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Chapter 6 Cash Flows EPS Taxation Unconsolidated Investments.

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Presentation on theme: "Chapter 6 Cash Flows EPS Taxation Unconsolidated Investments."— Presentation transcript:

1 Chapter 6 Cash Flows EPS Taxation Unconsolidated Investments

2 C62 Special issues uCash flow for the consolidated company uConsolidated earnings per share uTaxation –using a consolidated tax return –using separate tax returns for each affiliate uEquity method for influential investments

3 C63 Consolidated cash flow: The issues uImpact of the purchase –cash purchase is investing –stock issue is non-cash transaction uAmortizations are non-cash adjustment to operations uTransactions between firms are eliminated on the income statement and balance sheet we use for the analysis

4 C64 uCash purchase is “Investing.” There is usually also a non-cash portion (liabilities assumed and non-controlling interest). uCash paid is recorded net of sub’s cash received. uStock issue usually results in cash inflow (for the sub’s cash) and disclosure of the “non-cash” transaction uPooling was a non-event because prior balance sheet was retroactively consolidated Consolidated cash flow: Impact of the purchase

5 C65 uStart with consolidated net income (includes the NCI share). If you start with only controlling interest, the NCI must be added back to income. uAdd back amortizations from D&D to income; they are non-cash expenses Operations (+) Consolidated cash flow: Adjustments continued...

6 C66 uPurchase of additional sub shares is the purchase of treasury shares for the consolidated entity Financing (-) uAll parent dividends and dividends paid to NCI cash Financing (-) uBuying sub bonds is retirement for consolidated entity Financing (-) Consolidated cash flow: Adjustments (continued)

7 C67 Example: Cash purchase Balance Sheet of Company Acquired Cash10,000Liabilities30,000 Fixed assets80,000Equity60,000 D&D Schedule Price Paid100,000 Interest (80%  $60,000) 48,000 Excess52,000 Allocate to building (80%  50,000)40,00020 year Goodwill12,000

8 C68 To see cash flow impact, consider additions to parent balance sheet on purchase date: Fixed asset (increased 40,000)120,000 Goodwill12,000 Liabilities30,000 Cash (100, ,000 sub cash)90,000 NCI (20%  60,000)12,000 Non-cash “investing” is $30,000 liability & $12,000 NCI Cash Operations is +$2,000 depreciation adjustment Example: Cash purchase (continued) DrCr

9 C69 Example: Stock issued for sub Balance Sheet of Company Acquired Cash10,000Liabilities30,000 Fixed assets 80,000Equity60,000 D&D Schedule Price Paid (10,000 par $10 shares)100,000 Interest (80%  $60,000) 48,000 Excess52,000 Allocate to building (80%  50,000)40,00020 year Goodwill12,000

10 C610 To see cash flow impact, consider additions to parent balance sheet on purchase date: Cash (from Sub) 10,000 Fixed asset (increased 40,000)120,000 Goodwill12,000 Liabilities30,000 NCI (20%  60,000)12,000 Common stock, $10 par100,000 Non-cash “investing” is $30,000 liability is + $12,000 NCI + $100,000 stock issue Cash Operations is + $2,000 depreciation adjustment Example: Stock issued for sub (continued) DrCr

11 C611 Consolidated EPS Consolidated Basic EPS Consolidated net income [controlling interest only] Parent common shares  = Consolidated Diluted EPS P’s internally gen adj inc + Parent DEPS inc adj + (P’s owned Sub Equity Shares  Sub DEPS) Parent common shares = 

12 C612 Taxation of the consolidated entity Consolidated Return 2Requires 80% plus IRS rules 2No tax on separate books 2Tax based on “consolidated net income” from consol WS 2Inter-co profits have been eliminated - not taxed 2Allocate tax back to Parent & Sub books Separate Taxation 2Each firm paid tax on their reported income 2Parent may pay (and /or accrue) “secondary tax” on share of sub income 2Intercompany profits have been taxed - requires deferral 2Tax allocation techniques are employed

13 C613 Base example for taxation Parent Sub Sales300, ,000 Cost of Goods Sold(200,000)(90,000) Gross profit100,000 30,000 Expenses(40,000)(20,000) Gain on sale of machine 5,000 _______ Net Income65,000 10,000 uParent owns 80% interest uTax rate is 30% uGain on machine is 5 year asset sold to S by P (downstream) uS sells inventory to P at 20% GP, $50,000 sales during year, $20,000 in beg inv, $6,000 in end inv

14 C614 Consolidated taxation: Adjustments

15 C615 Consolidated taxation: Sub IDS Sub End inv profit (EI)1,200Internal gen NI10,000 Beg inv profit (BI) 4,000 Adjusted net12,800 Tax (3,840) Net income8,960 20% NCI1,792 Sub must record tax provision on its books

