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Assignment Question(s): (Marks 15)
Q1. Z Corporation acquired 100% of the outstanding common stock of Sake X Corporation for $ 3,000,000 cash and
50,000
shares of its own common stock ($1 par value), which was trading at $30 per share at the acquisition date.(3 marks)
Required: Prepare The Journal Entry to Record the Acquisition Transaction on the Acquiring Incorporation’s Journal.
Answer:
Q2. In The Process of the Acquisition, Z Incorporation Paid In Cash the Following Expenses ($): (3 marks)
Legal fees
50,000
Accounting fees 20,000
Travel expenses 5,000
Legal fees (SEC) 40,000
Accounting fees (SEC) 10,000
SEC filing fees 15,000
Required: Prepare the journal entry to record the acquisition expenses.
Answer:
Q3. Z Incorporation acquired significant influence over Y Company by purchasing 100 percent of the common stock of the Y Incorporation for $100,000; Y earns income of $50,000 and pays dividends of $10,000(4 marks)
Required: Pass Journal Entries To Update The Investment Account In Y Incorporation Using Equity Method And Cost Method.
Answer:
Q4. Given the Following Information for 2023(5 marks)
Z owns 70% of Y
Y net income for 2023 is $150,000
Y declares dividends of $10,000 during 2023.
Y has 20,000 shares of $ 1 par value per stock outstanding that issued for $10 per share.
Y beginning balance in Retained Earnings for 2023 is $50,000.
Required: Prepare Basic Elimination Entry Using Equity Method
Answer
Chapter 01
Intercorporate
Acquisitions and
Investments in
Other Entities
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
Understand and explain
different methods of
business expansion, types of
organizational structures,
and types of acquisitions.
1-2
Development of Complex Business Structures
Reasons for Enterprise expansion
◼
Size often allows economies of scale
◼
New earning potential
◼
Earnings stability through diversification
◼
Management rewards for bigger company size
◼
Prestige associated with company size
1-3
Organizational Structure and Business Objectives
A subsidiary is a corporation that is
controlled by another corporation,
referred to as a parent company.
Control is usually through majority
ownership of its common stock.
P
Because a subsidiary is a separate
legal entity, the parent’s risk
associated with the subsidiary’s
activities is limited.
S
◼
1-4
Organizational Structure and Ethical Considerations
Manipulation of financial reporting
◼
◼
◼
The use of subsidiaries or other entities to
borrow money without reporting the debt on
their balance sheets
Using special entities to manipulate profits
Manipulation of accounting for mergers and
acquisitions
⚫ Pooling-of-interests allowed for manipulation
⚫ The FASB did away with it and modified acquisition
accounting
1-5
Business Expansion: The Big Picture
Two Types of Expansion
◼
Internal Expansion
⚫
◼
Investment account (Parent) = BV of net assets (Sub)
External Expansion
⚫
Acquisition price usually is not the same as BV, carrying value, or
even FMV of net assets
P
$
External
Expansion
P
Stock
Sub
Shareholders
S
Internal
Expansion
Stock
$
S
1-6
Business Expansion for Within
New entities are created
subsidiaries
◼ partnerships
◼ joint ventures
◼ special entities
◼
Motivating factors:
Helps establish clear lines of control and facilitate the
evaluation of operating results
◼ Special tax incentives
◼ Regulatory reasons
◼ Protection from legal liability
◼ Disposing of a portion of existing operations
◼
1-7
Business Expansion
A spin-off
◼
Occurs when the ownership of a newly created or existing
subsidiary is distributed to the parent’s stockholders
without the stockholders surrendering any of their stock
in the parent company
A split-off
◼
Occurs when the subsidiary’s shares are exchanged for
shares of the parent, thereby leading to a reduction in the
outstanding shares of the parent company
1-8
Control: How?
The Usual Way
◼
Owning more than 50% of the subsidiary’s outstanding
voting stock (50% plus only 1 share will do it)
The Unusual Way
◼
Having contractual agreements or financial arrangements
that effectively achieves control
1-9
Business Expansion through Combinations
Traditional view
◼
Control is gained by acquiring a majority of the
company’s common stock.
However, it is possible to gain control with
less than majority ownership or with no
ownership at all:
Informal arrangements
◼ Formal agreements
◼
⚫ Consummation of a written agreement requires
recognition on the books of one or more of the
companies that are a party to the combination.
1-10
Forms of Organizational Structure
Expansion through business combinations
◼
◼
◼
Entry into new product areas or geographic
regions by acquiring or combining with other
companies.
A business combination occurs when “. . . an
acquirer obtains control of one or more
businesses.”
The concept of control relates to the ability to
direct policies and management.
1-11
Frequency of Business Combinations
1960s − Merger boom
◼
Conglomerates
1980s − Increase in the number of business
combinations
◼
Leveraged buyouts and the resulting debt
1990s − All previous records for merger activity
shattered
Downturn of the early 2000s, and decline in mergers
Increased activity toward the middle of 2003 that
accelerated through the middle of the decade
◼
Role of private equity
Effect of the credit crunch of 2007-2008
1-12
Organizational Structure and Reporting
Merger
◼
A business combination in which the acquired
company’s assets and liabilities are combined
with those of the acquiring company results in no
additional organizational components.
Financial reporting is based on the original
organizational structure.
1-13
Organizational Structure and Reporting
Controlling ownership
◼
◼
A business combination in which the acquired
company remains as a separate legal entity with a
majority of its common stock owned by the
purchasing company leads to a parent–subsidiary
relationship.
Accounting standards normally require
consolidated financial statements.
1-14
Organizational Structure and Reporting
Noncontrolling ownership
◼
The purchase of a less-than-majority interest in another
corporation does not usually result in a business
combination or controlling situation.
Other beneficial interest
◼
◼
One company may have a beneficial interest in another
entity even without a direct ownership interest.
The beneficial interest may be defined by the agreement
establishing the entity or by an operating or financing
agreement.
1-15
Practice Quiz Question #1
A common way to obtain corporate
control is:
a. by purchasing more than 50% of an
entity’s non-voting preferred stock.
b. by bribing the CEO.
c. by playing a video game about that
company.
d. by purchasing more than 50% of an
entity’s common stock.
e. none of the above.
1-16
Practice Quiz Question #1 Solution
A common way to obtain corporate
control is:
a. by purchasing more than 50% of an
entity’s non-voting preferred stock.
b. by bribing the CEO.
c. by playing a video game about that
company.
d. by purchasing more than 50% of an
entity’s common stock.
e. none of the above.
1-17
Learning Objective 2
Make calculations and
prepare journal entries for
the creation and purchase of
a business entity.
1-18
Creating Business Entities
The company transfers assets, and perhaps
liabilities, to an entity that the company has
created and controls and in which it holds
majority ownership.
◼
The company transfers assets and liabilities to
the created entity at book value, and the
transferring company recognizes an ownership
interest in the newly created entity equal to the
book value of the net assets transferred.
1-19
Creating Business Entities
Recognition of fair values of the assets
transferred in excess of their carrying values
on the books of the transferring company is
not appropriate in the absence of an arm’slength transaction.
No gains or losses are recognized on the
transfer by the transferring company.
1-20
Creating Business Entities
If the value of an asset transferred to a newly
created entity has been impaired prior to the
transfer and its fair value is less than the
carrying value on the transferring company’s
books, the transferring company should
recognize an impairment loss and transfer the
asset to the new entity at the lower fair value.
1-21
Internal Expansion: Creating a subsidiary
Parent sets up the new legal entity.
◼
Based on state laws
Parent transfers assets to the new company.
Subsidiary begins to operate.
Example: Parent sets up Sub and transfers
$1,000 for no-par stock.
P
Stock
Parent:
Investment in Sub
Cash
1,000
Sub:
Cash
Common Stock
1,000
1,000
$
S
1,000
1-22
Practice Quiz Question #2
When a parent company creates a
subsidiary through internal expansion,
the parent’s journal entry to transfer
assets to the newly created entity will
include a debit to
a.
b.
c.
d.
e.
Acquisition Expense.
Cash
Investment in Subsidiary
Common Stock.
none of the above.
1-23
Practice Quiz Question #2 Solution
When a parent company creates a
subsidiary through internal expansion,
the parent’s journal entry to transfer
assets to the newly created entity will
include a debit to
a.
b.
c.
d.
e.
Acquisition Expense.
Cash
Investment in Subsidiary
Common Stock.
none of the above.
1-24
Learning Objective 3
Understand and explain
the differences between
different forms of
business
combinations.
1-25
Forms of Business Combinations
A statutory merger
The acquired company’s assets and liabilities are
transferred to the acquiring company, and the acquired
company is dissolved, or liquidated
◼ The operations of the previously separate companies are
carried on in a single legal entity
◼
A statutory consolidation
◼
Both combining companies are dissolved and the assets
and liabilities of both companies are transferred to a
newly created corporation
1-26
Forms of Business Combinations
A stock acquisition
◼
◼
◼
◼
One company acquires the voting shares of another
company and the two companies continue to operate as
separate, but related, legal entities.
The acquiring company accounts for its ownership
interest in the other company as an investment.
