Consolidated Financial Statements: Income Taxes, Cash Flows, and Installment Acquisitions
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Consolidated Financial Statements: Income Taxes, Cash Flows, and Installment Acquisitions ACCT 501 (All examples are from the textbook by Larsen). Objectives of the Chapter. 1. To learn the accounting treatment of income taxes for a purchase-type business combination.

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Consolidated Financial Statements: Income Taxes, Cash Flows, and Installment Acquisitions

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Consolidated financial statements income taxes cash flows and installment acquisitions

Consolidated Financial Statements: Income Taxes, Cash Flows, and Installment Acquisitions

ACCT 501 (All examples are from the textbook by Larsen)


Objectives of the chapter

Objectives of the Chapter

  • 1. To learn the accounting treatment of income taxes for a purchase-type business combination.

  • 2. To learn the preparation of consolidated statement of cash flows.

  • 3. To study the accounting for installment acquisitions of a subsidiary in a purchase-type business combination.

Income Taxes and Cash Flows


Income taxes in business combinations and consolidations

Income Taxes in Business Combinations and Consolidations

  • The discussion of the accounting for income taxes in business combinations and consolidated financial statements are subdivided in three sections:

  • a. Income taxes attributable to current fair values excess of purchased identifiable net assets;

  • b. Income taxes attributable to undistributed earnings of subsidiaries;

  • c. Income taxes attributable to unrealized and realized intercompany profits (gains).

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets

  • When a purchase-type business combination is qualified as a "tax-free corporate reorganization" under the IRC, a new income tax basis (i.e., based on the current fair value)is Not required for the combinee's net assets.

  • In this situation, a temporary difference mayresult between provisions for deprecation and amortization in the combinee's financial statements and income tax returns.

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • The other situation which can also result in temporary difference is in the pooling-type business combination, in which there is no revaluation of combinee's net assets.

  • When the pooling-type business combination is not qualified as a "tax free corporation reorganization" under the IRC, the income tax basis of the combinee's net assets may be changed.

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd1

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • In recognition of this problem, the FASB requires the following:

  • a deferred tax liability or asset be recognized in accordance with the requirements for differences between the assigned value (i.e., the current value at the business combination) and the tax bases (I.e., the carrying amount) of the assets and liabilities.

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd2

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • Example: assume that the purchase-type business combination of Regal Corp. and the combinee,Thorne Company, completed on 6/1/1999, met the requirements for a "tax-free corporation reorganization" for income tax purposes.

  • Regal paid $800,000 for all of Thornes' identifiable net assets except cash.

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd3

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • The current fair values of Thorne's identifiable net assets were equal to their carrying amounts, except for the following assets:

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd4

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd5

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • If the carrying amounts (equal to current fair values) of Thorne's other identifiable assets and liabilities were $390,000 and $650,000, respectively, and the income tax rate is 40%, Regal's journal entry to record the business combination with Thorne Company on 6/1/1999, would be as follows:

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd6

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • Investment in Net Assetsa 800,000 Cash800,000

  • Inventoriesb 100,000 Land250,000 Building640,000 Machinery 120,000 Other Identifiable Assets390,000 Goodwill 34,000

  • Deferred Income Tax Lia.84,000cOther Liability650,000Investment in Net Assets 800,000

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd7

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • Notes for the above journal entries:

  • a. To record acquisition of net assets of Thorne Company except cash.

  • b. To allocate cost of Thorne's net assets to identifiable net assets; to establish liability for deferred income tax attributable to differences between current fair values and tax bases of assets; and to allocate remainder of cost to goodwill.

  • c. Current fair value excess of assets *tax rate = $210,000 *40% = $84,000

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd8

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

  • The deferred income liability ($84,000) will be extinguished when the temporary differences reverse through sale or deprecation.

