Chapter 10
SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE,
AND CONSOLIDATED INCOME TAXATION
Answers to Questions
1 The complications come from the need to consider the contractual rights of the preferred stockholders in
allocating the investee’s equity and income between preferred and common stockholders.
2 Net income and or stockholder’s equity should be allocated first to the preferred stockholders based on
the preferred stock contracts, then the remainder will be allocated to the common stockholders.
3 Under the circumstances, the noncontrolling interest holds 100% of the preferred stock and the remaining
% of common stock. Since the preferred stock has no fair value, we can use its call price to calculate the
amount. We separate the preferred and common components by calculating 100% of the preferred
components and the remaining % of the common components. For example, 100% 1,000 shares
$110 call price as the preferred components and 10% remaining ownership $500,000 common equity
as the common components.
4 Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of
noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated to
preferred plus 20 percent of the income allocated to common.
5 There is no difference between the controlling share of consolidated EPS and parent company EPS.
6 An investor company’s EPS computations must reflect the potential dilution of an equity investee’s
common stock equivalents and other potentially dilutive securities if the effect is material.
7 Procedures applied in computing a parent company’s EPS computations are the same as those for a
corporation without equity investments except when the subsidiary has outstanding common stock
equivalents or other potentially dilutive securities.
8 Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and
then it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary
common stock.
Copyright © 2015 Pearson Education Limited
,10-2 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
9 If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted
earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in
subsidiary diluted EPS. Alternatively, when subsidiary securities are convertible into the parent’s
common stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities
had been issued by the parent.
10 The replacement computation does not involve unrealized profits from downstream sales because these
items relate solely to parent operations and do not affect the noncontrolling interest. In the case of
unrealized profits from upstream sales, however, unrealized profits are deducted in the replacement
computation which involves subtracting the parent’s equity in subsidiary realized income and adding
back the parent’s equity in subsidiary diluted EPS (also based on subsidiary realized income).
11 Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that qualifies
as an “affiliated group” may elect to file consolidated tax returns. Once consolidated returns are elected,
it may be difficult to obtain IRS permission to file separate returns.
12 Yes. Consolidated entities that meet the requirements of an affiliated group can and often do elect to file
separate income tax returns.
13 The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against
gains of other members of the affiliated group, (2) intercompany profits between group members are
eliminated from taxable income until realized, and (3) intercorporate dividends are fully excluded from
taxable income. (But note that 3 is not a unique advantage of filing a consolidated return.)
14 Dividends received by a member of an affiliated group from other group members are excluded from
federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns.
15 Temporary differences result because investors that are not members of an affiliated group record income
from equity investments as it is earned, but pay taxes only when dividends are actually received.
16 In providing for income taxes on undistributed earnings of equity investees, the parent/investor debits
income tax expense and credits deferred tax liability as part of the determination of all income taxes for
the period. The investment and investment income accounts are not affected.
17 Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated
entity is a member of an affiliated group and elects to file consolidated tax returns.
Copyright © 2015 Pearson Education Limited
,Chapter 10 10-3
SOLUTIONS TO EXERCISES
Solution E10-1 [AICPA adapted]
1 a
Sob income to preferred $20,000 20% owned $ 4,000
Sob income to common $100,000 80% owned 80,000
Income from Sob $ 84,000
2 a
$150,000 20% taxable 30% tax rate
3 d
All dividend income is excluded from a consolidated group.
4 d
Intercompany profit is deferred in the consolidated tax return until
realized through sale to an outside entity.
Copyright © 2015 Pearson Education Limited
, 10-4 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution E10-2 [Preferred stock](in thousands)
Common stockholders'
a. equity $ 380,000
Goodwill $ 75,000
Implied fair
value $ 455,000
Purchase price (80% * implied fair value) $ 364,000
Common stockholders'
b. equity $ 380,000
Preferred stockholders' equity
(1,000 share at 102 call
price) $ 102,000
Total stockholders'
equity $ 482,000
c. Income from subsidiary $ 36,000
Common stock portion of income
(Income from subsidiary /80%) $ 45,000
Net income $ 60,000
Preferred stock portion of income $ 15,000
Noncontrollling interest share - common
(20% * common stock portion of income) $ 9,000
Noncontrolling interest share - preferred
(100%* preferred stock portion of income) $ 15,000
Total noncontrolling interest share $ 24,000
Copyright © 2015 Pearson Education Limited
SUBSIDIARY PREFERRED STOCK, CONSOLIDATED EARNINGS PER SHARE,
AND CONSOLIDATED INCOME TAXATION
Answers to Questions
1 The complications come from the need to consider the contractual rights of the preferred stockholders in
allocating the investee’s equity and income between preferred and common stockholders.
2 Net income and or stockholder’s equity should be allocated first to the preferred stockholders based on
the preferred stock contracts, then the remainder will be allocated to the common stockholders.