Parent–subsidiary relationship
For general-purpose financial reporting, a parent company
and its subsidiaries present consolidated financial
statements that appear largely as if the companies had
actually merged into one.
1-27
Forms of Business Combinations
AA Company
AA Company
BB Company
(a) Statutory Merger
AA Company
CC Company
BB Company
(b) Statutory Consolidation
AA Company
AA Company
BB Company
BB Company
(c) Stock Acquisition
1-28
Determining the Type of Business Combination
AA Company invests in BB Company
Acquires
Acquires net
net
assets
assets
Acquires stock
Yes
Acquired
Acquired company
company
liquidated?
liquidated?
No
Record
Record as
as statutory
statutory
merger
or
merger or statutory
statutory
consolidation
consolidation
Record
Record as
as stock
stock
acquisition
acquisition and
and
operate
as
subsidiary
operate as subsidiary
1-29
Forms of Business Combination—Details
Option #1: Statutory Merger
◼ Peaceful Merger:
⚫ One entity transfers assets to another in exchange for stock
and/or cash.
⚫ It liquidates pursuant to state laws.
◼ Hostile Takeover:
⚫ One company buys the stock of another, creating a temporary
parent-subsidiary relationship.
⚫ The parent then liquidates the subsidiary into the parent pursuant
to state laws.
◼ The result: One legal entity survives.
1-30
Statutory Merger: Peaceful Merger
A Shareholders
T Shareholders
A stock + up
to 50% boot
A Corp.
T Corp.
A stock
+ boot
T assets
• Need SH approval from both corporations.
1-31
Statutory Merger: The Result
A and T Shareholders
A Corp.
(A & T Assets)
1-32
Statutory Merger: Hostile Takeover
A Shareholders
A Corp.
T Shareholders
T Corp.
1-33
Statutory Merger: Hostile Takeover
A takes all of T’s assets and liquidates the
corporate shell.
A & T Shareholders
A
T
T Assets
1-34
Statutory Merger: The (Same) Result
A and T Shareholders
A Corp.
(A & T Assets)
1-35
Forms of Business Combination—Details
Option #2: Statutory Consolidation
◼ New corporation (Newco) is created.
◼ Newco issues stock to both combining companies in
exchange for their stock.
◼ Each combining company becomes a temporary
subsidiary of Newco.
◼ Both subs are liquidated into Newco and become
divisions.
◼ Result: One legal entity survives.
1-36
Statutory Consolidation: The Process
X Shareholders
Y Shareholders
N Stock
N Stock
X Corp.
Y Corp.
N Stock
N Stock
Newco
Corp.
• Need SH approval from both corporations.
1-37
Statutory Consolidation: The Result
X and Y Shareholders
Newco Corp.
(X & Y Assets)
1-38
Forms of Business Combination—Details
Option #3: HOLDING COMPANY:
◼ Similar to a statutory consolidation except that the two
subsidiaries are NOT liquidated into newly formed parent
corporation.
◼ Instead, the new company issues its stock to the
shareholders of the two existing corporations in exchange
for their stock in the two new subsidiary corporations.
1-39
Holding Company: The Starting Point
Newco
Corp.
X Shareholders
Y Shareholders
X
Corp.
Y
Corp.
1-40
Holding Company: The Result
X & Y Shareholders
N Stock
X & Y Stock
Newco
Corp.
X
Corp.
Y
Corp.
1-41
Practice Quiz Question #3
A way to force out a target company’s
dissenting shareholders is to use:
a.
b.
c.
d.
e.
acquisition accounting.
pooling of interests accounting.
a statutory merger.
a statutory consolidation.
none of the above.
1-42
Practice Quiz Question #3 Solution
A way to force out a target company’s
dissenting shareholders is to use:
a.
b.
c.
d.
e.
acquisition accounting.
pooling of interests accounting.
a statutory merger.
a statutory consolidation.
none of the above.
1-43
Learning Objective 4
Make calculations and
prepare journal entries for
different types of business
combinations through the
acquisition of stock or
assets.
1-44
Accounting for Business Combinations
Big Picture: Valuation of the acquired company
◼
◼
◼
In the past, there were two methods:
⚫
Pooling of Interests Method (Investment = BV of Sub)
⚫
Purchase Method (Investment in Sub = FV given)
SFAS 141 (Effective July 2001) required purchase method.
SFAS 141R (Effective December 2008) modified rules—
“Acquisition Method”
⚫
FASB 141R may not be applied retroactively
1-45
Acquisition Accounting
The acquirer recognizes all assets acquired and
liabilities assumed in a business combination and
measures them at their acquisition-date fair values.
◼
If less than 100 percent of the acquiree is acquired, the
noncontrolling interest also is measured at its acquisitiondate fair value.
Fair value measurement
◼
The FASB decided in FASB 141R to focus directly on the
value of the consideration given.
1-46
Goodwill
Components used in determining goodwill:
1. The fair value of the consideration given by the acquirer
2. The fair value of any interest in the acquiree already held
by the acquirer
3. The fair value of the noncontrolling interest in the
acquiree, if any
The total of these three amounts, all measured at
the acquisition date, is compared with the
acquisition-date fair value of the acquiree’s net
identifiable assets, and the difference is goodwill.
1-47
The Acquisition Method
Establishes A New Basis of Accounting
The new basis of accounting depends on the
acquirer’s purchase price (FMV) + the NCI’s (FMV).
The depreciation cycle for fixed assets starts over
based on current values and estimates.
If acquisition price > FMV, goodwill exists.
Recognize as an asset.
◼ Do not amortize.
◼ Evaluate periodically for possible impairment.
◼
If acquisition price < FMV, a bargain purchase
element (formerly called “negative goodwill”)
exists.
1-48
The Pooling of Interests Method
No longer allowed!
The target company’s basis of accounting in its
assets was used by the consolidated group.
The depreciation cycle merely continued along as
if no business combination had occurred.
Goodwill was never recognized; thus, future
income statements did not have goodwill
amortization expense.
◼
Managers loved it!
1-49
Methods of Effecting Business Combinations
Acquisition of assets
◼
Statutory Merger
◼
Statutory Consolidation
Acquisition of stock
◼
◼
A majority of the outstanding voting shares usually is
required unless other factors lead to the acquirer gaining
control
Noncontrolling interest: The total of the shares of an
acquired company not held by the controlling shareholder
Acquisition by other means
1-50
Valuation of Business Entities
Value of individual assets and liabilities
◼
Value determined by appraisal
Value of potential earnings
◼
“Going-concern value” based on:
⚫ A multiple of current earnings.
⚫ Present value of the anticipated future net cash flows
generated by the company.
Valuation of consideration exchanged
1-51
Acquiring Assets vs. Stock
Major Decision Factors
◼
Legal considerations—Buyer must be extremely
careful NOT to assume responsibility for (and
thus “inherit”) the target company’s:
⚫ Unrecorded liabilities.
⚫ Contingent liabilities (lawsuits).
vs.
1-52
Acquiring Assets vs. Stock
Major Decision Factors (continued)
◼
Tax considerations—Often requires major
negotiations involving resolution of:
⚫ Seller’s tax desires.
⚫ Buyer’s tax desires.
◼
Ease of consummation—Acquiring common stock
is simple compared with acquiring assets.
vs.
1-53
Acquiring Assets
Major Advantages of Acquiring Assets
◼
◼
Will not inherit a target’s contingent liabilities
(excluding environmental).
Will not inherit a target’s unwanted labor union.
Major Disadvantages of Acquiring Assets
◼
◼
Transfer of titles on real estate and other assets
can be time-consuming.
Transfer of contracts may not be possible.
1-54
Acquiring Common Stock
Advantages of Acquiring Common Stock
Easy transfer
◼ May inherit nontransferable contracts
◼
Disadvantages of Acquiring Common Stock
May inherit contingent liabilities or unwanted
labor union connection.
◼ May acquire unwanted facilities/units.
◼ Will likely be hard to access target’s cash.
◼
1-55
Organizational Forms—What acquired?
Common Stock—Results
in a parent-subsidiary
relationship.
Target’s Assets—Results in a
home office-branch/division
relationship.
P
Home Office
P controls S
S
Branch/Division
One legal entity
1-56
Practice Quiz Question #4
To qualify for acquisition accounting
treatment:
a. one company must acquire common
stock of the other combining company.
b. a statutory consolidation must occur.
c. each company must be approximately
the same size.
d. a stock-for-stock exchange must occur.
e. none of the above.
1-57
Practice Quiz Question #4 Solution
To qualify for acquisition accounting
treatment:
a. one company must acquire common
stock of the other combining company.
b. a statutory consolidation must occur.
c. each company must be approximately
the same size.
d. a stock-for-stock exchange must occur.
e. none of the above.
1-58
Practice Quiz Question #5
In acquisition accounting:
a. common stock must be the
consideration given.
b. goodwill is not reported.
c. a statutory merger occurs.
d. a change of basis in accounting occurs.
e. none of the above.
1-59
Practice Quiz Question #5 Solution
In acquisition accounting:
a. common stock must be the
consideration given.
b. goodwill is not reported.
c. a statutory merger occurs.
d. a change of basis in accounting occurs.
e. none of the above.
