Chapter 02

Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential
McGraw-Hill/Irwin Copyright 2011 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.

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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.

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Financial Reporting Basis by Ownership Level

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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%

Usually equity method and consolidation (but cost method is also okay here)

Significant influence
50%

Control Why is the cost method okay?

100%
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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
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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 parents balance sheet.

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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.

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Learning Objective 2

Prepare journal entries using the cost method for accounting for investments

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The Cost Method: How It Works

Record the investment at cost. General Rule:

Leave it on the books at cost.

S
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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 S Corp: Cash Common Stock Additional PICCS

100,000
100,000 100,000 1,000 99,000
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The Cost Method: How It Works General Rule

The investment remains on parents books at cost Record income at the parent level ONLY when sub declares a dividend. Generally, the subs income does not affect parents investment account balance. However, the parent cannot ignore the subs losses. Parent writes-down investment ONLY IF value has been impaired. Write-downs result in a NEW cost basis.
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The Cost Method: How It Works

The cost method is a one-way street! The investment can be written downbut never written up.

Investment Account
Cost Impairment Loss

New Cost Basis

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The Cost Method: Pros & Cons Pros

Minimal G/L bookkeeping by parent Simple consolidation procedures Overly conservative valuation Parent can manipulate its reported income.

Cons

Why? Parent controls when sub pays dividends!

PCO statementsif used internally or issued may be misleading.

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The Cost Method: Key Concept Although the parent can manipulate its own reported net income, it can never manipulate consolidated net income.

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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.

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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.

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Example: The Cost Method

ABC Company acquires 20 percent of XYZ Companys 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
Record purchase of XYZ Company stock.

100,000

100,000

Cash Dividend Income

4,000 4,000

Record dividend income from XYZ Company stock: $20,000 x 0.20.

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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 investors viewpoint The investors 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 investees point of view.

Acquisition at interim date

Does not create any major problems when the cost method is used. Potential difficulty: liquidating dividend determination
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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 Recorded at cost similar to initial purchase New percentage ownership is calculated to determine whether switch to the equity method is required

Purchases of additional shares

Sales of shares

Accounted for in the same manner as the sale of any other noncurrent asset

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Practice Quiz Question #2

Under the cost method, a subs dividends would:

a. b. c. d. e. NOT be eliminated in consolidation. be the parents income from investment. decrease the parents investment account. increase the parents investment account. none of the above.

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Learning Objective 3

Prepare journal entries using the equity method for accounting for investments.

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The Equity Method: How It Works

The equity method is accrual basis driven:

Record income at the parent level based on subs earnings and lossesa built in valuation technique.

It isnt the same as fair value accounting. Nevertheless, the investment generally goes up and down based on the operations of the investee company.

Subs dividends reduce the parents investment (the parent has less invested).

Investment in Sub Cost Income Losses Dividends

Income from Sub Losses Income

Adj. Bal.

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The Equity Method: How It Works

The equity method is a two-way street!
The investment can be:
1. written up based on the subs income AND 2. written down based on sub losses and dividends

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The Equity Method: Pros and Cons Pros

Based on economic activitynot the parentcontrolled dividend policy. Has two built-in checking figures:

Consolidated NI = Parents NI Consolidated RE = Parents RE

Cons

Requires continual bookkeeping. Unnecessary work if PCO statements are not used internally or issued to outsiders.
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The Equity Method The equity method is intended to reflect the investors changing equity or interest in the investee. The investment is recorded at the initial purchase price and adjusted each period for the investors share of the investees profits or losses and the dividends declared by the investee.

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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 investors 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 investees voting stock is presumed to have the ability to exercise significant influence over the investee.
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The Equity Method Investors equity in the investee

The investor records its investment at the original cost This amount is adjusted periodically:
Reported by Investee
Net income Net loss Dividend declaration

Effect on Investors Accounts

Record income from investment Increase investment account Record loss from investment Decrease investment account Record asset (cash or receivable) Decrease investment account
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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
12,000 12,000

Investment in XYZ Company Stock Income from Investee

Record income from investment in XYZ Company ($60,000 x 0.20).