  • Example: assume that the inventories were sold during the year ended 5/31/2000, the deferred tax liability would be reduced by $12,400, computed as follows:

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd9

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

Cost of goods sold (inventories current fair value excess $20,000

Building depreciation attributable to current fair value excess (140,000 / 20) 7,000 Machinery depreciation attributable to current fair value excess ($20,000 / 5) 4,000

Total reversing temporary differences $31,000

Income tax effect ($31,000 X 0.40) $12,400

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd10

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

Assuming Regal Corp. had pre-tax financial income of $420,000 (net of tax-deductible goodwill amortization of $2,267) for the year ended May 31, 2000,

and there were no temporary difference between pre-tax financial income and taxable income other than those resulting from the business combination with Thorne Company,

Regal's journal entry for income taxes on May 31, 2000, is as follows:

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries

Income Taxes Attributable to Undistributed Earnings of Subsidiaries

  • The FASB requires that a deferred income tax liability be recognized for an excess of the reported investment income in a subsidiary over its tax basis(i.e., cash dividends received from the subsidiary) if this excess is temporary and will be reverted in the future.a

Income Taxes and Cash Flows


Income taxes attributable to current fair values of purchased identifiable net assets contd11

Income Taxes Attributable to Current Fair Values of Purchased Identifiable Net Assets (contd.)

Income Taxes Expensec 168,000 Deferred Income Tax Liability 12,400 Income Taxes Payable b 180,400

a. Income tax effect of the temporary difference reversion = > $31,000 X 0.40 = $12,400. b.Taxable income x 40% = >($420,000 + $31,000) X 40% c. $180,400 – $12,400 = $168,000 d. The tax-deductible goodwill amortization expense of $2,267 is included in the measurement of both pre-tax financial income and taxable income. It is based on the 15-year amortization period.

  • If the excess is permanent in duration, no deferred income tax liability is recognized for the excess. a. Applies to the excess arose in fiscal years beginning after 12/15/1992.

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

  • Example:

  • Pinkley Corp. owns 75% of the outstanding common stock of Seabright Company, which it acquired for cash on 4/1/1999. Goodwill acquired by Pinkley in the purchase-type business combination was $30,000 and was to be amortized over 15 years.

  • Seabright's identifiable net assets were fairly priced at their carrying amounts.

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd1

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

  • For the year ended 3/1/2000, Pinkley had pre-tax financial income, exclusive of goodwill amortization and intercompany investment income under the equity method, of $100,000.

  • Seabright's pre-tax financial income was $50,000, and dividends declared and paid by Seabright during fiscal year 2000 totaled $10,000.

  • The income tax rate for both companies is 40%.

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd2

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

  • Income tax laws provide for a dividend-received deduction rate of 80% on dividends from less-than-80%-owned domestic corporations.

  • Neither Pinkley nor Seabright had an temporary differences.

  • Neither had any income subject to preference income tax rates.

  • There were no intercompany profits resulting from transactions between Pinkley and Seabright.

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd3

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

  • Seabright's journal entry to accrue income taxes on 3/31/2000 is as follows:

    Income Taxes Expense 20,000

    Income Taxes Payable 20,000

    To record income taxes expense for Fiscal Year 2000 => $50,000 X 40%.

    •On 3/31, 2000, Pinkley Corp. prepares the following journal entries for income taxes payable, the subsidiary's operating results, and deferred income tax liability:

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd4

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

Amortization Expense 2,000Investment in Seabright Cop. 2,000

To record amortization of goodwill for Fiscal Year 2000 ($30,000 / 15 = $2,000)

Income Taxes Expense39,200

Income Taxes Payable 39,200

To record income taxes expense for Fiscal Year 2000 on income exclusive of intercompary investment income = > ($100,000 - $2,000) X 40% = $39,200.

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd5

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

Cash 7,500 Investment in Seabright 7,500

To record div. declared and paid by sub.$10,000 X 0.75 = $7,500

Investment in Seabright 22,500 Intercompany Investment Income 22,500

To accrue share of subsidiary’s net income for Fiscal Year 2000 ($30,000* X 0.75 = $22,500) *$50,000 - $20,000 = $30,000

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd6

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

Income Taxes Expense 1,800 Income Taxes Payable 600 Deferred Income Tax Liability 1,200

  • To provide for income taxes on intercompany investment income from subsidiary as follows:

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd7

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

Net income of subsidiary $ 30,000 Less: Depre. and amor. attributable to differences between current fair values and carrying amounts of subsidiary’s net assets 0 Income of subsidiary subject to income taxes $30,000 Parent company’s share ($30,000 X 0.75) $22,500 Less: Dividend-received deduction($22,500 X 0.80) $18,000 Amount subject to income taxes $ 4,500 Income taxes expense ($4,500 X 0.40) $ 1,800

Income Taxes and Cash Flows


Income taxes attributable to undistributed earnings of subsidiaries contd8

Income Taxes Attributable to Undistributed Earnings of Subsidiaries (contd.)