1-60
Learning Objective 5
Make calculations and
business combination
journal entries in the
presence of a differential,
goodwill, or a bargain
purchase element.
1-61
The Acquisition Method: Items Included in the
Acquirer’s Cost
Category #1: The fair value of the consideration
given
Category #2: Certain out-of-pocket direct costs
◼
In the past, these were included in acquisition.
◼
Now expense!
Category #3: Contingent consideration
◼
Paid subsequent to the acquisition date
1-62
Acquirer’s Cost: Category 1
Types of Consideration: Practically of any
type
◼ Cash.
◼ Common stock.
WSJ 10/22/11 ... 77 5/8
◼ Preferred stock.
◼ Notes receivable or Bonds
◼ Used trucks.
1-63
Acquirer’s Cost: Category 1
General Rule
◼ Use the FMV of the consideration given.
Exception
◼ Use the FMV of the property received… if it is
more readily determinable.
P
stock
stock
Sub
Shareholders
S
1-64
Group Exercise 1: Basic Acquisition
Pete Inc. acquired 100% of the outstanding
common stock of Sake Inc. for $2,500,000 cash and
20,000 shares of its own common stock ($1 par
value), which was trading at $50 per share at the
acquisition date.
$+
Stock
Pete
Stock
Sake
Shareholders
Sake
Required: Prepare the journal entry to record the acquisition.
1-65
Group Exercise 1: Basic Acquisition
Pete Inc. acquired 100% of the outstanding
common stock of Sake Inc. for $2,500,000 cash and
20,000 shares of its own common stock ($1 par
value), which was trading at $50 per share at the
acquisition date.
Acquisition Cost:
Cash
$2,500,000
Stock
1,000,000
Total
$3,500,000
$+
Stock
Pete
Investment in Sake
3,500,000
Cash
Common Stock
Additional Paid-in Cap.
Stock
2,500,000
20,000
980,000
Sake
Shareholders
Sake
1-66
Acquirer’s Cost: Category 2
In the past, costs traceable to the acquisition were
capitalized:
◼ Legal fees—the acquisition agreement
◼ Purchase investigation fees
◼ Finder’s fees
◼ Travel costs
◼ Professional consulting fees
SFAS 141R requires that they be expensed in the
acquisition period.
Do not expense direct costs of issuing stock
◼
Charge to Additional Paid-In Capital
1-67
Group Exercise 2: Recording Direct Costs
Assume the same information provided in Exercise 1. In addition, assume
that Pete incurred the following direct costs:
Legal fees (acquisition) $ 52,000
Accounting fees
27,000
Travel expenses
11,000
Legal fees (stock issue)
31,000
Accounting fees (review)
14,000
SEC filing fees
9,000
Total
$144,000
$+
Stock
Pete
Stock
Prior to the consummation date, $117,000 had been
paid and charged to a deferred charges account pending
consummation of the acquisition. The remaining
$27,000 has not been paid or accrued.
Sake
Shareholders
Sake
Required: Prepare the journal entry to record the direct costs.
1-68
Group Exercise 2: Solution
Charge To
Acquisition
Additional
Expense
Paid-in Capital
Legal fees
$ 52,000
Accounting fees
27,000
Travel expenses
11,000
Legal fees—SEC
$ 31,000
Accounting fees—SEC
14,000
Filing fees—SEC
9,000
Totals
$ 90,000
$ 54,000
Acquisition Expense
Additional Paid-in Capital
Deferred Charges
Accrued Liabilities
90,000
54,000
117,000
27,000
1-69
Acquirer’s Cost: Category 3
Contingent Consideration
◼
Contingent payments depending on some
unresolved future event.
⚫ Example: agree to issue additional shares in 6 months
if shares given lose value.
◼
◼
Record at fair value as of the acquisition date.
Mark to market each subsequent period until the
contingent event is resolved.
1-70
Goodwill vs. Bargain Purchase Element
➔
Goodwill
FMV Given < FMV of Net Assets
➔
Bargain
Purchase
Element
FMV Given = FMV of Net Assets
➔
Neither GW
nor BPE
FMV Given > FMV of Net Assets
1-71
Goodwill: How to calculate it?
Goodwill is calculated as the residual
amount.
◼
First, estimate the FMV of identifiable net assets.
⚫
Includes both tangible AND intangible assets.
Second, subtract the total FMV of all identifiable
net assets from the total FMV given by owners.
◼ The residual is deemed to be goodwill.
◼
GW = Total FMV Given – FMV of Identifiable Net Assets
1-72
Goodwill Example
Assume Bigco Corp. pays $400,000 for Littleco Inc. and
that the estimated fair market values of assets, liabilities,
and equity accounts are as follows:
Accounts Receivable $ 100,000
Inventory
100,000
LT Marketable sec.
60,000
PP&E
140,000
Total Assets
$ 400,000
Liabilities
$200,000
Retained Earnings
Common Stock
Total Liab/Equity
100,000
100,000
$ 400,000
Net Assets = Total Assets – Total Liabilities
Net Assets = $ 400,000 – $200,000 = $200,000
Goodwill = Acquisition price – FMV Net Assets
= $400,000 – $200,000 = $200,000
1-73
Goodwill Example Continued
Journal Entry:
Accounts Receivable
Inventory
Marketable Securities
PP&E
Goodwill
Cash
Liabilities
$ 100,000
100,000
60,000
140,000
200,000
$ 400,000
200,000
1-74
Goodwill: What to Do With It?
Goodwill
◼
Must capitalize as an asset.
◼
Cannot amortize to earnings.
◼
◼
Must periodically (at least annually) assess for
impairment.
If impaired, must write it down—charge to
earnings.
1-75
Bargain Purchase Element: What to Do With It?
Bargain Purchase Element
◼
◼
Still record assets and liabilities assumed at their
fair values.
The amount by which consideration given
exceeds the fair value of net assets is a gain to the
acquirer.
1-76
Bargain Purchase Example
Assume Bigco Corp. pays $1500,000 for Littleco Inc. and
that the estimated fair market values of assets, liabilities,
and equity accounts are as follows:
Accounts Receivable $ 100,000
Inventory
100,000
LT Marketable sec.
60,000
PP&E
140,000
Total Assets
$ 400,000
Liabilities
$200,000
Retained Earnings
Common Stock
Total Liab/Equity
100,000
100,000
$ 400,000
Net Assets = Total Assets – Total Liabilities
Net Assets = $ 400,000 – $200,000 = $200,000
Goodwill = Acquisition price – Net Assets
= $150,000 – $200,000 = $(50,000)
1-77
Goodwill Example Continued
Journal Entry:
Accounts Receivable
Inventory
Marketable Securities
PP&E
Gain
Cash
Liabilities
$ 100,000
100,000
60,000
140,000
$ 50,000
150,000
200,000
1-78
Acquisition of Intangibles
SFAS 141R
An intangible asset should be recognized
separately from goodwill only if its benefits can
be separately identified.
◼ Finite intangible assets should be amortized over
their useful life with no arbitrary cap (i.e., no 40
year limit).
◼ Some intangible assets (such as goodwill) may
have an indefinite or infinite life. They should not
be amortized, but tested for impairment at least
annually.
◼
1-79
Intangible Assets:
More are recognized under SFAS 141R
Record at fair value but only if either of the
following two criteria are met:
1. Intangible arises from a legal or contractual
right.
2. Intangible does not arise from a legal or
contractual right but is separable.
1-80
Separately Recognized Intangibles
SFAS 141R specifies that the
following should be recognized
separately from goodwill:
◼
Marketing-related intangibles
⚫
◼
Customer-related intangibles
⚫
◼
normally items protected by copyrights
Contract-based intangibles
⚫
◼
customer lists, order backlogs, etc.
Artistic-related intangibles
⚫
◼
trademarks and internet domains
Key:
Purpose is to
get companies
to recognize
intangibles
separately from
goodwill.
licenses, franchises, broadcast rights
Technology-based intangible assets
⚫ both patented and unpatented
technologies
1-81
Group Exercise 3: Acquisition of Intangibles
On January 1, 2009, Buyer Company acquired 100-percent ownership of Target
Company for $9,400 cash.
Current Assets
$2,400
3,900 Total Assets
Property, Plant, and Equipment
1,500
Current Liabilities
500
1,600 Total Liabilities
Long-term Debt
1,100
Separately
Identifiable:
2,300 Net Assets
In addition, Target Company had the following intangible items on the
acquisition date (not included in Target’s balance sheet):
1,400 a. Trademarks (not recognized on Target’s books) because they were
internally developed. The trademarks have a value of $1,400. The useful
life of these trademarks is indefinite.
1,000 b. Ongoing research projects that have an estimated value of $1,000.
1,500 c. Internally-developed computer software with a value of $1,500. This
software has a useful life of three years.
800 d. Internally-developed patents with a value of $800. The patents have a
useful life of seven years.
200 e. Other separately-identifiable intangibles with a value of $200. These
assets have an average useful life of five years.
4,900
REQUIRED: Make Buyer’s journal entry to record the acquisition of Target.
1-82
Group Exercise 3: Solution
Purchase
Net
Separately
Price
− Assets − Identified Int. = G.W.