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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) Ending Balance 100,000 Dividends 12,000 ($20,000 x 0.20) 108,000
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4,000

The Equity Method Acquisition at Interim Date

No income earned by the investee before the date of acquisition may be accrued by the investor
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

Acquisition between balance sheet dates

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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.

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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 investors share of the investees 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

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Practice Quiz Question #3

Under the equity method, a subs dividends would:

a. b. c. d. e. NOT be eliminated in consolidation. be the parents income from investment. decrease the parents investment account. increase the parents investment account. none of the above.

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Practice Quiz Question #4

Under the equity method, a subs losses would:

a. b. c. d. e. never reduce the parents income. normally reduce the parents income. always reduce the parents income. always be eliminated in consolidation. none of the above.

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Learning Objective 4

Understand and explain differences between the cost and equity methods.

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The Cost and Equity Methods Compared

Item
Recorded amount of investment at date of acquisition Usual carrying amount of investment subsequent to acquisition

Cost Method
Original cost

Equity Method
Original Cost

Original cost

Original cost increased (decreased) by investors share of investees income (loss) and decreased by investors share of investees dividends

Income recognition by investor

Investors share of investees dividends declared from earnings since acquisition

Income

Investors share of investees earnings since acquisition, whether distributed or not

Reduction of investment

Investee dividends from earnings since acquisition by investor Investee dividends in excess of earnings since acquisition by investor

Reduction of investment

Reduction of investment

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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 Parents books at the end of year 2 using the equity method?

Investment in Sub
Beginning balance Ending balance Net income Ending balance 500

Net Loss
400 200 Dividends 550

100
50

What if Parent uses the cost method?

$500 COST!!!
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What journal entries would Parent make under each method?

Summary of Year 1 Equity Method Entries

Investment in Soup Corp. Cash
Record the initial investment in Soup Corp.

500 500 100 100

Income from Soup Corp. Investment in Soup. Corp.

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 100 0

Income from Soup Corp.

Net Loss 100

Ending Balance 100

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Summary of Year 2 Equity Method Entries

Investment in Soup Corp. Income from Soup Corp.
Record Pea Corp.s 100% share of Soup Corp.s Year 2 income.

200 200 50 50

Cash Investment in Soup. Corp.

Record Pea Corp.s 100% share of Soup Corp.s Year 2 dividends

Investment in Soup Corp.

Beginning Balance 400 Net Income 200

Income from Soup Corp.

Net Income 200

Dividends
Ending Balance 550

50
Ending Balance 200

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Example: Equity versus Cost Method

Equity Method
Investment in Soup Corp. Cash Income from Soup Corp. Investment in Soup Corp. Investment in Soup Corp. Income from Soup Corp. Dividends Receivable Investment in Soup Corp. 500 500 100 100 200 200 50 No Entry Dividends Receivable Dividend Income 50

Cost Method
Investment in Soup Corp. Cash No Entry 500 500

50

50

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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

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Learning Objective 5

Prepare journal entries using the fair value option.

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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
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Example: The Fair Value Option

Ajax Corporation purchases 40 percent of Barclay Companys 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
Record purchase of Barclay Company stock.

200,000

200,000

March1, 20X1 Cash Dividend Income

Record dividend income from Barclay Company.

1,500 1,500

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
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Learning Objective 6

Make calculations and prepare basic elimination entries for a simple consolidation.

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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

Investment > Book Value

Chapter 2
Chapter 4

Chapter 3
Chapter 5

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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.

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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

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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.
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The Basic Elimination Entry: The Equity Method

What needs to be eliminated?

The parents investment account

It represents the initial investment adjusted for the parents cumulative share of the subsidiarys income and dividends.

The parents income from sub account

The subsidiarys equity accounts

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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 Parents books at the end of year 2 using the equity method?

Investment in Sub
Beginning balance Ending balance Net income Ending balance 500

Net Loss
400 200 Dividends 550

100
50

What accounts need to be eliminated? How are they eliminated?