Taxes currently payable based on dividend received ($7,500 X 0.20 X 0.40 ) $ 600 Taxes deferred until earnings remitted by subsidiary $ 1,200 Income Taxes expense $ 1,800

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits gains

Income Taxes Attributable to Intercompany Profits (Gains)

  • The IRC permits an affiliated groupa of corporation to file a consolidated income tax return rather than separate returns.

  • Intercompany profits and losses are eliminated in a consolidated income tax return just as they are in consolidated financial statements.

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits gains contd

Income Taxes Attributable to Intercompany Profits (Gains) (contd.)

  • Note a:

  • An "affiliated group" for tax purposes is defined as a group of corporations connected through stock ownership with a common parent corp. which owns directly at least 80% of the voting power of all subsidiaries and at least 80% of each class of the nonvoting stock of at least one of the other affiliates.

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits gains contd1

Income Taxes Attributable to Intercompany Profits (Gains) (contd.)

  • If a parent company and its subsidiaries do not qualify for the "affiliated group" status, or if they elect to file separate tax returns, the provisions of SFAS No. 109, "Accounting for Income Taxes" for the recognition of deferred tax assets and liabilities will be applied.

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory

Income Taxes Attributable to Intercompany Profits in Inventory

  • For unrealized intercompany profits in inventory at the end of the first year for an affiliated group's operation, return to the working paper elimination on page 354 of the textbook for Post Corp. and Sage Company (a 95% partially owned subsidiary of Post) on 12/31/2001, which is as follows:

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory contd

Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

Intercomany Sales—Sage120,000

Intercompany CGS—Sage 96,000 CGS—Post 16,000 Inventories—Post 8,000

To eliminate intercompany sales, cost of goods sold (CGS), and unrealized intercomany profit in inventories

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory contd1

Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

If Post and Sage file separate income taxreturns for year 2001, the following additional working paper elimination is required on 12/31/2001:

Deferred Income Tax Asset—Sage 3,200 Income Taxes Expense—Sage 3,200

To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany profits in parent company’s inventories on Dec. 31, 2001 ($8,000 X 0.40 = $3,200)

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory contd2

Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

  • Note: the $3,200 reduction in income tax expense should be considered in the computation for the minority interest in net income of the subsidiary for the year ended 12/31/2001.

  • For the unrealized intercompany profits in beginning and ending inventories, return to the working paper elimination on p356 of the textbook for the year ended 12/31/2002, which follows:

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory contd3

Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

Retained Earnings—Sagea 7,600 Minority Interest in NA of Sub. 400 Intercompary Sales—Sage 150,000

Intercompany CGS—Sage 120,000 CGS—Post 26,000Inventories—Post 12,000

a. $8,000X0.95

To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories.

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory contd4

Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

If the affiliated group file income separately, the following additional working paper eliminations are required on 12/31/2002:

Deferred Income Tax Asset—Sage 4,800 Income Taxes Expense—Sage 4,800

To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany profits in parent company’s inventories on Dec. 31, 2002 ($12,000X0.40=$4,800).

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory contd5

Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

Income Taxes Expense—Sage 3,200 Retained Earning—Sage a 3,040 Minority Interest in Net Assetsb&c 160

To provide for income taxes attributable to realized intercompany profits in parent company’s inventories on Dec. 31, 2001. ($8,000X0.40=$3,200)

a. $3,200X0.95; or $7,600X0.40. b. $3,200X0.05; or $400X0.40. c. This elimination reflects the income tax effects of the realization by the consolidated group, on a FIFO basis,of the intercompnay profits in the parent company's beginning inventories.

Income Taxes and Cash Flows


Income taxes attributable to intercompany profits in inventory contd6

Income Taxes Attributable to Intercompany Profits in Inventory (contd.)