$9,400
$2,300
$4,900
$2,200
Current Assets
Property, Plant, and Equipment
Trademarks
In-Process Research and Development
Computer Software
Patents
Other Intangible Assets
Goodwill
Current Liabilities
Long-term Debt
Cash
2,400
1,500
1,400
1,000
1,500
800
200
2,200
500
1,100
9,400
1-83
Acquisition Method – Comprehensive Example
Entries Recorded by Acquiring Company
Entries Recorded by Acquired Company
Merger Expense
40,000
Cash
40,000
Record costs related to acquisition of Sharp Company.
Investment in Point Stock
610,000
Current Liabilities
100,000
Accumulated Depreciation
150,000
Cash and Receivables
Inventory
Land
Buildings and Equipment
Gain on Sale of Net Assets
Record transfer of assets to Point Corporation.
Deferred Stock Issue Costs
25,000
Cash
25,000
Record costs related to issuance of common stock.
On the date of combination, Point records the acquisition
of Sharp with the following entry:
Cash and Receivables
45,000
Inventory
75,000
Land
70,000
Buildings and Equipment
350,000
Patent
80,000
Goodwill
100,000
Current Liabilities
110,000
Common Stock
100,000
Additional Paid-In Capital
485,000
Deferred Stock Issue Costs
25,000
Record acquisition of Sharp Company.
Common Stock
100,000
Additional Paid-In Capital
50,000
Retained Earnings
150,000
Gain on Sale of Net Assets
310,000
Investment in Point Stock
Record distribution of Point Corporation stock.
45,000
65,000
40,000
400,000
310,000
610,000
1-84
Acquisition Accounting
Testing for goodwill impairment
When goodwill arises in a business combination, it
must be assigned to individual reporting units.
◼ To test for impairment, the fair value of the reporting
unit is compared with its carrying amount.
◼ If the fair value of the reporting unit exceeds its
carrying amount, the goodwill of that reporting unit is
considered unimpaired.
◼ If the carrying amount of the reporting unit exceeds its
fair value, an impairment of the reporting unit’s
goodwill is implied.
◼
1-85
Acquisition Accounting
The amount of the reporting unit’s goodwill
impairment is measured as the excess of the
carrying amount of the unit’s goodwill over the
implied value of its goodwill.
The implied value of its goodwill is determined as
the excess of the fair value of the reporting unit over
the fair value of its net assets excluding goodwill.
Goodwill impairment losses are recognized in
income from continuing operations or income
before extraordinary gains and losses.
1-86
Acquisition Accounting
Financial reporting subsequent to a
business combination
Financial statements prepared subsequent to a
business combination reflect the combined entity
only from the date of combination.
◼ When a combination occurs during a fiscal period,
income earned by the acquiree prior to the
combination is not reported in the income of the
combined enterprise.
◼
1-87
Practice Quiz Question #6
A form of consideration that is not
allowed in acquisition accounting is:
a.
b.
c.
d.
e.
Cash.
Bonds.
Preferred stock.
Common stock.
none of the above.
1-88
Practice Quiz Question #6 Solution
A form of consideration that is not
allowed in acquisition accounting is:
a.
b.
c.
d.
e.
Cash.
Bonds.
Preferred stock.
Common stock.
none of the above.
1-89
Practice Quiz Question #7
Which of the following costs can be
added to the cost of an acquisition?
a.
b.
c.
d.
e.
f.
g.
Legal fees.
Accounting fees.
Costs of issuing common stock.
A pro rata portion of the CEO’s salary.
Travel costs.
Costs of the M&A department.
None of the above.
1-90
Practice Quiz Question #7 Solution
Which of the following costs can be
added to the cost of an acquisition?
a.
b.
c.
d.
e.
f.
g.
Legal fees.
Accounting fees.
Costs of issuing common stock.
A pro rata portion of the CEO’s salary.
Travel costs.
Costs of the M&A department.
None of the above.
1-91
Learning Objective 6
Understand additional
considerations associated
with business combinations.
1-92
Additional Considerations
Uncertainty in business combinations
◼
Measurement Period
⚫ FASB 141R allows for this period of time to
properly ascertain fair values.
⚫ The period ends once the acquirer obtains the
necessary information about the facts as of the
acquisition date.
⚫ May not exceed one year.
1-93
Additional Considerations
Contingent consideration
Sometimes the consideration exchanged is not fixed in amount,
but rather is contingent on future events; e.g., a contingentshare agreement
◼ FASB 141R requires contingent consideration to be valued at
fair value as of the acquisition date and classified as either a
liability or equity.
◼
Acquiree contingencies
Under FASB 141R, the acquirer must recognize all
contingencies that arise from contractual rights or obligations
and other contingencies if it is more likely than not that they
meet the definition of an asset/liability at the acquisition date.
◼ Recorded by the acquirer at acquisition-date fair value.
◼
1-94
Additional Considerations
In-process research and development
◼
◼
◼
The FASB concluded that valuable ongoing
research and development projects of an acquiree
are assets and should be recorded at their
acquisition-date fair values, even if they have no
alternative use.
These projects should be classified as indefinitelived and, therefore, should not be amortized until
completed or abandoned.
They should be tested for impairment.
1-95
Additional Considerations
Noncontrolling equity held prior to combination
◼
An acquirer that held an equity position in an acquiree
immediately prior to the acquisition date must revalue
that equity position to its fair value at the acquisition date
and recognize a gain or loss on the revaluation.
Acquisitions by contract alone
◼
The amount of the acquiree’s net assets at the date of
acquisition is attributed to the noncontrolling interest and
included in the noncontrolling interest reported in
subsequent consolidated financial statements.
1-96
Consolidation: The Concept
Parent creates or gains control of the subsidiary.
The result: a single legal entity.
P
S
1-97
Consolidation– The Big Picture
How do we report the results of subsidiaries?
Parent
Company
80%
51%
21%
Sub A
Sub B
Sub C
Consolidation
Equity Method
(plus the Equity Method)
1-98
Consolidation: The Concept
Two or more separate entities under
common control
Present “as if ” they were one company.
Two or more sets of books are merged
together into one set of financial statements
1-99
Consolidation: Basic Idea
Presentation:
◼ Sum the parent’s and subsidiary’s accounts.
◼ We’ll start covering this in detail in Chapter 2.
“One-line” consolidation
Replace with…
Liabilities
Equity
Total Liabilities & Equity
$ 300 $200
1,300 500
$1,600 $700
“The Detail”
Cash
Investment in Sub
PP&E
Total Assets
Parent Sub Consolidated
$ 200 $100
$ 300
500
900 600
1,500
$1,600 $700
$1,800
$ 500
1,300
$1,800
1-100
Consolidation Entries
Just a quick introduction…
Two examples of eliminating entries:
◼
The “Basic” eliminating entry
⚫
◼
Removes the “investment” account from the parent’s balance
sheet and the subsidiary’s equity accounts.
An intercompany loan (from Parent to Sub)
Equity
Worksheet
Investment in Sub
Entry
Only!
Payable to Parent
Receivable from Sub
500
500
100
100
1-101
Simple Consolidation Example
Cash
Receivable from Sub
Investment in Sub
PP&E
Total Assets
Parent Sub
$ 200 $100
100
500
800
600
$1,600 $700
Liabilities
Payable to Parent
Equity
Total Liabilities & Equity
$ 300 $100
100
1,300 500
$1,600 $700
DR CR
100
500
100
500
Cons.
$ 300
0
0
1,400
$1,700
$ 400
0
1,300
$1,700
1-102
Conclusion
The End
Chapter 02
Reporting Intercorporate
Investments and
Consolidation of Wholly
Owned Subsidiaries with
No Differential
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
Understand and explain how
ownership and control can
influence the accounting
for investments in common
stock.
2-2
Accounting for Investments in Common Stock
The method used to account for investments in
common stock depends on:
◼
◼
the level of influence or control that the investor
is able to exercise over the investee.
choices made by the investor because of options
available.
2-3
Financial Reporting Basis by Ownership Level
2-4
Investment vs. Ownership
Consolidation eliminates the investment account and
replaces it with “the detail.”
Account for as
trading, AFS, or
Cost Investments
Ownership
Percentage
Equity method
or Fair Value
Option
No
significant
influence
0%
20%
Significant
influence
Usually equity method
and consolidation
(but cost method is
also okay here)
Control
50%
Why is the cost
method okay?
100%
2-5
Accounting for Investments in Common Stock
The Cost Method
◼
Used for reporting investments in equity securities
when both consolidation and equity-method reporting
are inappropriate
The Equity Method
◼
◼
◼
Used when the investor exercises significant influence
over the operating and financial policies of the investee
and consolidation is not appropriate
May not be used in place of consolidation if
consolidation is appropriate
Its primary use is in reporting nonsubsidiary
investments
2-6
Accounting for Investments in Common Stock
Consolidation
◼
◼
◼
Involves combining for financial reporting the individual
assets, liabilities, revenues, and expenses of two or more
related companies as if they were part of a single company
Normally is appropriate when one company, referred to
as the parent, controls another company, referred to as a
subsidiary
A subsidiary that is not consolidated with the parent is
referred to as an unconsolidated subsidiary and is shown
as an investment on the parent’s balance sheet.
