Professional Documents
Culture Documents
Reporting Intercorporate
Investments and
Consolidation of Wholly
Owned Subsidiaries with
No Differential
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 2-1
2-2
Accounting for Investments in Common Stock
2-3
Financial Reporting Basis by Ownership Level
Default
assumption
2-4
Investment vs. Ownership
Consolidation eliminates the investment account and
replaces it with “the detail.”
Account for as
trading, AFS, or
Cost Investments
Usually equity method
and consolidation
Ownership Percentage (but cost method is
Equity method also okay here)
or Fair Value
Option
No
significant Control
Significant
influence
influence
2-5
Investment vs. Ownership
Consolidation eliminates the investment account and
replaces it with “the detail.”
Account for as
trading, AFS, or
Cost Investments
Usually equity method
and consolidation
Ownership Percentage (but cost method is
Equity method also okay here)
or Fair Value
Option
No
significant Control
Significant
influence
influence
Why is the cost
0% 20% 50% method okay? 100%
2-6
Investment vs. Ownership
Consolidation eliminates the investment account and
replaces it with “the detail.”
Account for as
trading, AFS, or
Cost Investments
Usually equity method
and consolidation
Ownership Percentage (but cost method is
Equity method also okay here)
or Fair Value The investment
account is eliminated
Option in the consolidated
No financial statements
significant Control
Significant
influence
influence
Why is the cost
0% 20% 50% method okay? 100%
2-7
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
2-8
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.
2-9
Practice Quiz Question #1
2-10
Practice Quiz Question #1 Solution
2-11
Learning Objective 2-2
2-12
The Cost Method: How It Works
S
2-13
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 Corp:
P Investment in S Corp 100,000
Cash 100,000
S Corp:
S Cash 100,000
Common Stock 1,000
Additional PIC—CS 99,000
2-14
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
losses.
Parent writes-down investment ONLY IF value
2-15
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.
2-16
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:
Cash 4,000
Dividend Income 4,000
Record dividend income from XYZ Company stock: $20,000 x 0.20.
2-17
The Cost Method
2-18
Practice Quiz Question #2
2-19
Practice Quiz Question #2 Solution
2-20
Learning Objective 2-3
2-21
The Equity Method: How It Works
2-23
The Equity Method: Pros and Cons
Pros
Based on economic activity—not the parent-
controlled 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.
2-24
The Equity Method
2-25
The Equity Method
2-26
The Equity Method
2-27
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 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
2-28
Example: The Equity Method
Recognition of dividends
Cash 4,000
Investment in XYZ Company Stock 4,000
Record receipt of dividend from XYZ Company ($20,000 x 0.20).
2-29
The Equity Method
2-30
The Equity Method
2-31
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
2-32
Practice Quiz Question #3
2-33
Practice Quiz Question #3 Solution
2-34
Practice Quiz Question #4
2-35
Practice Quiz Question #4 Solution
2-36
Learning Objective 2-4
2-37
The Cost and Equity Methods Compared
2-38
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 400
Net income 200 Dividends 50
2-40
Summary of Year 2 Equity Method Entries
Cash 50
Investment in Soup. Corp. 50
Record Pea Corp.’s 100% share of Soup Corp.’s Year 2 dividends
2-41
Example: Equity versus Cost Method
Cash 50 Cash 50
Investment in Soup Corp. 50 Dividend Income 50
2-42
Practice Quiz Question #5
2-43
Practice Quiz Question #5 Solution
2-44
Learning Objective 2-5
2-45
The Fair Value Option
The accounting standards permit 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
2-46
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 200,000
Cash 200,000
Record purchase of Barclay Company stock.
March1, 20X1
Cash 1,500
Dividend Income 1,500
Record dividend income from Barclay Company.