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The Basic Elimination Entry: Equity Method

The investment account represents the initial investment adjusted for the parents cumulative share of the subsidiarys income and dividends. Therefore, the elimination entry eliminates:

The subsidiarys paid-in capital accounts (original investment) Beginning retained earnings (past earnings / dividends) The subsidiarys current year earnings and dividends

Generically, it looks like this:

Common Stock Additional Paid-in Capital Retained Earnings (Beginning Balance) Income from Sub Dividends Declared Investment in Sub XXX XXX XXX XXX XXX XXX
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The Basic Elimination Entry: Equity Method

Total = Book Value Additional Common + Paid-In + Retained Stock Capital Earnings

Beginning Book Value + Net Income Dividends

Ending Book Value

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
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Learning Objective 7

Prepare a consolidation worksheet.

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Worksheet: Draw lines

Pea Corp. Income Statement Sales Less: COGS Less: Other Expenses Income from Soup Corp. Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Investment in Soup Corp. PP&E (net) Total Assets Liabilities Common Stock Additional Paid-in Capital Retained Earnings Total Liabilities & Equity 1,200 (600) (450) 200 350 Soup Corp. 600 (300) (100) 200 Elimination Entries DR CR Consolidated

150 350 (100) 400

(100) 200 (50) 50

250 550 900 1,700 300 200 800 400 1,700

100 600 700 150 50 450 50 700

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Worksheet: Eliminations, Sub-totals, Carry down

Pea Corp. Income Statement Sales Less: COGS Less: Other Expenses Income from Soup Corp. Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Investment in Soup Corp. PP&E (net) Total Assets Liabilities Common Stock Additional Paid-in Capital Retained Earnings Total Liabilities & Equity 1,200 (600) (450) 200 350 Soup Corp. 600 (300) (100) 200 200 Elimination Entries DR CR Consolidated

150 350 (100) 400

(100) 200 (50) 50

100 50

250 550 900 1,700 300 200 800 400 1,700

100 550 600 700 150 50 450 50 700

50 450

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Worksheet: Eliminations, Sub-totals, Carry down

Pea Corp. Income Statement Sales Less: COGS Less: Other Expenses Income from Soup Corp. Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Investment in Soup Corp. PP&E (net) Total Assets Liabilities Common Stock Additional Paid-in Capital Retained Earnings Total Liabilities & Equity 1,200 (600) (450) 200 350 Soup Corp. 600 (300) (100) 200 200 200 0 Elimination Entries DR CR Consolidated

150 350 (100) 400

(100) 200 (50) 50

200 200

100 0 50 150

250 550 900 1,700 300 200 800 400 1,700

100 550 600 700 150 50 450 50 700 0 550

50 450 200 700

150 150
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The Equity Method: Things to Remember in Consolidation Consolidated net income EQUALS the parents net income.
Parent $350

Consolidated $350

Consolidated retained earnings EQUALS the parents retained earnings.

Parent $400

Consolidated $400

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Group Exercise 1
Pinkett, Inc. Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Smith, Inc. Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Inventory Investment in Smith, Inc. Property, Plant, & Equipment Less: Accumulated Depreciation Total Assets Accounts Payable Long-term Debt Common Stock Retained Earnings Total Liabilities & Equity 840,000 (516,000) (12,000) (192,000) 36,000 156,000 Smith, Inc. 300,000 (156,000) (10,000) (98,000) 36,000 Elimination Entries DR CR Consolidated

REQUIRED Assume Pinkett acquired Smith on 1/1/11 Prepare all elimination entries as of 12/31/11.

132,000 156,000 (108,000) 180,000

72,000 36,000 (12,000) 96,000

54,000 114,000 204,000 156,000 336,000 (144,000) 720,000 168,000 360,000 12,000 180,000 720,000

48,000 66,000 90,000 210,000 (30,000) 384,000 84,000 144,000 60,000 96,000 384,000

Prepare a consolidation worksheet at 12/31/11.

Assume Smiths accumulated depreciation on 1/1/11 was $20,000.