2-7
Practice Quiz Question #1
If Company A purchases 45% of the
outstanding common stock of Company B,
the investment in Company B should be
accounted for
a.
b.
c.
d.
e.
as an available-for-sale investment.
as a consolidated subsidiary.
as a trading investment.
as an equity method investment.
none of the above.
2-8
Practice Quiz Question #1 Solution
If Company A purchases 45% of the
outstanding common stock of Company B,
the investment in Company B should be
accounted for
a.
b.
c.
d.
e.
as an available-for-sale investment.
as a consolidated subsidiary.
as a trading investment.
as an equity method investment.
none of the above.
2-9
Learning Objective 2
Prepare journal entries
using the cost method for
accounting for investments
2-10
The Cost Method: How It Works
Record the investment at “cost.”
General Rule:
◼
Leave it on the books at cost.
P
S
2-11
The Cost Method: How It Works
Review
◼
◼
Assume P Corp creates a subsidiary, S Corp, and invests $100,000
cash in exchange for all of the $1 par common stock (1,000 shares).
What journal entries would P and S make at the time of the
investment?
P
S
P Corp:
Investment in S Corp
Cash
100,000
S Corp:
Cash
Common Stock
Additional PIC—CS
100,000
100,000
1,000
99,000
2-12
The Cost Method: How It Works
General Rule
The investment remains on parent’s books at cost
⚫ Record income at the parent level ONLY when
sub declares a dividend.
◼ Generally, the sub’s income does not affect
parent’s investment account balance.
⚫ However, the parent cannot ignore the sub’s
losses.
⚫ Parent writes-down investment ONLY IF value
has been impaired.
⚫ Write-downs result in a NEW cost basis.
◼
2-13
The Cost Method: How It Works
The cost method is a one-way street!
The investment can be written down—but never
written up.
Investment Account
Cost
Impairment
Loss
New Cost
Basis
2-14
The Cost Method: Pros & Cons
Pros
Minimal G/L bookkeeping by parent
◼ Simple consolidation procedures
◼
Cons
Overly conservative valuation
◼ Parent can manipulate its reported income.
◼
Why?
⚫ Parent controls when sub pays dividends!
⚫
◼
PCO statements—if used internally or issued—
may be misleading.
2-15
The Cost Method: Key Concept
Although the parent can manipulate its
own reported net income, it can never
manipulate consolidated net income.
2-16
The Cost Method
Used when the investor lacks the ability
either to control or to exercise significant
influence over the investee.
Accounting Procedures
◼
The cost method is consistent with the treatment
normally accorded noncurrent assets.
2-17
The Cost Method
At the time of purchase, the investor records its
investment in common stock at the total cost
incurred in making the purchase.
The investment continues to be carried at its
original cost until the time of sale.
Income from the investment is recognized as
dividends are declared by the investee.
Recognition of investment income before a dividend
declaration is inappropriate.
2-18
Example: The Cost Method
ABC Company acquires 20 percent of XYZ Company’s
common stock for $100,000 at the beginning of the year but
does not gain significant influence over XYZ. During the year,
XYZ has net income of $60,000 and pays dividends of
$20,000. ABC Company records the following entries:
Investment in XYZ Company Stock
Cash
100,000
100,000
Record purchase of XYZ Company stock.
Cash
Dividend Income
4,000
4,000
Record dividend income from XYZ Company stock: $20,000 x 0.20.
2-19
The Cost Method
Declaration of dividends in excess of earnings since
acquisition
◼
◼
◼
Liquidating dividends: Dividends declared by the investee in excess of
its earnings since acquisition by the investor from the investor’s
viewpoint
The investor’s share of these liquidating dividends is treated as a
return of capital, and the investment account balance is reduced by
that amount.
These dividends usually are not liquidating dividends from the
investee’s point of view.
Acquisition at interim date
◼
Does not create any major problems when the cost method is used.
◼
Potential difficulty: liquidating dividend determination
2-20
The Cost Method
Changes in the number of shares held
◼
Changes resulting from stock dividends, stock splits, or
reverse splits receive no formal recognition in the
accounts of the investor
Purchases of additional shares
Recorded at cost similar to initial purchase
◼ New percentage ownership is calculated to determine
whether switch to the equity method is required
◼
Sales of shares
◼
Accounted for in the same manner as the sale of any other
noncurrent asset
2-21
Practice Quiz Question #2
Under the cost method, a sub’s dividends
would:
a.
b.
c.
d.
e.
NOT be eliminated in consolidation.
be the parent’s income from investment.
decrease the parent’s investment account.
increase the parent’s investment account.
none of the above.
2-22
Practice Quiz Question #2 Solution
Under the cost method, a sub’s dividends
would:
a.
b.
c.
d.
e.
NOT be eliminated in consolidation.
be the parent’s income from investment.
decrease the parent’s investment account.
increase the parent’s investment account.
none of the above.
2-23
Learning Objective 3
Prepare journal entries
using the equity method
for accounting for
investments.
2-24
The Equity Method: How It Works
The equity method is accrual basis driven:
◼
Record income at the parent level based on sub’s earnings
and losses—a built in valuation technique.
⚫
⚫
◼
It isn’t the same as fair value accounting.
Nevertheless, the investment generally goes up and down based
on the operations of the investee company.
Sub’s dividends reduce the parent’s investment (the
parent has less invested).
Investment in Sub
Cost
Income
Losses
Dividends
Adj. Bal.
Income from Sub
Losses
Income
2-25
The Equity Method: How It Works
The equity method is a two-way street!
The investment can be:
1. written up based on the sub’s income AND
2. written down based on sub losses and dividends
2-26
The Equity Method: Pros and Cons
Pros
Based on economic activity—not the parentcontrolled dividend policy.
◼ Has two built-in checking figures:
◼
Consolidated NI = Parent’s NI
⚫ Consolidated RE = Parent’s RE
⚫
Cons
Requires continual bookkeeping.
◼ Unnecessary work if PCO statements are not
used internally or issued to outsiders.
◼
2-27
The Equity Method
The equity method is intended to reflect the
investor’s changing equity or interest in the
investee.
The investment is recorded at the initial
purchase price and adjusted each period for
the investor’s share of the investee’s profits
or losses and the dividends declared by the
investee.
2-28
The Equity Method
APB Opinion No. 18 (as amended) requires that the
equity method be used for:
1. Corporate joint ventures
2. Companies in which the investor’s voting stock interest
gives the investor the “ability to exercise significant
influence over operating and financial policies” of that
company
“Significant influence” criterion – 20 percent rule
◼
In the absence of evidence to the contrary, an investor
holding 20 percent or more of an investee’s voting stock
is presumed to have the ability to exercise significant
influence over the investee.
2-29
The Equity Method
Investor’s equity in the investee
The investor records its investment at the
original cost
◼ This amount is adjusted periodically:
◼
Reported by Investee
Effect on Investor’s Accounts
Net income
Record income from investment
Increase investment account
Net loss
Record loss from investment
Decrease investment account
Dividend declaration
Record asset (cash or receivable)
Decrease investment account
2-30
Example: The Equity Method
ABC Company acquires significant influence over XYZ
Company by purchasing 20 percent of the common stock of
the XYZ Company for $100,000, XYZ earns income of $60,000
and pays dividends of $20,000.
Recognition of income
This entry (equity accrual) is normally is made as an
adjusting entry at the end of the period
◼ If the investee reports a loss, the investor recognizes its
share of the loss and reduces the carrying amount of the
investment by that amount
◼
Investment in XYZ Company Stock
Income from Investee
12,000
12,000
Record income from investment in XYZ Company ($60,000 x 0.20).
2-31
Example: The Equity Method
Recognition of dividends
Cash
Investment in XYZ Company Stock
4,000
4,000
Record receipt of dividend from XYZ Company ($20,000 x 0.20).
Carrying amount of the investment
Investment in XYZ Common Stock
Original Cost
Equity Accrual
(60,000 x 0.20)
100,000
Ending Balance
108,000
Dividends
12,000
($20,000 x 0.20)
4,000
2-32
The Equity Method
Acquisition at Interim Date
◼
No income earned by the investee before the
date of acquisition may be accrued by the
investor
Acquisition between balance sheet dates
◼
The amount of income earned by the investee from
the date of acquisition to the end of the fiscal period
may need to be estimated by the investor in
recording the equity accrual
2-33
The Equity Method
Purchases of additional shares
◼
◼
If the equity method was being used to account
for shares already held, the acquisition involves
adding the cost of the new shares to the
investment account and applying the equity
method from the date of acquisition forward.
New and old investments in the same stock are
combined for financial reporting purposes.
2-34
The Equity Method
Sale of shares
Treated the same as the sale of any noncurrent asset
◼ First, the investment account is adjusted to the date of
sale for the investor’s share of the investee’s current
earnings
◼ Then, a gain or loss is recognized for the difference
between the proceeds received and the carrying amount
of the shares sold
◼ If only part of the investment is sold, the investor must
decide whether to continue using the equity method or
to change to the cost method
◼
2-35
Practice Quiz Question #3
Under the equity method, a sub’s
dividends would:
a.
b.
c.
d.
e.