2-48
Overview of the Consolidation Process
2-49
Overview of the Consolidation Process
2-50
The Consolidation Worksheet (Fig. 2-3, p. 61)
Elimination Entries
Parent Subsidiary DR CR Consolidated
Income Statement
Revenues
Expense
Expense
Net Income
Total Assets
Liabilities
Equity
Common Stock
Retained Earnings
Total Liabilities and Equity
2-51
Overview of the Consolidation Process
2-52
The Basic Elimination Entry: The Equity Method
2-53
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 400
Net income 200 Dividends 50
2-55
The Basic Elimination Entry: Equity Method
Additional
Total = Common + Paid-In + Retained
Book Value Stock Capital Earnings
Original Book Value 400) 50 450 (100)
+ Net Income 200 200)
Dividends (50) (50)
Ending Book Value 550 50 450 50)
0 0
2-58
Learning Objective 2-7
Prepare a
consolidation
worksheet.
2-59
Worksheet: Pre-Consolidation Balances
Elimination Entries
Pea Corp. Soup Corp. DR CR Consolidated
Income Statement
Sales 1,200 600
Less: COGS (600) (300)
Less: Other Expenses (450) (100)
Income from Soup Corp. 200
Net Income 350 200
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550
PP&E (net) 900 600
Total Assets 1,700 700
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550
PP&E (net) 900 600
Total Assets 1,700 700
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550 550
PP&E (net) 900 600
Total Assets 1,700 700
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550 550
PP&E (net) 900 600
Total Assets 1,700 700 0 550
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550 550
PP&E (net) 900 600
Total Assets 1,700 700 0 550
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550 550
PP&E (net) 900 600
Total Assets 1,700 700 0 550
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550 550
PP&E (net) 900 600
Total Assets 1,700 700 0 550
Balance Sheet
Cash 250 100 350
Investment in Soup Corp. 550 550 0
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850
Balance Sheet
Cash 250 100 350
Investment in Soup Corp. 550 550 0
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850
2-69
Group Exercise 1
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales 840,000 300,000 REQUIRED
Less: COGS (516,000) (156,000)
Less: Depreciation Expense (12,000) (10,000) • Assume Pinkett
Less: Other Expenses (192,000) (98,000) acquired Smith on
Income from Smith, Inc. 36,000 1/1/11
Net Income 156,000 36,000
• Prepare all
Statement of Retained Earnings elimination
Beginning Balance 132,000 72,000 entries as of
Net Income 156,000 36,000
12/31/11.
Less: Dividends Declared (108,000) (12,000)
Ending Balance 180,000 96,000
• Prepare a
consolidation
Balance Sheet
Cash 54,000 48,000 worksheet at
Accounts Receivable 114,000 66,000 12/31/11.
Inventory 204,000 90,000
Investment in Smith, Inc. 156,000 • Assume Smith’s
Property, Plant, & Equipment 336,000 210,000 accumulated
Less: Accumulated Depreciation (144,000) (30,000) depreciation on
Total Assets 720,000 384,000 1/1/11 was
$20,000.
Accounts Payable 168,000 84,000
Long-term Debt 360,000 144,000
Common Stock 12,000 60,000
Retained Earnings 180,000 96,000
Total Liabilities & Equity 720,000 384,000
2-70
Group Exercise 1
Objective:
Eliminate equity accounts of Sub
Eliminate equity method accounts of Parent.
Book Value Calculations
Total Common Retained
= +
Book Value Stock Earnings
Original Book Value
+ Net Income
Dividends
Ending Book Value
2-74
Group Exercise 1: Solution
The optional accumulated depreciation elimination entry:
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.