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Group Exercise 1
Objective:
Eliminate equity accounts of Sub Eliminate equity method accounts of Parent.

Book Value Calculations

Total Book Value Original Book Value + Net Income Dividends Ending Book Value
=

Common Stock

Retained Earnings

Basic Elimination Entry

Common Stock Retained Earnings (BB) Income from Smith, Inc. Dividends Declared Investment in Smith, Inc.
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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

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Group Exercise 1: Solution

Pinkett, Inc. Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Smith, Inc. Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Inventory Investment in Smith, Inc. Property, Plant, & Equipment Less: Accumulated Depreciation Total Assets Accounts Payable Long-term Debt Common Stock Retained Earnings Total Liabilities & Equity 840,000 (516,000) (12,000) (192,000) 36,000 156,000 Smith, Inc. 300,000 (156,000) (10,000) (98,000) 36,000 36,000 36,000 0 Elimination Entries DR CR Consolidated

132,000 156,000 (108,000) 180,000

72,000 36,000 (12,000) 96,000

72,000 36,000 108,000

0 12,000 12,000

54,000 114,000 204,000 156,000 336,000 (144,000) 720,000 168,000 360,000 12,000 180,000 720,000

48,000 66,000 90,000 210,000 (30,000) 384,000 84,000 144,000 60,000 96,000 384,000 156,000 20,000 20,000 20,000 176,000

60,000 108,000 168,000

12,000 12,000

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Appendix 2B

Consolidation and the Cost Method.

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Consolidation Entries: Cost Method Pre-Consolidation Balances

Pinkett, Inc. 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 $ 1,200 600 450 50 200 Smith, Inc. $ 600 300 100 200 Elimination Entries DR CR Consolidated

250 200 100 350

(100) 200 50 50

$ $

250 500 900 1,650 300 200 800 350 1,650

100 600 700 150 50 450 50 700

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The Basic Elimination Entry: The Cost Method

Cost Method

The investment account is generally exactly equal to the sum of the subsidiarys paid-in capital accounts. Unless the parent records an impairment loss. 50 450 500

Common Stock Additional Paid-in Capital Investment in Sub

Under the cost method, we also eliminate dividends from sub to parent. 50 50
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Dividend Income Dividends Declared

Consolidation Entries: Cost Method Complete the Worksheet

Pinkett, Inc. 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 $ 1,200 600 450 50 200 Smith, Inc. $ 600 300 100 200 50 50 Elimination Entries DR CR Consolidated

250 200 100 350

(100) 200 50 50

50 50 50 50

$ $

250 500 900 1,650 300 200 800 350 1,650

100 500 600 700 150 50 450 50 700 0 0

500

50 450 50 550

50 50
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Group Exercise 1: Cost Method Consolidation

Pinkett, Inc. 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 $ 840,000 (516,000) (204,000) 12,000 132,000 Smith, Inc. $ 300,000 (156,000) (108,000) 36,000 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?

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 84,000 144,000 60,000 96,000 384,000

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Group Exercise 1: Cost Method Consolidation

Pinkett, Inc. 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 $ 840,000 (516,000) (204,000) 12,000 132,000 Smith, Inc. $ 300,000 (156,000) (108,000) 36,000 Elimination Entries DR CR Consolidated

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 84,000 144,000 60,000 96,000 384,000

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The Cost Method: Things to Remember in Consolidation

Consolidated net income does NOT equal the parents net income.

P $200

S $200

Subs Div $50 =

CONS $350

Consolidated retained earnings does NOT equal the parents retained earnings. P $350 S $50 CONS $400

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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 methodthis holds true for all three statements.

Equity Method Consolidated Statements

Cost Method Consolidated Statements

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PCO Statements: Presented in Notes to the Consolidated Statements Retained Earnings Available for Dividends:

Based on the parents G/L amountnot on the consolidated retained earnings amount. Use of the equity method in PCO statements produces identical retained earnings amounts. Use of the cost method in PCO statements creates confusion.

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Conclusion

The End