NOT be eliminated in consolidation.
be the parent’s income from investment.
decrease the parent’s investment account.
increase the parent’s investment account.
none of the above.
2-36
Practice Quiz Question #3 Solution
Under the equity method, a sub’s
dividends would:
a.
b.
c.
d.
e.
NOT be eliminated in consolidation.
be the parent’s income from investment.
decrease the parent’s investment account.
increase the parent’s investment account.
none of the above.
2-37
Practice Quiz Question #4
Under the equity method, a sub’s losses
would:
a.
b.
c.
d.
e.
never reduce the parent’s income.
normally reduce the parent’s income.
always reduce the parent’s income.
always be eliminated in consolidation.
none of the above.
2-38
Practice Quiz Question #4 Solution
Under the equity method, a sub’s losses
would:
a.
b.
c.
d.
e.
never reduce the parent’s income.
normally reduce the parent’s income.
always reduce the parent’s income.
always be eliminated in consolidation.
none of the above.
2-39
Learning Objective 4
Understand and explain
differences between the
cost and equity methods.
2-40
The Cost and Equity Methods Compared
Item
Cost Method
Equity Method
Recorded amount of
investment at date of
acquisition
Original cost
Original Cost
Usual carrying amount of
investment subsequent to
acquisition
Original cost
Original cost increased
(decreased) by investor’s share
of investee’s income (loss) and
decreased by investor’s share of
investee’s dividends
Income recognition by
investor
Investor’s share of
investee’s dividends
declared from earnings
since acquisition
Investor’s share of investee’s
earnings since acquisition,
whether distributed or not
Investee dividends from
earnings since acquisition by
investor
Income
Reduction of investment
Investee dividends in excess
of earnings since acquisition
by investor
Reduction of investment
Reduction of investment
2-41
Example: Equity Method versus Cost Method
Pea Corporation created Soup Corporation with a transfer of $500 cash.
During Soup Corp.’s first year of operations, it generated a net loss of $100
and paid no dividends. During Soup Corp.’s second year of operations, it
generated net income of $200 and paid dividends of $50. What is the
balance in the Investment in Sub account on Parent’s books at the end of
year 2 using the equity method?
Investment in Sub
Beginning balance
500
Net Loss
100
Ending balance
Net income
400
200 Dividends
50
Ending balance
550
What if Parent uses the cost method?
$500 COST!!!
What journal entries would Parent make under each method?
2-42
Summary of Year 1 Equity Method Entries
Investment in Soup Corp.
Cash
500
500
Record the initial investment in Soup Corp.
Income from Soup Corp.
Investment in Soup. Corp.
100
100
Record Pea Corp.’s 100% share of Soup Corp.’s Year 1 net loss.
Investment in Soup Corp.
Acquisition Price 500
Ending Balance
400
Net Loss
Dividends
Income from Soup Corp.
100
0
Net Loss
100
Ending Balance 100
2-43
Summary of Year 2 Equity Method Entries
Investment in Soup Corp.
Income from Soup Corp.
200
200
Record Pea Corp.’s 100% share of Soup Corp.’s Year 2 income.
Cash
Investment in Soup. Corp.
50
50
Record Pea Corp.’s 100% share of Soup Corp.’s Year 2 dividends
Investment in Soup Corp.
Income from Soup Corp.
Beginning Balance 400
Net Income
200
Net Income
Dividends
Ending Balance
550
200
50
Ending Balance 200
2-44
Example: Equity versus Cost Method
Equity Method
Cost Method
Investment in Soup Corp.
Cash
500
Income from Soup Corp.
Investment in Soup Corp.
100
Investment in Soup Corp.
Income from Soup Corp.
200
Dividends Receivable
Investment in Soup Corp.
50
500
Investment in Soup Corp.
Cash
500
500
No Entry
100
No Entry
200
50
Dividends Receivable
Dividend Income
50
50
2-45
Practice Quiz Question #5
On 1/1/X4, Phillip invested $650,000 in Sleeper (100%
owned). For 20X4, Sleeper:
(1) earned $90,000,
(2) declared dividends of $60,000, and
(3) paid dividends of $40,000.
What amounts does Phillip report?
Cost
Equity
Investment income for 20X4
Investment in Sleeper at year-end
Retained earnings increase
2-46
Practice Quiz Question #5 Solution
On 1/1/X4, Phillip invested $650,000 in Sleeper (100%
owned). For 20X4, Sleeper:
(1) earned $90,000,
(2) declared dividends of $60,000, and
(3) paid dividends of $40,000.
What amounts does Phillip report?
Cost
Equity
Investment income for 20X4
$60,000 $90,000
Investment in Sleeper at year-end $650,000 $680,000
Retained earnings increase
$60,000 $90,000
2-47
Learning Objective 5
Prepare journal entries
using the fair value
option.
2-48
The Fair Value Option
FASB 159 permits but does not require companies
to make fair value measurements
Option available only for investments that are not
required to be consolidated
◼ Rather than using the cost or equity method to report
nonsubsidiary investments in common stock, investors
may report those investments at fair value
◼ The investor remeasures the investment to its fair value at
the end of each period
◼ The change in value is then recognized in income for the
period
◼ Normally the investor recognizes dividend income in the
same manner as under the cost method
◼
2-49
Example: The Fair Value Option
Ajax Corporation purchases 40 percent of Barclay Company’s common stock on
January 1, 20X1, for $200,000. Barclay has net assets on that date with a book
value of $400,000 and fair value of $465,000. On March 1, 20X1, Ajax receives a
cash dividend of $1,500 from Barclay. On March 31, 20X1, Ajax determines the fair
value of its investment in Barclay to be $207,000. During the first quarter of 20X1,
Ajax records the following entries:
January 1, 20X1
Investment in Barclay Stock
Cash
200,000
200,000
Record purchase of Barclay Company stock.
March1, 20X1
Cash
Dividend Income
1,500
1,500
Record dividend income from Barclay Company.
March 31, 20X1
Investment in Barclay Stock
Unrealized Gain on Increase in Value of Barclay Stock
Record increase in value of Barclay stock.
7,000
7,000
2-50
Learning Objective 6
Make calculations and
prepare basic elimination
entries for a simple
consolidation.
2-51
Overview of the Consolidation Process
Chapter 2 introduces the most simple setting for a
consolidation.
The subsidiary is wholly owned.
◼ It is either a created subsidiary or we assume it is
purchased for an amount equal to the book value of net
assets.
◼
Wholly Owned
Subsidiary
Partially Owned
Subsidiary
Investment = Book Value
Chapter 2
Chapter 3
Investment > Book Value
Chapter 4
Chapter 5
2-52
Overview of the Consolidation Process
The objective is to combine the financial statements
of two or more entities as if they are a single
corporation.
The consolidation worksheet facilitates the
combining of the two companies.
Certain accounts need to be eliminated in the
consolidation process to avoid “double counting.”
◼
Replaces “one-line” consolidation with the “detail.”
2-53
The Consolidation Worksheet (Fig. 2-3, p. 68)
Elimination Entries
Parent
Subsidiary
DR
CR
Consolidated
Income Statement
Revenues
Expense
Expense
Net Income
Statement of Retained Earnings
Retained Earnings (1/1)
Add: Net Income
Less: Dividends
Retained Earnings (12/31)
Balance Sheet
Assets
Total Assets
Liabilities
Equity
Common Stock
Retained Earnings
Total Liabilities and Equity
2-54
Overview of the Consolidation Process
In the consolidation worksheet, the three
financial statements need to articulate.
◼
◼
Net income from the income statement carries down to
the statement of retained earnings.
The ending balance in retained earnings carries down to
the balance sheet.
Elimination entries are entered into the
“Elimination Entries” column (debit or credit)
to eliminate any amounts that would result in
“double counting.”
2-55
The Basic Elimination Entry: The Equity Method
What needs to be eliminated?
◼
The parent’s investment account
⚫
It represents the initial investment adjusted
for the parent’s cumulative share of the
subsidiary’s income and dividends.
◼
The parent’s income from sub account
◼
The subsidiary’s equity accounts
2-56
Example: Equity Method
Pea Corporation created Soup Corporation with a transfer of $500 cash.
During Soup Corp.’s first year of operations, it generated a net loss of $100
and paid no dividends. During Soup Corp.’s second year of operations, it
generated net income of $200 and paid dividends of $50. What is the
balance in the Investment in Sub account on Parent’s books at the end of
year 2 using the equity method?
Investment in Sub
Beginning balance
500
Net Loss
100
Ending balance
Net income
400
200 Dividends
50
Ending balance
550
What accounts need to be eliminated?
How are they eliminated?
2-57
The Basic Elimination Entry: Equity Method
The investment account represents the initial investment
adjusted for the parents cumulative share of the subsidiary’s
income and dividends.
Therefore, the elimination entry eliminates:
◼
◼
◼
The subsidiary’s paid-in capital accounts (original investment)
Beginning retained earnings (past earnings / dividends)
The subsidiary’s current year earnings and dividends
Generically, it looks like this:
Common Stock
XXX
Additional Paid-in Capital
XXX
Retained Earnings (Beginning Balance)
XXX
Income from Sub
XXX
Dividends Declared
XXX
Investment in Sub
XXX
2-58
The Basic Elimination Entry: Equity Method
Additional
Total = Common + Paid-In + Retained
Book Value
Stock
Capital
Earnings
Beginning Book Value
+ Net Income
− Dividends
400)
200)
(50)
50
450
(100)
200)
(50)
Ending Book Value
550)
50
450
50)
Note that the “blue” numbers appear
in the basic elimination entry.