  • Note to the working paper elimination of year 2002:

    The decrease on the subsidiary's I/T expense of $4,800 and the increase on subsidiary's the I/T expense of $3,200 are included in the computation of the minority interest in subsidiary's net income.

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in land

Income Taxes Attributable to Unrealized Intercompany Gain in Land

Return to the working paper elimination on p65 of chapter 8 notes for the intercompany gain resulting from an intercompany sale of land by the parent company on 12/31/2001(Post):

Intercompany Gain on Saleof Land—Post 50,000 Land—Sage 50,000

To eliminate unrealized intercompany gain on sale of land.

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in land contd

Income Taxes Attributable to Unrealized Intercompany Gain in Land(contd.)

Assuming a 40% income tax, the following working paper elimination is needed if Post and Sage filed separate income tax returns for year the year ended 12/31/2001:

Deferred Income Tax Asset—Post 20,000

Income Taxes Expense—Posta 20,000

a. This decrease in the expense has no impact on the minority interest in subsidiary's net income.

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in land contd1

Income Taxes Attributable to Unrealized Intercompany Gain in Land(contd.)

The purposes of the working paper elimination on 12/31/01:

  • To defer income taxes provided on separate income tax returns of parent company applicable to unrealized intercompany gain in subsidiary's land on Dec. 31, 2001 ($50,000X0.04=$20,000).

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in land contd2

Income Taxes Attributable to Unrealized Intercompany Gain in Land(contd.)

  • The following working paper elimination applies to all subsequent years for this intercompany sale of land as long as Sage does not sell the land to an outsider:

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in land contd3

Income Taxes Attributable to Unrealized Intercompany Gain in Land(contd.)

  • In years subsequent to year 2001, as long as the subsidiary owns the land, the following tax related working paper elimination is also required at the end of the year:

    Deferred Income Tax Asset—Post 20,000

    Retained Earnings—post 20,000

    To defer income taxes attributable to unrealized intercompany gain in subsidiary’s land ($50,000x 40%).

  • This elimination has no impact on the minority interest in subsidiary's net income.

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in land contd4

Income Taxes Attributable to Unrealized Intercompany Gain in Land(contd.)

When Sage sold the land, the following elimination would be prepareda:

Income Tax Expense-Postb 20,000 Retained Earnings- Post 20,000

a. This is due to the intercompany gain is realized by Sage on behave of Post

b. No impact on the minority interest in subsidiary's net income

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in a depreciable plant assets

Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets

  • Return to the working paper elimination on p76 of chapter 8 note for illustration:

    12/31/2001

    Intercompany Gain on Sale of Machinery—Sage 23,800 Machinery—Post 23,800

    To eliminate unrealized intercompany gain of $23,800 on sale of Post's machinery to Sage on 12/31/3001.

  • This intercompany gain will be realized through the periodic depreciation of the asset.

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in a depreciable plant assets contd

Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.)

  • Assuming separate income tax (I/T) returns and an I/T tax rate of 40%, the following additional working paper elimination is required on 12/31/2001:

  • Deferred I/T Asset—Sage 9,520

    I/T Expense—Sage a 9,520

    To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany gain in parent company’s machinery on Dec. 31, 2001 (23,800X0.40=$9,520).

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in a depreciable plant assets contd1

Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.)

a. The $9,520 increase in the Sage's net income should be included in the computation of minority interest in the subsidiary's net income for year 2001.

  • For the year ended 12/31/2002, the working paper elimination of the intercompany gain is as follows:

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in a depreciable plant assets contd2

Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.)

12/31/2002

Retained Earning—Sagea 22,610 Minority Interest in Net Assets of Subsidiaryb 1,190 Accu. Depre.—Post 4,760

Machinery—Post 23,800Depre. Expense—Post 4,760

a. $23,800X0.95 b.$23,800X0.05

To eliminate unrealized intercompary gain in machinery and in related depreciation. Gain element in depreciation company is 23,800X0.20=$4,760 based on five-year economic life.

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in a depreciable plant assets contd3

Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.)

