1. Chapter 6
Cash Flows
EPS
Taxation
Unconsolidated Investments

2. Special issues Cash flow for the consolidated company
Consolidated earnings per share
Taxation
using a consolidated tax return
using separate tax returns for each affiliate
Equity method for influential investments C6

3. Consolidated cash flow: The issues
Impact of the purchase
cash purchase is investing
stock issue is non-cash transaction
Amortizations are non-cash adjustment to operations
Transactions between firms are eliminated on the income statement and balance sheet we use for the analysis C6

4. Consolidated cash flow: Impact of the purchase
Cash purchase is “Investing.” There is usually also a non-cash portion (liabilities assumed and non-controlling interest).
Cash paid is recorded net of sub’s cash received.
Stock issue usually results in cash inflow (for the sub’s cash) and disclosure of the “non-cash” transaction
Pooling was a non-event because prior balance sheet was retroactively consolidated C6

5. Consolidated cash flow: Adjustments
Start with consolidated net income (includes the NCI share). If you start with only controlling interest, the NCI must be added back to income.
Add back amortizations from D&D to income; they are non-cash expenses
Operations (+)
continued . . . C6

6. Consolidated cash flow: Adjustments (continued)
Purchase of additional sub shares is the purchase of treasury shares for the consolidated entity
Financing (-)
All parent dividends and dividends paid to NCI cash
Buying sub bonds is retirement for consolidated entity C6

7. Example: Cash purchase
Balance Sheet of Company Acquired
Cash 10,000 Liabilities 30,000
Fixed assets 80,000 Equity 60,000
D&D Schedule
Price Paid 100,000
Interest (80%  $60,000) 48,000
Excess 52,000
Allocate to building (80%  50,000) 40, year
Goodwill 12,000 C6

8. Example: Cash purchase (continued)
To see cash flow impact, consider additions to parent balance sheet on purchase date:
Fixed asset (increased 40,000) 120,000
Goodwill 12,000
Liabilities 30,000
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 Dr Cr C6

9. Balance Sheet of Company Acquired
Example:
Stock issued for sub
Balance Sheet of Company Acquired
Cash 10,000 Liabilities 30,000
Fixed assets 80,000 Equity 60,000
D&D Schedule
Price Paid (10,000 par $10 shares) 100,000
Interest (80%  $60,000) 48,000
Excess 52,000
Allocate to building (80%  50,000) 40, year
Goodwill 12,000 C6

10. Stock issued for sub (continued)
Example:
Stock issued for sub (continued)
To see cash flow impact, consider additions to parent balance sheet on purchase date:
Cash (from Sub) ,000
Fixed asset (increased 40,000) 120,000
Goodwill 12,000
Liabilities 30,000
NCI (20%  60,000) 12,000
Common stock, $10 par 100,000
Non-cash “investing” is $30,000 liability is + $12,000 NCI + $100,000 stock issue
Cash Operations is + $2,000 depreciation adjustment Dr Cr C6

11. Consolidated EPS
Consolidated net income [controlling interest only]
Parent common shares
Consolidated Basic EPS = 
P’s internally gen adj inc + Parent DEPS inc adj + (P’s owned Sub Equity Shares  Sub DEPS)
Parent common shares
Consolidated Diluted EPS =  C6

12. Taxation of the consolidated entity
Consolidated Return
Requires 80% plus IRS rules
No tax on separate books
Tax based on “consolidated net income” from consol WS
Inter-co profits have been eliminated - not taxed
Allocate tax back to Parent & Sub books
Separate Taxation
Each firm paid tax on their reported income
Parent may pay (and /or accrue) “secondary tax” on share of sub income
Intercompany profits have been taxed - requires deferral
Tax allocation techniques are employed C6

13. Base example for taxation
Parent Sub
Sales 300, ,000
Cost of Goods Sold (200,000) (90,000)
Gross profit 100, ,000
Expenses (40,000) (20,000)
Gain on sale of machine 5,000 _______
Net Income 65, ,000
Parent owns 80% interest
Tax rate is 30%
Gain on machine is 5 year asset sold to S by P (downstream)
S sells inventory to P at 20% GP, $50,000 sales during year, $20,000 in beg inv, $6,000 in end inv C6