Note that this is a
deficit balance!
Basic Elimination Entry
Common Stock
Additional Paid-in Capital
Income from Soup Corp.
Retained Earnings (BB)
Dividends Declared
Investment in Soup Corp.
Original amount invested (100%)
Original amount invested (100%)
Soup Corp.’s reported income
Beginning balance in retained earnings
100% of Soup Corp.’s dividends
Net book value in investment account
2-59
The Basic Elimination Entry: Equity Method
Additional
Total = Common + Paid-In + Retained
Book Value
Stock
Capital
Earnings
Beginning Book Value
+ Net Income
− Dividends
400)
200)
(50)
50
450
(100)
200)
(50)
Ending Book Value
550)
50
450
50)
Note that the “blue” numbers appear
in the basic elimination entry.
Note that this is a
deficit balance!
Basic Elimination Entry
Common Stock
50
Additional Paid-in Capital
450
Income from Soup Corp.
200
Retained Earnings (BB)
Dividends Declared
Investment in Soup Corp.
Original amount invested (100%)
Original amount invested (100%)
Soup Corp.’s reported income
100 Beginning balance in retained earnings
50 100% of Soup Corp.’s dividends
550 Net book value in investment account
2-60
Basic Elimination Entry: The Equity Method
Basic Elimination Entry
Common Stock
50
Additional Paid-in Capital
450
Income from Soup Corp.
200
Retained Earnings (BB)
100
Dividends Declared
50
Investment in Soup Corp.
550
Investment in Soup Corp.
Income from Soup Corp.
Beginning Balance 400
Net Income
200
Net Income
Dividends
Ending Balance
50
Ending Balance 200
550
550
0
200
Basic
200
0
2-61
Learning Objective 7
Prepare a
consolidation
worksheet.
2-62
Worksheet: Pre-Consolidation Balances
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
Elimination Entries
DR
CR
Consolidated
200
600
700
2-63
Worksheet: Draw lines
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
Elimination Entries
DR
CR
Consolidated
200
600
700
2-64
Worksheet: Eliminations, Sub-totals, Carry down
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
Elimination Entries
DR
CR
Consolidated
200
200
100
50
550
600
700
50
450
2-65
Worksheet: Eliminations, Sub-totals, Carry down
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
100
0
50
150
550
2-66
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
100
0
50
150
550
2-67
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
1,800
200
200
200
200
0
100
0
50
150
550
2-68
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
1,800
(900)
200
200
200
200
0
100
0
50
150
550
2-69
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
1,800
(900)
(550)
200
200
200
200
0
100
0
50
150
550
2-70
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
1,800
(900)
(550)
0
0
100
0
50
150
550
2-71
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
1,800
(900)
(550)
0
350
100
0
50
150
550
2-72
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
100
0
50
150
1,800
(900)
(550)
0
350
150
550
2-73
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
100
0
50
150
1,800
(900)
(550)
0
350
150
350
550
2-74
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
100
0
50
150
1,800
(900)
(550)
0
350
150
350
(100)
550
2-75
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
2-76
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
350
550
2-77
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
350
0
2-78
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
350
0
1,500
2-79
Worksheet: Add across
Pea Corp.
Soup Corp.
Elimination Entries
DR
CR
Consolidated
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
600
700
0
550
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
50
450
200
700
150
150
200
200
200
200
200
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
350
0
1,500
1,850
2-80
Worksheet: Add across
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
200
Elimination Entries
DR
CR
200
200
200
200
Consolidated
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
600
700
0
550
350
0
1,500
1,850
450
50
450
200
700
150
150
2-81
Worksheet: Add across
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
200
Elimination Entries
DR
CR
200
200
200
200
Consolidated
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
600
700
0
50
450
200
700
550
350
0
1,500
1,850
450
200
150
150
2-82
Worksheet: Add across
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
200
Elimination Entries
DR
CR
200
200
200
200
Consolidated
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
600
700
0
50
450
200
700
550
350
0
1,500
1,850
450
200
800
150
150
2-83
Worksheet: Add across
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
200
Elimination Entries
DR
CR
200
200
200
200
Consolidated
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
600
700
0
50
450
200
700
550
150
150
350
0
1,500
1,850
450
200
800
400
2-84
Worksheet: Add across
Pea Corp.
Soup Corp.
Income Statement
Sales
Less: COGS
Less: Other Expenses
Income from Soup Corp.
Net Income
1,200
(600)
(450)
200
350
600
(300)
(100)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
150
350
(100)
400
(100)
200
(50)
50
Balance Sheet
Cash
Investment in Soup Corp.
PP&E (net)
Total Assets
250
550
900
1,700
100
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
300
200
800
400
1,700
150
50
450
50
700
200
Elimination Entries
DR
CR
200
200
200
200
Consolidated
0
1,800
(900)
(550)
0
350
100
0
50
150
150
350
(100)
400
550
350
0
1,500
1,850
150
150
450
200
800
400
1,850
550
600
700
0
50
450
200
700
2-85
The Equity Method: Things to Remember in
Consolidation
Consolidated net income EQUALS the
parent’s net income.
Parent
$350
=
Consolidated
$350
Consolidated retained earnings EQUALS
the parent’s retained earnings.
Parent
$400
=
Consolidated
$400
2-86
Group Exercise 1
Pinkett, Inc.
Income Statement
Sales
Less: COGS
Less: Depreciation Expense
Less: Other Expenses
Income from Smith, Inc.
Net Income
840,000
(516,000)
(12,000)
(192,000)
36,000
156,000
Smith, Inc.
300,000
(156,000)
(10,000)
(98,000)
Elimination Entries
DR
CR
Consolidated
REQUIRED
• Assume Pinkett
acquired Smith on
1/1/11
36,000
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
132,000
156,000
(108,000)
180,000
72,000
36,000
(12,000)
96,000
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Smith, Inc.
Property, Plant, & Equipment
Less: Accumulated Depreciation
Total Assets
54,000
114,000
204,000
156,000
336,000
(144,000)
720,000
48,000
66,000
90,000
210,000
(30,000)
384,000
Accounts Payable
Long-term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
168,000
360,000
12,000
180,000
720,000
84,000
144,000
60,000
96,000
384,000
• Prepare all
elimination
entries as of
12/31/11.
• Prepare a
consolidation
worksheet at
12/31/11.
• Assume Smith’s
accumulated
depreciation on
1/1/11 was
$20,000.
2-87
Group Exercise 1
Objective:
Eliminate equity accounts of Sub
Eliminate equity method accounts of Parent.
Book Value Calculations
Total
Book Value
=
Common
Stock
+
Retained
Earnings
Original Book Value
+ Net Income
− Dividends
Ending Book Value
Basic Elimination Entry
Common Stock
Retained Earnings (BB)
Income from Smith, Inc.
Dividends Declared
Investment in Smith, Inc.
2-88
Group Exercise 1: Solution
Objective:
Eliminate equity accounts of Sub
Eliminate equity method accounts of Parent.
Book Value Calculations
Total
Book Value
=
Note that the “blue”
numbers appear in the
basic elimination entry.
Common
Stock
+
Retained
Earnings
Original Book Value
+ Net Income
− Dividends
132,000)
36,000)
(12,000)
60,000
72,000)
36,000)
(12,000)
Ending Book Value
156,000)
60,000
96,000)
Basic Elimination Entry
Common Stock
Retained Earnings (BB)
Income from Smith, Inc.
Dividends Declared
Investment in Smith, Inc.
2-89
Group Exercise 1: Solution
Objective:
Eliminate equity accounts of Sub
Eliminate equity method accounts of Parent.
Book Value Calculations
Total
Book Value
=
Common
Stock
+
Retained
Earnings
Original Book Value
+ Net Income
− Dividends
132,000)
36,000)
(12,000)
60,000
72,000)
36,000)
(12,000)
Ending Book Value
156,000)
60,000
96,000)
Basic Elimination Entry
Common Stock
Retained Earnings (BB)
Income from Smith, Inc.
Dividends Declared
Investment in Smith, Inc.
60,000
72,000
36,000
12,000
156,000
2-90
Group Exercise 1: Solution
The optional accumulated depreciation elimination entry:
Accumulated Depreciation
Buildings and Equipment
Property, Plant & Equipment
210,000
20,000
20,000
Accumulated Depreciation
20,000
2-91
Group Exercise 1: Solution
The optional accumulated depreciation elimination entry:
Accumulated Depreciation
Buildings and Equipment
Property, Plant & Equipment
20,000
20,000
Accumulated Depreciation
210,000
20,000
20,000
20,000
190,000
0
Shows the Buildings and Equipment “as if” they have been
recorded on the Sub’s books as new assets at book value.
2-92
Group Exercise 1: Solution
Pinkett,
Inc.
Smith,
Inc.