  • The elimination for income taxes attributable to the intercompany gain for the year ended 12/31/2002 is as follows:

    I/T Expense—Sagea 1,904 Deferred I/T Asset—Sageb 7,616

    Retained Earning—Sagec 9,044 Minority Interest in NA of Sub.d 476

    a.$4,760 x 40% b. 9,520-$1,904 c.$9,520X0.95; or $22,610X40% d. $9,520X0.05; or $1,190X40%

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in a depreciable plant assets contd4

Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.)

  • The purposes of the above working paper elimination are:

  • To provide income taxes expense on intercompany gain realized through parent company’s depreciation (4,760X0.40=$1,904);

  • To defer income taxes attributable to the remainder of unrealized gain.

Income Taxes and Cash Flows


Income taxes attributable to unrealized intercompany gain in a depreciable plant assets contd5

Income Taxes Attributable to Unrealized Intercompany Gain in a Depreciable Plant Assets (contd.)

  • Comments to the above working paper elimination:

  • The decrease in the subsidiary's net income is included in the computation of the minority interest in the subsidiary's net income for year 2002.

  • Comparable working paper eliminations to the above elimination are necessary on December 31, years 2003, 2004,2005 and 2006.

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds

  • Return to the 12/31/2001 working paper elimination on p131 of Chapter 8 notes for illustration:

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds contd

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

  • The following working paper elimination is required on 12/31/2001 to accompany the above working paper elimination assuming a separate income tax return filing, a 40% income tax rate and the gain on extinguishment of debt is not material:

  • Income Taxes Expense –Sage a 9,840

    • Deferred Income Tax Lia.-Sage 9,840

  • To provide for income taxes attributable to subsidiary's realized gain on parent company's acquisition of the subsidiary's bonds ($24,601*40%)

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds contd1

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

  • The purpose of the elimination on 12/31/2001:

  • To provide for income taxes attributable to subsidiary's realized gain on parent company's acquisition of the subsidiary's bonds ($24,601*40%).

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds contd2

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

  • Note to the elimination on 12/31/2001:

    The increase in expense of the subsidiary ($9,840) in the above elimination should be included in the computation of the minority interest in net income of the subsidiary for year 2001.

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds contd3

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

  • The working paper elimination for the bonds and interest on 12/31/2002 is as follows:

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds contd4

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

  • The following I/T related working paper elimination is necessary to accompany the above elimination:

  • 12/31/02

    Retained Earnings – Sagea 9,348 Minority Interest in NA of Sub.b 492 I/T Expense – Sage c 1,905 Deferred I/T Lia.d 7,935

    a. $9,840x 0.95 or $23,371 x 40% b. $9,840x 0.05 c. $38,576-$33,813) x 40% d. $9,840-$1,905

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds contd5

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

  • The purposes of the I/T related working paper elimination prepared on 12/31/02:

  • To reduce the subsidiary’s income taxes expense for amount attributable to recorded intercompany gain (for consolidation purposes) on subsidiary’s bond;

  • To provide for remaining deferred income taxes on unrecorded portion of gain.

Income Taxes and Cash Flows


Income taxes attributable to intercompany gain on extinguishment of bonds contd6

Income Taxes Attributable to Intercompany Gain on Extinguishment of Bonds (contd.)

  • Note to the I/T related working paper elimination on 12/31/2002:

  • The $1,905 decrease in expense (increase in the subsidiary's net income is included in the computation of the minority interest in the subsidiary's net income for the year ended 12/31/2002

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains

Summary: Income Taxes Attributable to Intercompany Profits (Gains)

  • The unrealized intercompany profits (gains) resulting from intercompany transactions of affiliated companies required interperiod tax allocation when the affiliated companies file separate income tax returns.

  • The elimination of unrealized intercompany profits causes a temporary difference.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains contd

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-contd.

  • The elimination of unrealized intercompany gains for consolidation purposes will result in a taxable income exceeding a pre-tax financial income.

  • Thus, a deferred income tax assets must be accounted for in the working paper eliminations that accompany the profit (gain) eliminations.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains contd1

Summary: Income Taxes Attributable to Intercompany Profits (Gains)- contd.

  • In the case of intercompany bonds, pre-tax financial income exceeds taxable income of the accounting period of the realized gain.