14. Consolidated taxation: Adjustments

15. Consolidated taxation: Sub IDS
End inv profit (EI) 1,200 Internal gen NI 10,000
Beg inv profit (BI) 4,000
Adjusted net 12,800 Tax (3,840)
Net income 8,960
20% NCI 1,792
Sub must record tax provision on its books C6

16. Consolidated taxation: Parent IDS
Gain on mach (F1) 5,000 Intern gen NI before tax 65,000
Realized gain (F2) 1,000
Adjusted net income 61,000 Tax (18,300)
Net income 42,700
80% of S’s NI after tax + 7,168
Controlling Interest 49,868 C6

17. Consolidated tax: Worksheet
In Worksheet 6-1:
Neither P or S has tax provision on books; if there were one, we would reverse it out.
Eliminations, prior to tax entry, do not change from prior chapters
Provision T for tax based on consolidated income
Take care on parent IDS to avoid taxing Sub income again
Tax provision on IDS must be recorded on books of P and S C6

18. Separate tax: Worksheet In Worksheet 6-2:
Confirm the tax provision on P’s and S’s incomes, P’s provision includes secondary tax on 75% of sub income.
Confirm P’s deferred tax liability for the undistributed share of sub income (current and prior years).
Eliminations prior to tax do not change from prior chapters
continued . . . C6

19. Worksheet (continued)
Separate tax:
Worksheet (continued)
Entry T1 adjusts for tax impact on RE adjustments
Entry T2 adjusts for tax impact of current year adjustments
All IDS adjustments are net of tax, including double tax on P’s share of S income. C6

20. Separate taxation example: Adjustments for current year

21. Separate taxation: Tax adjustment
Tax adjustment schedule: Deferred Tax Asset increase (decrease)
Item Total 80% Par 20% 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) C6

22. Separate taxation: Sub IDS Sub
End inv profit (EI) 1,200 Int gen NI before tax 10,000
Beg inv profit (BI) 4,000
Adjusted inc before tax 12,800
30% tax (3,840)
Adj inc net of tax 8,960
Minority share (20%) 1,792 C6

23. Separate taxation: Parent IDS Parent
Gain on mach. (F1) 5,000 Int gen NI before tax 65,000
Realized gain (F2) 1,000
Adj. inc. before tax 61,000
30% tax (18,300)
Net income 42,700
80% Sub Adj Net Inc + 7,168
Secondary tax on $7,168* (430)
Adjusted net inc ,438
* $7,168  20% included  30% tax rate C6

24. Influential investments: Equity Method
D&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
Investee profits are adjusted via the IDS. Only the investor’s share of profits is deferred
Double tax applies (20%)
Tax allocation applies to only the double tax
investor must accrue tax on undistributed investee income C6

25. Influential investment: Example
D&D of Excess Schedule
Price paid $80,000
Equity (30%  $250,000) 75,000
Excess: patents with 5 year amortization ,000
Investor sells inventory to investee: 30% GP, $10,000 goods in beg inv, $40,000 goods in end inv
At beginning of year, investee sold machine (5 years life) to investor at $10,000 profit
Investee reports income of $60,000 (before tax)
30% tax rate; 80% income exclusion C6

26. Influential investment: IDS to calculate investment income
IDS for Investee
Mach gain 10,000 Int generated income 60,000
no inventory adj. here! Realized mach gain 2,000
Adjusted Inc 52,000
Tax at 30% 15,600
Net Inc 36,400
30% interest 10,920
Less patent amort (1,000)
Equity income 9,920 C6

27. Influential investment: Entries to record income
Investment in Investee 9,920
Investment income 9,920
Provision for Tax* 655
DTL 655
* ([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 C6

28. Influential investment: Entries to record income (cont’d)
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 C6

29. Influential investment: Special issues
You can’t equity adjust below “zero.”
memo entries to track unrecorded losses
future income not recognized until it exceeds unrecorded losses
Investor defers profit on own interest on own books.
Achieve influence with subsequent purchases
retroactive conversion to sophisticated equity
Loose influence
stop using sophisticated equity; no retroactive adjustment C6