3 Under the circumstances, the noncontrolling interest holds 100% of the preferred stock and the remaining
% of common stock. Since the preferred stock has no fair value, we can use its call price to calculate the
amount. We separate the preferred and common components by calculating 100% of the preferred
components and the remaining % of the common components. For example, 100% 1,000 shares
$110 call price as the preferred components and 10% remaining ownership $500,000 common equity
as the common components.
4 Assuming that the parent does not hold any of the subsidiary’s preferred stock, the computation of
noncontrolling interest share for an 80 percent owned subsidiary is 100 percent of the income allocated to
preferred plus 20 percent of the income allocated to common.
5 There is no difference between the controlling share of consolidated EPS and parent company EPS.
6 An investor company’s EPS computations must reflect the potential dilution of an equity investee’s
common stock equivalents and other potentially dilutive securities if the effect is material.
7 Procedures applied in computing a parent company’s EPS computations are the same as those for a
corporation without equity investments except when the subsidiary has outstanding common stock
equivalents or other potentially dilutive securities.
8 Subsidiary EPS computations are only needed when computing diluted EPS, never for basic EPS, and
then it is only needed when the subsidiary has potentially dilutive securities convertible into subsidiary
common stock.
Copyright © 2015 Pearson Education Limited
,10-2 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
9 If a subsidiary has dilutive securities convertible into subsidiary common stock, the parent’s diluted
earnings are adjusted by replacing the parent’s equity in subsidiary realized income with its equity in
subsidiary diluted EPS. Alternatively, when subsidiary securities are convertible into the parent’s
common stock, the parent’s diluted earnings and common shares are adjusted as if the dilutive securities
had been issued by the parent.
10 The replacement computation does not involve unrealized profits from downstream sales because these
items relate solely to parent operations and do not affect the noncontrolling interest. In the case of
unrealized profits from upstream sales, however, unrealized profits are deducted in the replacement
computation which involves subtracting the parent’s equity in subsidiary realized income and adding
back the parent’s equity in subsidiary diluted EPS (also based on subsidiary realized income).
11 Consolidated tax returns are not required for a consolidated entity, but a consolidated entity that qualifies
as an “affiliated group” may elect to file consolidated tax returns. Once consolidated returns are elected,
it may be difficult to obtain IRS permission to file separate returns.
12 Yes. Consolidated entities that meet the requirements of an affiliated group can and often do elect to file
separate income tax returns.
13 The primary advantages of filing consolidated tax returns are (1) losses of affiliates are offset against
gains of other members of the affiliated group, (2) intercompany profits between group members are
eliminated from taxable income until realized, and (3) intercorporate dividends are fully excluded from
taxable income. (But note that 3 is not a unique advantage of filing a consolidated return.)
14 Dividends received by a member of an affiliated group from other group members are excluded from
federal income taxation regardless of whether the affiliated group elects to file consolidated tax returns.
15 Temporary differences result because investors that are not members of an affiliated group record income
from equity investments as it is earned, but pay taxes only when dividends are actually received.
16 In providing for income taxes on undistributed earnings of equity investees, the parent/investor debits
income tax expense and credits deferred tax liability as part of the determination of all income taxes for
the period. The investment and investment income accounts are not affected.
17 Unrealized and constructive gains and losses give rise to temporary differences unless the consolidated
entity is a member of an affiliated group and elects to file consolidated tax returns.
Copyright © 2015 Pearson Education Limited
,Chapter 10 10-3
SOLUTIONS TO EXERCISES
Solution E10-1 [AICPA adapted]
1 a
Sob income to preferred $20,000 20% owned $ 4,000
Sob income to common $100,000 80% owned 80,000
Income from Sob $ 84,000
2 a
$150,000 20% taxable 30% tax rate
3 d
All dividend income is excluded from a consolidated group.
4 d
Intercompany profit is deferred in the consolidated tax return until
realized through sale to an outside entity.
Copyright © 2015 Pearson Education Limited
, 10-4 Subsidiary Preferred Stock, Consolidated Earnings per Share, and Consolidated Income Taxation
Solution E10-2 [Preferred stock](in thousands)
Common stockholders'
a. equity $ 380,000
Goodwill $ 75,000
Implied fair
value $ 455,000
Purchase price (80% * implied fair value) $ 364,000
Common stockholders'
b. equity $ 380,000
Preferred stockholders' equity
(1,000 share at 102 call
price) $ 102,000
Total stockholders'
equity $ 482,000
c. Income from subsidiary $ 36,000
Common stock portion of income
(Income from subsidiary /80%) $ 45,000
Net income $ 60,000
Preferred stock portion of income $ 15,000
Noncontrollling interest share - common
(20% * common stock portion of income) $ 9,000
Noncontrolling interest share - preferred
(100%* preferred stock portion of income) $ 15,000
Total noncontrolling interest share $ 24,000
Copyright © 2015 Pearson Education Limited
