 Hello and welcome to this session in which we will discuss financial statement consolidation where indirect control exists and the form of the control is mutual ownership. Now on the prior session we looked at two forms of ownership which is indirect ownership specifically father son grandson and connecting affiliation and basically in father son grandson alphabet owns google google owns youtube then indirectly father son grandson alphabet consolidate youtube because alphabet controls youtube through google we also looked at this triangular format where we have alphabet controls google then let's assume 75 google owns 30 of youtube then well alphabet has no relationship with youtube because they cannot control google does not control youtube but let's assume alphabet purchased 25 percent in youtube now alphabet controls youtube and directly in this session we're going to be looking at another form it which is called the mutual ownership this exists when the two companies in a business combination hold equity interests in each other so basically we have company a and company b company a holds shares in company company b holds shares in company a and company a holds shares in company b this often happens as a result of financial battles that occur during a takeover basically one company is trying to take over another company so what they do the company that's being taken over they will start to buy shares in the company that's acquiring them this is called the pacman defense it's occasionally adopted when the target company attempt to avoid the takeover by reversing role and acquiring shares of the of its investor so you're trying to buy me i will try to buy shares in your company a case and point is Porsche i'm sure you heard about this company car were in 2005 they tried to take over Volkswagen so they started to buy shares into Volkswagen so what Volkswagen did in 2008 when the financial crisis hit and less people were buying Porsche they tried to buy Porsche shares when the stock price dropped and by 2012 they took over the company so this is basically i'm Porsche trying to buy Volkswagen Volkswagen ending up ended up buying Porsche now the best way to discuss this is to look at the accounting and basically look at an example before we proceed any further i have a public announcement about my company farhat lectures dot com farhat accounting lectures is a supplemental educational tool that's going to help you with your cpa exam preparation as well as your accounting courses my cpa material is aligned with your cpr view course such as becker roger wiley gleam miles my accounting courses are aligned with your accounting courses broken down by chapter and topics my resources consist of lectures multiple choice questions true false questions as well as exercises go ahead start your free trial today no obligation no credit card required so the first thing we want to discuss the accounting aspect of it well accounting of parent stock held by the sub so how do we account for this well let's assume we have alphabet and google alphabet is the parent company shares of the parent company which is alphabet the own the parent company of google held by the subsidiary google are not to be treated outstanding in the consolidated financial statement so an alphabet and google when the parent and the sub i use alphabet and google because i think it's easy for you to remember when we consolidate well the shares held by google of alphabet they are not outstanding those are eliminated and we're going to see later in an example to reclassify we reclassify the cost of these purchases from a common equity that are sorry as an investment and consider them as treasury stock it will be a worksheet worksheet entry simply put the subsidiary does not involve parties outside the affiliated group simply put if that's the case then they're treasury stock because the sub is considered part of the parent so simply put what i'm trying to say is the cost of the parent company shares held by the affiliate is reported as treasury stock on the consolidated so when they consolidate they will take out the investment and turn it into a turn it into treasury stock and you will see in an example also dividend on the stock are considered enter entity transfer that must be eliminated and this should make sense because the sub paying paying to the parent parent paying to the sub it's enter enter entity transfers it should be eliminated the best way is to look at an example now this example it's going to be a lot of data if you want to copy down the information or if you are part of farhat lectures you can download the slides and work through them just fyi adam company purchased 60 interest in ryan company in january first 20x0 paying 420 000 in cash okay so adam basically took control 60 of ryan company ryan book value at that date was reported to be 600 000 that's the book value and the fair value of the non-controlling interest is 280 now from the fair value of the non-controlling interest if we take if the fair value of the non-controlling interest is 280 if we take 280 divided by 4 if we take 280 000 divided by 0.4 not 4.4 will tell us that the fair value of ryan company is 700 000 that's the fair oops that's the fair value of ryan company so any access date any access acquisition date fair value of ryan book is assigned to franchise to be amortized over 40 years do we have any access yes we do the fair value is 600 000 the book value is the book value of ryan company is 600 we have 100 000 what are we going to do with this access fair value we're going to assign it to a franchise and amortize it over 40 years it doesn't matter over 40 20 25 just to make the point now subsequently on january first 20x1 well ryan decided to buy 25 of adam company by paying 250 000 which is the fair value the 250 000 represent the fair value of adam company so