2-75
Group Exercise 1: Solution
Pinkett, Smith, Elimination Entries
Inc. Inc. DR CR Consolidated
Income Statement
Sales 840,000 300,000
Less: COGS (516,000) (156,000)
Less: Depreciation Expense (12,000) (10,000)
Less: Other Expenses (192,000) (98,000)
Income from Smith, Inc. 36,000 36,000
Net Income 156,000 36,000 36,000 0
Balance Sheet
Cash 54,000 48,000
Accounts Receivable 114,000 66,000
Inventory 204,000 90,000
Investment in Smith, Inc. 156,000 156,000
Property, Plant, & Equipment 336,000 210,000 20,000
Less: Accumulated Depreciation (144,000) (30,000) 20,000
Total Assets 720,000 384,000 20,000 176,000
2-76
Group Exercise 1: Solution
Pinkett, Smith, Elimination Entries
Inc. Inc. DR CR Consolidated
Income Statement
Sales 840,000 300,000 1,140,000
Less: COGS (516,000) (156,000) (672,000)
Less: Depreciation Expense (12,000) (10,000) (22,000)
Less: Other Expenses (192,000) (98,000) (290,000)
Income from Smith, Inc. 36,000 36,000 0
Net Income 156,000 36,000 36,000 0 156,000
Balance Sheet
Cash 54,000 48,000 102,000
Accounts Receivable 114,000 66,000 180,000
Inventory 204,000 90,000 294,000
Investment in Smith, Inc. 156,000 156,000 0
Property, Plant, & Equipment 336,000 210,000 20,000 526,000
Less: Accumulated Depreciation (144,000) (30,000) 20,000 (154,000)
Total Assets 720,000 384,000 20,000 176,000 948,000
2-77
Appendix 2B
Consolidation and
the Cost Method.
2-78
Consolidation Entries: Cost Method —
Pre-Consolidation Balances
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales $ 1,200 $ 600
Less: COGS 600 300
Less: Expenses 450 100
Dividend Income 50
Net Income $ 200 $ 200
Balance Sheet
Cash $ 250 $ 100
Investment in Sub 500
Property, Plant, & Equipment 900 600
Total Assets $ 1,650 $ 700
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 50
Additional Paid-in Capital 450
Investment in Sub 500
2-80
Consolidation Entries: Cost Method —
Eliminations, Sub-totals, Carry down
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales $ 1,200 $ 600
Less: COGS 600 300
Less: Expenses 450 100
Dividend Income 50 50
Net Income $ 200 $ 200 50
Balance Sheet
Cash $ 250 $ 100
Investment in Sub 500 500
Property, Plant, & Equipment 900 600 0
Total Assets $ 1,650 $ 700 0 500
Balance Sheet
Cash $ 250 $ 100
Investment in Sub 500 500
Property, Plant, & Equipment 900 600 0
Total Assets $ 1,650 $ 700 0 500
Balance Sheet
Cash $ 250 $ 100
Investment in Sub 500 500
Property, Plant, & Equipment 900 600 0
Total Assets $ 1,650 $ 700 0 500
Balance Sheet
Cash $ 250 $ 100
Investment in Sub 500 500
Property, Plant, & Equipment 900 600 0
Total Assets $ 1,650 $ 700 0 500
2-84
Consolidation Entries: Cost Method —
Worksheet: Add across
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Less: Expenses 450 100 550
Dividend Income 50 50
Net Income $ 200 $ 200 50 $ 350
Balance Sheet
Cash $ 250 $ 100 $ 350
Investment in Sub 500 500
Property, Plant, & Equipment 900 600 0 1,500
Total Assets $ 1,650 $ 700 0 500 $ 1,850
2-85
Consolidation Entries: Cost Method —
Worksheet Complete
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Less: Expenses 450 100 550
Dividend Income 50 50
Net Income $ 200 $ 200 50 $ 350
Balance Sheet
Cash $ 250 $ 100 $ 350
Investment in Sub 500 500
Property, Plant, & Equipment 900 600 0 1,500
Total Assets $ 1,650 $ 700 0 500 $ 1,850
2-86
Group Exercise 1: Cost Method Consolidation
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales $ 840,000 $ 300,000
Less: COGS (516,000) (156,000)
Less: Expenses (204,000) (108,000)
Dividend Income 12,000
Net Income $ 132,000 $ 36,000 REQUIRED
Statement of Retained Earnings
• Prepare all consolidation
Balances, 1/1/X3 $ 60,000 $ 72,000
Add: Net Income 132,000 36,000 entries as of 12/31/X3.
