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    • APA style reference use only 1-2 goodreferences Required Texts ( the book if you want to uses as REFERENCE Baker, R., Christensen, T., & Cottrell, D. (2012). Essentials of advanced financial accounting (1st ed.). New York, NY: McGraw-Hill/Irwin. ISBNs: 9780078025648 (print); 9780077505240 (e-copy). 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…

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