16 C616 Parent Gain on mach (F1)5,000Intern gen NI before tax65,000 Realized gain (F2)1,000 Adjusted net income61,000 Tax (18,300) Net income42,700 80% of S’s NI after tax+ 7,168 Controlling Interest49,868 Consolidated taxation: Parent IDS

17 C617 Consolidated tax: Worksheet In Worksheet 6-1: uNeither P or S has tax provision on books; if there were one, we would reverse it out. uEliminations, prior to tax entry, do not change from prior chapters uProvision T for tax based on consolidated income uTake care on parent IDS to avoid taxing Sub income again uTax provision on IDS must be recorded on books of P and S

18 C618 Separate tax: Worksheet In Worksheet 6-2: uConfirm the tax provision on P’s and S’s incomes, P’s provision includes secondary tax on 75% of sub income. uConfirm P’s deferred tax liability for the undistributed share of sub income (current and prior years). uEliminations prior to tax do not change from prior chapters continued...

19 C619 Separate tax: Worksheet (continued) uEntry T1 adjusts for tax impact on RE adjustments uEntry T2 adjusts for tax impact of current year adjustments uAll IDS adjustments are net of tax, including double tax on P’s share of S income.

20 C620 Separate taxation example: Adjustments for current year

21 C621 Separate taxation: Tax adjustment Tax adjustment schedule: Deferred Tax Asset increase (decrease) ItemTotal80% Par20% NCI Mach gain deferred ($5,000 .3) 1,500 1,500 Mach gain realized ($1,000 .3) (300) (300) Beg Inv realized ($4,000 .3) (1,200)(960)(240) secondary tax ($2,800 .8 .2 .3) (134)(134) End Inv deferred ($1,200 .3) secondary tax ($840 .8 .2 .3) _____ Total (168)

22 C622 Separate taxation: Sub IDS Sub End inv profit (EI)1,200Int gen NI before tax10,000 Beg inv profit (BI)4,000 Adjusted inc before tax 12,800 30% tax(3,840) Adj inc net of tax8,960 Minority share (20%)1,792

23 C623 Separate taxation: Parent IDS Parent Gain on mach. (F1)5,000Int gen NI before tax65,000 Realized gain (F2)1,000 Adj. inc. before tax61,000 30% tax(18,300) Net income42,700 80% Sub Adj Net Inc+ 7,168 Secondary tax on $7,168* (430) Adjusted net inc 49,438 * $7,168  20% included  30% tax rate

24 C624 Influential investments: Equity Method uD&D is still used to determine excess and schedule amortizations –amortizations now come out of the investment account –there is no amortization of goodwill component of excess uInvestee profits are adjusted via the IDS. Only the investor’s share of profits is deferred uDouble tax applies (20%) uTax allocation applies to only the double tax –investor must accrue tax on undistributed investee income

25 C625 Influential investment: Example D&D of Excess Schedule Price paid$80,000 Equity (30%  $250,000)75,000 Excess: patents with 5 year amortization 5,000 uInvestor sells inventory to investee: 30% GP, $10,000 goods in beg inv, $40,000 goods in end inv uAt beginning of year, investee sold machine (5 years life) to investor at $10,000 profit uInvestee reports income of $60,000 (before tax) u30% tax rate; 80% income exclusion

26 C626 Influential investment: IDS to calculate investment income IDS for Investee Mach gain10,000Int generated income60,000 no inventory adj. here!Realized mach gain2,000 Adjusted Inc52,000 Tax at 30%15,600 Net Inc36,400 30% interest10,920 Less patent amort(1,000) Equity income 9,920

27 C627 Influential investment: Entries to record income Investment in Investee9,920 Investment income9,920 Provision for Tax*655 DTL655 * ([9, ,000  ]  20% included  30% tax rate).  Amort of excess is not tax deductible. Deferred gross profit (beginning inv) 900 Sales rev (10,000  30% GP  30% interest )900 Sales Rev (4,000  30% GP  30% interest ) 3,600 Deferred gross profit (ending inv) 3,600

28 C628 Provision for tax (900  30% )270 DTA (on beginning inventory)270 DTA (on ending inventory)1,080 Provision for tax (3,600  30% )1,080 Influential investment: Entries to record income (cont’d)

29 C629 Influential investment: Special issues uYou can’t equity adjust below “zero.” –memo entries to track unrecorded losses –future income not recognized until it exceeds unrecorded losses uInvestor defers profit on own interest on own books. uAchieve influence with subsequent purchases –retroactive conversion to sophisticated equity uLoose influence –stop using sophisticated equity; no retroactive adjustment


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