Income Statement
Sales
Less: COGS
Less: Depreciation Expense
Less: Other Expenses
Income from Smith, Inc.
Net Income
840,000
(516,000)
(12,000)
(192,000)
36,000
156,000
300,000
(156,000)
(10,000)
(98,000)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
132,000
156,000
(108,000)
180,000
72,000
36,000
(12,000)
96,000
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Smith, Inc.
Property, Plant, & Equipment
Less: Accumulated Depreciation
Total Assets
54,000
114,000
204,000
156,000
336,000
(144,000)
720,000
48,000
66,000
90,000
210,000
(30,000)
384,000
20,000
20,000
176,000
Accounts Payable
Long-term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
168,000
360,000
12,000
180,000
720,000
84,000
144,000
60,000
96,000
384,000
60,000
108,000
168,000
12,000
12,000
36,000
Elimination Entries
DR
CR
36,000
36,000
72,000
36,000
108,000
Consolidated
0
0
12,000
12,000
156,000
20,000
2-93
Group Exercise 1: Solution
Pinkett,
Inc.
Smith,
Inc.
Income Statement
Sales
Less: COGS
Less: Depreciation Expense
Less: Other Expenses
Income from Smith, Inc.
Net Income
840,000
(516,000)
(12,000)
(192,000)
36,000
156,000
300,000
(156,000)
(10,000)
(98,000)
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
132,000
156,000
(108,000)
180,000
72,000
36,000
(12,000)
96,000
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Smith, Inc.
Property, Plant, & Equipment
Less: Accumulated Depreciation
Total Assets
54,000
114,000
204,000
156,000
336,000
(144,000)
720,000
48,000
66,000
90,000
210,000
(30,000)
384,000
Accounts Payable
Long-term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
168,000
360,000
12,000
180,000
720,000
84,000
144,000
60,000
96,000
384,000
36,000
Elimination Entries
DR
CR
36,000
36,000
72,000
36,000
108,000
0
1,140,000
(672,000)
(22,000)
(290,000)
0
156,000
0
12,000
12,000
132,000
156,000
(108,000)
180,000
176,000
102,000
180,000
294,000
0
526,000
(154,000)
948,000
12,000
12,000
252,000
504,000
12,000
180,000
948,000
156,000
20,000
20,000
20,000
60,000
108,000
168,000
Consolidated
2-94
Appendix 2B
Consolidation and
the Cost Method.
2-95
Consolidation Entries: Cost Method —
Pre-Consolidation Balances
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
600
300
100
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
600
700
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
Consolidated
150
50
450
50
700
2-96
The Basic Elimination Entry: The Cost Method
Cost Method
The investment account is generally exactly equal to the
sum of the subsidiary’s paid-in capital accounts.
◼ Unless the parent records an impairment loss.
◼
Common Stock
Additional Paid-in Capital
Investment in Sub
◼
50
450
500
Under the cost method, we also eliminate dividends from
sub to parent.
Dividend Income
Dividends Declared
50
50
2-97
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
Consolidated
600
300
100
50
50
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-98
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
Consolidated
$
1,800
50
50
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-99
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
Consolidated
$
1,800
900
50
50
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-100
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
Consolidated
$
1,800
900
550
50
50
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-101
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-102
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
150
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-103
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
50
50
Consolidated
$
1,800
900
550
$
350
$
150
350
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-104
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
50
50
50
50
Consolidated
$
1,800
900
550
$
350
$
150
350
100
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-105
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
150
350
100
400
50
50
50
50
$
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-106
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-107
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
50
50
50
50
500
$
600
700
0
0
1,500
500
150
50
450
50
700
50
450
50
550
50
50
2-108
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
$
1,500
1,850
50
50
50
50
500
$
600
700
0
0
500
150
50
450
50
700
50
450
50
550
50
50
2-109
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
$
1,500
1,850
$
450
50
50
50
50
500
$
600
700
150
50
450
50
700
0
0
50
450
50
550
500
50
50
2-110
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
$
1,500
1,850
50
50
50
50
500
$
600
700
150
50
450
50
700
0
0
500
$
50
450
50
550
450
200
50
50
2-111
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
$
1,500
1,850
50
50
50
50
500
$
600
700
150
50
450
50
700
0
0
500
$
50
450
50
550
450
200
800
50
50
2-112
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
$
1,500
1,850
50
50
50
50
500
$
600
700
150
50
450
50
700
0
0
500
$
50
450
50
550
50
50
450
200
800
400
2-113
Consolidation Entries: Cost Method —
Complete the Worksheet
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Beginning Balance
Net Income
Less: Dividends Declared
Ending Balance
Balance Sheet
Cash
Investment in Sub
Property, Plant, & Equipment
Total Assets
Liabilities
Common Stock
Additional Paid-in Capital
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
1,200
600
450
50
200
$
$
200
250
200
100
350
$
$
(100)
200
50
50
250
500
900
1,650
$
100
$
$
$
$
$
$
$
300
200
800
350
1,650
Elimination Entries
DR
CR
600
300
100
50
50
Consolidated
$
1,800
900
550
$
350
$
$
150
350
100
400
$
350
$
1,500
1,850
50
50
50
50
500
$
600
700
150
50
450
50
700
0
0
500
$
50
450
50
550
50
50
$
450
200
800
400
1,850
2-114
Group Exercise 1: Cost Method Consolidation
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Balances, 1/1/X3
Add: Net Income
Less: Dividends
Balances, 12/31/X3
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Sub
Property & Equipment
Accumulated Depreciation
Total Assets
Payables & Accruals
Long-term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
840,000
(516,000)
(204,000)
12,000
132,000
$
300,000
(156,000)
(108,000)
$
36,000
60,000
132,000
(108,000)
84,000
$
72,000
36,000
(12,000)
96,000
54,000
114,000
204,000
60,000
336,000
(144,000)
624,000
$
$
$
$
$
$
$
$
168,000
360,000
12,000
84,000
624,000
$
$
48,000
66,000
90,000
210,000
(30,000)
384,000
Elimination Entries
DR
CR
Consolidated
REQUIRED
• Prepare all consolidation
entries as of 12/31/X3.
• Prepare a consolidation
worksheet at 12/31/X3.
• What is the maximum
dividend the parent could
declare ($84,000 or
$180,000) if cash were
available?
84,000
144,000
60,000
96,000
384,000
2-115
Group Exercise 1: Cost Method Consolidation
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Balances, 1/1/X3
Add: Net Income
Less: Dividends
Balances, 12/31/X3
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Sub
Property & Equipment
Accumulated Depreciation
Total Assets
Payables & Accruals
Long-term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
$
300,000
(156,000)
(108,000)
$
36,000
$
$
$
$
$
$
$
840,000
(516,000)
(204,000)
12,000
132,000
60,000
132,000
(108,000)
84,000
54,000
114,000
204,000
60,000
336,000
(144,000)
624,000
168,000
360,000
12,000
84,000
624,000
$
$
$
$
72,000
36,000
(12,000)
96,000
48,000
66,000
90,000
210,000
(30,000)
384,000
84,000
144,000
60,000
96,000
384,000
Elimination Entries
DR
CR
Consolidated
Basic Elimination Entry
Investment elimination
entry
Common Stock
Investment in
Sub
00
60,000
60,0
Dividend elimination entry
Dividend Income
Dividend
Declared
00
12,000
12,0
2-116
Group Exercise 1: Cost Method Consolidation
Solution
Income Statement
Sales
Less: COGS
Less: Expenses
Dividend Income
Net Income
Statement of Retained Earnings
Balances, 1/1/X3
Add: Net Income
Less: Dividends
Balances, 12/31/X3
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Sub
Property & Equipment
Accumulated Depreciation
Total Assets
Payables & Accruals
Long-term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
Pinkett, Inc.
Smith, Inc.
$
840,000
(516,000)
(204,000)
12,000
132,000
$
$
36,000
60,000
132,000
(108,000)
84,000
$
72,000
36,000
(12,000)
96,000
54,000
114,000
204,000
60,000
336,000
(144,000)
624,000
$
$
$
$
$
$
$
$
168,000
360,000
12,000
84,000
624,000
$
Elimination Entries
DR
CR
300,000
(156,000)
(108,000)
12,000
12,000
Consolidated
$
1,140,000
(672,000)
(312,000)
$
156,000
$
132,000
156,000
(108,000)
180,000
12,000
12,000
12,000
12,000
48,000
66,000
90,000
$
$
102,000
180,000
294,000
60,000
$
210,000
(30,000)
384,000
84,000
144,000
60,000
96,000
384,000
60,000
$
$
60,000
12,000
72,000
12,000
12,000
$
546,000
(174,000)
948,000
252,000
504,000
12,000
180,000
948,000
2-117
The Cost Method: Things to Remember in
Consolidation
Consolidated net income does NOT equal the parent’s net
income.
P
$200
+
S
$200
Sub’s Div
−
$50
=
CONS
$350
Consolidated retained earnings does NOT equal the parent’s
retained earnings.
P
$350
+
S
$50
=
CONS
$400
2-118
Consolidation: The Most Important Point of All on
Investment Basis
The consolidated statement amounts are
identical whether the parent uses the cost
method or the equity method—this h…