notice ryan went back said you know what you purchase 60 of my stocks i'm going to go back and purchase 25 of your stock so this is where we have a mutual ownership no dividend was paid by either ryan or adam company and on january first 20x1 ryan book value was 800 000 so notice ryan book value was 600 000 january first 20x0 a year later it was 800 000 which is and 840 by the end of the year so the 800 000 is 300 i'm sorry the 840 is 300 common stock and 540 retained earnings now what else do we know adam book value was 1.7 million at the beginning of x1 and 1.8 million at the end of the year of the and at the end of x1 and it represents 1 million in common stock and 800 000 in retained earnings there was no enter entity transaction and no additional stocks has been sold so the stock you know we did not issue any additional stocks each company applies the initial value method prepare the working entries to consolidate the two companies for 20x1 and what's the net income attributable to the non controlling interest well the first thing we want to know is figure out the annual access amortization which is i basically showed it to you we paid 420 000 consideration transferred plus the controlling interest will give us a fair value of 700 000 which is the way i did it on the prior slide i said if the nci is 40 percent if i take 280 over 40 which which is giving will give you 700 000 or you can say well if i paid 420 000 for the 60 percent and i'm told the 280 percent represent 40 percent i know the fair value of the company is 700 000 i just want to make sure you you understand this inside out back and forth the book value was 600 000 access fair value is 100 000 we're gonna we're gonna divide this over 40 over 40 years not 20 over 40 years if we divide it over 40 years if we take 100 000 divided by 40 that's going to give us 2500 of access amortization per year the first thing we're going to do we're going to accrue net income to the parent during the previous year well how do we compute this it's going to be the accrued net income to the parent is 100 000 i'm sorry not 100 000 200 000 what why do we know it's 200 000 it's 200 000 times my screen keeps clicking 200 000 times 60 percent now where did we get the 200 000 from okay well let's let's look at what we what we have in the priors from the prior slide we know that the book value went from 600 000 a frying company to 800 000 in that year and we are told that no we did not issue an additional common stock and we did not pay dividend so the only difference the only difference the increase in book value must have been the income which is increased retained earnings so if we take 200 000 times 60 percent that's 120 000 then we have to deduct 60 percent of the 2500 which belongs to them it ends up to be we're going to increase the investment in ryan 18500 and we're going to credit the retained earnings the beginning retained earnings in adam 18500 to accrue net income of the parent company during the prior year and update the investment now the second thing we're going to do is we're going to eliminate the sub equity account against the investment income and to recognize the non-controlling interest well how much was it it was 800 000 common stock 300 retained earnings 500 this is the beginning of the year we're going to credit 480 000 which is 800 000 times 60 percent in ryan company and the remaining goes to the non-controlling interest again this is as of 1 1 20 x 1 which we had book value of 800 000 now by the end of the year it was 840 but we do this entry at the beginning of the year what we're going to do next is reclassify the cost of the parent of the cost of the parent shares as treasury stock remember ryan company paid 250 000 to purchase 25 percent now during consolidation what we're going to do we're going to take those investment and reclassified as treasury stock therefore we debit treasury stock 250 and we credit investment in ryan investment actually investment in adam not in ryan because the investment is in adam we have to reclassify it investment in adam 250 reclassifying the investment to treasury stock in the consolidation we're not done yet let's take a look at what else that we need to know we need to recognize any unamortized portion of the acquisition date of our fair value well remember the franchise we started with 100 000 for the first year we deducted 25 000 at not 25 000 2500 what's going to happen we have to reinstate on the consolidation process we have to put on the books the franchise and credit the investment in ryan which is 97 500 then we have to do one more thing is we have to book this 2500 for this year which is to record the trademark or the franchise or whatever the asset that we added as amortization expense the franchise and we are going to debit amortization expense 2500 credit franchise 2500 so next year this entry would look like 95 000 95 000 because we amortized again 2500 then this entry will appear again now we also have to compute or we're asked to compute the net income attributable to the non-controlling interest well the book value starting at the beginning of x1 was 800 000 at the end of the year it was 840 000 and we are told there was no dividend we are told there's no new stocks issued what does that mean it means the only difference is net income net income of 40 000 well the nci they own 40 it's going to be 40 000 minus the amortization 2500 times 40 percent and that's going to be the share of the nci which happens to be 15 000 what should you do now go to far hat lectures if you are an advanced accounting student look at additional exercises mcqs that's going to help you understand this concept better this topic is not covered on the cpa exam but it's covered in your advanced accounting course study it learn it move on invest in yourself invest in your career good luck and of course stay safe