  • Thus, a deferred income tax liability must be provided in a working paper elimination.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains contd2

Summary: Income Taxes Attributable to Intercompany Profits (Gains) – contd.

  • The following pages summarize the working paper eliminations for the intercompany transactions on inventory, land, depreciable plant assets and extinguishment of bonds for the year ended 12/31/2002.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains inventory

Summary: Income Taxes Attributable to Intercompany Profits (Gains) – Inventory

POST CORPORATION AND SUBSIDIARY

Partial Working Paper Eliminations

December 31, 2002

To eliminate intercompany sales, cost of goods, and unrealized intercompany profits in inventories.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains inventory1

Summary: Income Taxes Attributable to Intercompany Profits (Gains) –Inventory

To defer income taxes provided on separate income tax returns of subsidiary applicable to unrealized intercompany profits in parent company’s inventories on Dec. 31, 2002 ($12,000X0.40=$4,800).

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains inventory2

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Inventory

To provide for income taxes attributable to realized intercompany profits parent company’s inventories on Dec. 31, 2001($8,000X0.40=$3,200).

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains land

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Land

  • To eliminate unrealized intercompany in land.

  • To defer income taxes attributable to unrealized intercompany gain in subsidiary’s land ($50,000X0.40=$20,000).

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains plant assets

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Plant Assets

  • To eliminate unrealized intercompany gain in machinery and in related depreciation. Gain element in depreciation computed as $23,800X0.20=$4,760, based on five-year economic life.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains plant assets1

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Plant Assets

  • To provide for income taxes expense on intercompany gain realized through parent company’s depreciation ($4,760X0.40=$1,904); and to defer income taxes attributable to remainder of unrealized gain.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains bonds

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Bonds

To eliminate subsidiary’s bonds owned by parent company, and related interest revenue and expense; and to increase subsidiary’s beginning retained earning by amount of unamortized realized gain on the extinguishment of the bond.

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains bonds1

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Bonds

  • To reduce the subsidiary’s income taxes expense for amount attributable to recorded intercompany gain (for consolidation purposes) on subsidiary’s bonds; and to provide for remaining deferred income taxes on unrecorded portion of gain

Income Taxes and Cash Flows


Summary income taxes attributable to intercompany profits gains comments

Summary: Income Taxes Attributable to Intercompany Profits (Gains)-Comments

  • All the forgoing eliminations except (d) and (e) affect the net income of Sage Company.

  • The corresponding amount of those eliminations are included in the computation of minority interest in net income of subsidiary for year 2002

Income Taxes and Cash Flows


Consolidated statement of cash flows general comments

Consolidated Statement of Cash Flows – General Comments

  • The consolidated statement of cash flows is prepared as described in intermediate accounting textbooks with a few points deserves special attention:

  • The depreciation and amortization expense added (when using the indirect method) to total consolidated income is the consolidated deprecation and amortization expense.

Income Taxes and Cash Flows


Consolidated statement of cash flows general comments contd

Consolidated Statement of Cash Flows-General Comments (contd.)

  • The minority interest in net income of subsidiary (an expense on the consolidated income statement) should also be added to the consolidated net income in preparing the net cash flows of the operating activities.

  • Only cash dividends paid by the parent company and cash dividends paid by partially owned subsidiary to minority stockholders are reported as cash flows from financing activities.

Income Taxes and Cash Flows


Consolidated statement of cash flows general comments contd1

Consolidated Statement of Cash Flows – General Comments(contd.)

  • A cash acquisition by the parent company of additional shares of common directly from a subsidiary has no impact on the consolidated cash flows and is not reported in a consolidated statement of cash flows.

  • A cash acquisition by the parent company of additional shares of common directly from minority stockholders reduces consolidated cash and is reported in a consolidated statement of cash flows as an investing activity.

Income Taxes and Cash Flows


Consolidated statement of cash flows general comments contd2

Consolidated Statement of Cash Flows – General Comments(contd.)

  • A cash acquisition by the parent company of additional shares of common directly from a subsidiary has no impact on the consolidated cash flows and is not reported in a consolidated statement of cash flows.

