
b. In 2014, Pandu Tbk has both indirect and direct ownership of Dewa Tbk, so the structure is the
connecting affiliates. The percentage of ownership is calculated as follows:
Pandu’sindirect ownership of Dewa (a) + Pandu’s direct ownership of Dewa = 74%
Solution E9-2
Computational approach
Penang's separate earnings $100,000
Add: Penang's share of Minang's separate earnings
(80% x $80,000) $ 64,000
Add: Penang's share of Kelang's separate earnings $ 24,000
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, 9-4 Indirect and Mutual Holdings
(80% x 60% x $50,000)
Controlling share of consolidated net income $188,000
Minang's direct noncontrolling interest share
(20% x $80,000) $ 16,000
Kelang's indirect noncontrolling interest share
(80% x 40% x $50,000) $ 16,000
Kelang's direct noncontrolling interest share
(40% x $50,000) $ 20,000
Noncontrolling interest share $ 52,000
Solution E9-3
a Under treasury stock approach, cost method is used, so:
Penn's separate earnings $ 50,000
Penn's share of Sinn's earnings
(80% x $25,000) $ 20,000
Controlling share of consolidated
net income $ 70,000
b Under conventional approach, equity method is used, so:
Penn’s separate earnings $ 50,000
Penn's share of Sinn's earnings ´
(80% x $41,667.67)-(20% x $83,888.33) $ 16,667
Controlling share of consolidated
net income $ 66,667
*
Determine Penn’s and Sinn's income under consolidation
basis
P = Penn's income + Sinn's mutual income
S = Sinn's income + Penn's mutual income
P = $50,000 + 0.8S
S = $25,000 + 0.2P
P = $50,000 + 0.8($25,000 + 0.2P)
0.84P = $70,000
P = $83,333.33
S = $25,000 + 0.2($83,333.33)
S = $41,667.67
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