Less: Dividends (108,000) (12,000)
Balances, 12/31/X3 $ 84,000 $ 96,000 • Prepare a consolidation
worksheet at 12/31/X3.
Balance Sheet
Cash $ 54,000 $ 48,000
Accounts Receivable 114,000 66,000
• What is the maximum
Inventory 204,000 90,000 dividend the parent could
Investment in Sub 60,000 declare ($84,000 or
Property & Equipment 336,000 210,000
Accumulated Depreciation (144,000) (30,000) $180,000) if cash were
Total Assets $ 624,000 $ 384,000 available?
Payables & Accruals $ 168,000 84,000
Long-term Debt 360,000 144,000
Common Stock 12,000 60,000
Retained Earnings 84,000 96,000
Total Liabilities & Equity $ 624,000 384,000
2-87
Group Exercise 1: Cost Method Consolidation
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales $ 840,000 $ 300,000
Less: COGS (516,000) (156,000)
Less: Expenses (204,000) (108,000)
Dividend Income 12,000
Net Income $ 132,000 $ 36,000 Basic Elimination Entry
Statement of Retained Earnings
Investment elimination entry
Balances, 1/1/X3 $ 60,000 $ 72,000 Common Stock 60,000
Add: Net Income 132,000 36,000
Less: Dividends (108,000) (12,000)
Investment in
Balances, 12/31/X3 $ 84,000 $ 96,000 Sub 60,00
0
Balance Sheet
Cash $ 54,000 $ 48,000
Accounts Receivable 114,000 66,000 Dividend elimination entry
Inventory 204,000 90,000 Dividend Income 12,000
Investment in Sub 60,000
Property & Equipment 336,000 210,000
Dividend
Accumulated Depreciation (144,000) (30,000) Declared 12,00
Total Assets $ 624,000 $ 384,000 0
Payables & Accruals $ 168,000 84,000
Long-term Debt 360,000 144,000
Common Stock 12,000 60,000
Retained Earnings 84,000 96,000
Total Liabilities & Equity $ 624,000 384,000
2-88
Group Exercise 1: Cost Method Consolidation
Solution
Elimination Entries
Pinkett, Inc. Smith, Inc. DR CR Consolidated
Income Statement
Sales $ 840,000 $ 300,000 $ 1,140,000
Less: COGS (516,000) (156,000) (672,000)
Less: Expenses (204,000) (108,000) (312,000)
Dividend Income 12,000 12,000
Net Income $ 132,000 $ 36,000 12,000 $ 156,000
Balance Sheet
Cash $ 54,000 $ 48,000 $ 102,000
Accounts Receivable 114,000 66,000 180,000
Inventory 204,000 90,000 294,000
Investment in Sub 60,000 60,000
Property & Equipment 336,000 210,000 546,000
Accumulated Depreciation (144,000) (30,000) (174,000)
Total Assets $ 624,000 $ 384,000 60,000 $ 948,000
2-89
The Cost Method: Things to Remember in
Consolidation
Consolidated net income does NOT equal the parent’s net
income.
P S CONS
$350 + $50 = $400
2-90
Consolidation: The Most Important Point of
All on Investment Basis
Equity Cost
Method Method
Consolidated = Consolidated
Statements Statements
2-91
QUIZ 1 - Q1
92
QUIZ 1 - Q2
On January 1, 20X9, Zigma Company acquired 100 percent of Standard Company's common shares
at underlying book value. Zigma uses the equity method in accounting for its ownership of
Standard. On December 31, 20X9, the trial balances of the two companies are as follows:
Prepare the eliminating entries needed as of December 31, 20X9, to complete a consolidation
worksheet.
93
QUIZ - SOLUTION
Additional:
PSAK 67, PSAK 4, PSAK 15
94
QUIZ - SOLUTION
95
Conclusion
The End
2-96