  • A cash acquisition by the parent company of additional shares of common directly from minority stockholders reduces consolidated cash and is reported in a consolidated statement of cash flows as an investing activity.

Income Taxes and Cash Flows


Illustration of consolidated statement of cash flows

Illustration of Consolidated Statement of Cash Flows

  • Example:

  • Parent Corp. owned 100% of Sub Company for a few years through a purchase-type business combination. Sub has one class of common stock and its total stockholder's equity on 12/31/99 was $500,000.

  • On 1/2/2000, parent sold 30% of its investment in Sub's common stock to outsiders for $205,000, which was $55,000 more than the carrying amount of the investment in Parent's records.

Income Taxes and Cash Flows


Illustration of consolidated statement of cash flows contd

Illustration of Consolidated Statement of Cash Flows (contd.)

  • Sub had a net income of $100,000 for Year 2000 and paid cash dividends of $60,000 during Year 2000.

  • During Year 2000, Parent issued additional common stock and cash of $290,000 for plant assets which a current fair value of $490,000.

  • The consolidated entity had additional long-term borrowings of $93,000 during Year 2000, and interest payments totaled $62,000 (none was capitalized). Income tax payments totaled $234,000.

Income Taxes and Cash Flows


Illustration of consolidated statement of cash flows contd1

Illustration of Consolidated Statement of Cash Flows (contd.)

  • The followings are the consolidated income statement for Year 2000, the consolidated statement of stockholder's equity for Year 2000, and the comparative consolidated balance sheets on December 31, 1999 and 2000:

Income Taxes and Cash Flows


Consolidated income statement for the year ended 12 31 2000

Consolidated Income statement for the Year ended 12/31/2000

Income Taxes and Cash Flows


Consolidated statement of stockholders equity for year ended 12 31 2000

Consolidated Statement of Stockholders' Equity For Year Ended 12/31/2000

Income Taxes and Cash Flows


Consolidated balance sheets

Consolidated Balance Sheets

  • December 31,

  • 2000 1999

Income Taxes and Cash Flows


Consolidated balance sheets contd

Consolidated Balance Sheets(contd.)

  • December 31,

  • 2000 1999

Income Taxes and Cash Flows


Working paper for consolidated statement of cash flows for year ended 12 31 2000 indirect method

Working Paper for Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (indirect Method)

Income Taxes and Cash Flows


Consolidated financial statements income taxes cash flows and installment acquisitions

Working Paper for Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (indirect Method) (contd.)

Income Taxes and Cash Flows


Consolidated financial statements income taxes cash flows and installment acquisitions

Working Paper for Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (indirect Method) (contd.)

Income Taxes and Cash Flows


Consolidated financial statements income taxes cash flows and installment acquisitions

Working Paper for Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (indirect Method) (contd.)

Income Taxes and Cash Flows


Consolidated financial statements income taxes cash flows and installment acquisitions

Working Paper for Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (indirect Method) (contd.)

Income Taxes and Cash Flows


Consolidated statement of cash flows for year ended 12 31 2000

Consolidated Statement of Cash Flows for Year Ended 12/31/2000

Income Taxes and Cash Flows


Consolidated statement of cash flows for year ended 12 31 2000 contd

Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (contd.)

Income Taxes and Cash Flows


Consolidated statement of cash flows for year ended 12 31 2000 contd1

Consolidated Statement of Cash Flows for Year Ended 12/31/2000 (contd.)

Income Taxes and Cash Flows


Notes to the above consolidated statement of cash flows

Notes to the Above Consolidated Statement of Cash Flows

  • Net cash provided by operating activities includes the minority interest in net income of Sub Company.

  • Net cash provided by operating activities excludes the gain of $55,000 from sale of the 30% of investment in Sub company. The proceeds received, $205,000, are reported as as a component of investing activity.

Income Taxes and Cash Flows


Notes to the above consolidated statement of cash flows1

Notes to the Above Consolidated Statement of Cash Flows

  • Only the dividends paid to stockholders of the Parent Corp ($160,000) and to minority stockholders of Sub Company ($18,000, Not, $60,000) are reported as cash flows from financing activities.

  • The issuance of common stock by Parent to acquire plant assets is a noncash transaction (a direct exchange).

Income Taxes and Cash Flows


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