Professional Documents
Culture Documents
Additional
Consolidation
Reporting Issues
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General Overview
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Learning Objective 10-1
Prepare a consolidated
statement of cash flows.
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Consolidated Statement of Cash Flows
(1 of 2)
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Consolidated Statement of Cash Flows
(2 of 2)
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Consolidated Cash Flow Statement Illustrated
(1 of 4)
December 31
20X1 20X2
Cash $269,000 $276,000
Accounts Receivable 125,000 230,000
Inventories 175,000 270,000
Land 225,000 185,000
Buildings & Equipment 1,460,000 1,560,000
Goodwill 9,375 9,375
Total Debits $2,263,375 $2,530,375
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Consolidated Cash Flow Statement Illustrated
(3 of 4)
Sales $720,000
Gain on Sale of Land 30,000
$750,000
Less: Cost of Goods Sold $340,000
Depreciation Expense 76,000
Other Expenses 105,000 (521,000)
Consolidated Net Income $229,000
Income to Noncontrolling Interest (13,800)
Income to Controlling Interest $215,200
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Consolidated Cash Flow Statement Illustrated
(4 of 4)
Worksheet for Peerless Products and Subsidiary Consolidated Statement of Cash Flows, 20X2
Figure 10-1
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Consolidated Statement of Cash Flows
—Two Methods (1 of 2)
Nearly all major companies use the indirect method.
Critics have argued that the direct method is less
confusing to the reader and more useful.
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Consolidated Statement of Cash Flows
—Two Methods (2 of 2)
The only section of the cash flow statement
affected by the difference in approaches is the
operating activities section.
Under the indirect approach, the operating activities
section starts with net income and, to derive cash
provided by operating activities, adjusts for all items
affecting cash and net income differently.
Under the direct approach, the operating activities section
of the statement shows the actual cash flows.
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Consolidated Statement of Cash Flows
for the Year Ended December 31, 20X2
Figure 10-2
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Consolidated Statement of Cash Flows
—Direct Method
Under the direct approach, the operating activities
section of the statement shows the actual cash flows.
In this example, the only cash flows related to
operations are as follows:
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Practice Quiz Question #1
Which of the following statements is true?
a. After the consolidated income statement
and balance sheet have been prepared, the
statement of cash flows is calculated in the
same way as for a single company.
b. The preparation of a consolidated
statement of cash flows requires
procedures that are unique to consolidated
companies.
c. A consolidated statement of cash flows is
not required under U.S. GAAP.
d. The consolidated statement of cash flows is
calculated from the subsidiary’s financial
statements alone.
10-14
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Practice Quiz Question #1 Solution
Which of the following statements is true?
a. After the consolidated income statement
and balance sheet have been prepared, the
statement of cash flows is calculated in the
same way as for a single company.
b. The preparation of a consolidated
statement of cash flows requires
procedures that are unique to consolidated
companies.
c. A consolidated statement of cash flows is
not required under U.S. GAAP.
d. The consolidated statement of cash flows is
calculated from the subsidiary’s financial
statements alone.
10-15
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Learning Objective 10-2
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Consolidation Following an Interim
Acquisition
When one company purchases another company’s common
stock, the subsidiary is viewed as being part of the
consolidated entity only from the time the stock is acquired.
When a subsidiary is acquired during a fiscal period, the
results of the subsidiary’s operations are included in the
consolidated statements only for the portion of the year that
the stock is owned by the parent.
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Consolidation Following an Interim
Acquisition: Illustration (1 of 5)
Peanut purchases 75 percent of Snoopy’s outstanding common stock on July
1, 20X1, for an amount equal to 75 percent of the book value of Snoopy’s net
assets. Prior to the acquisition, Snoopy had earned net income of $35,000
and declared $8,000 of dividends. The income and dividends for the year are
summarized in the following table:
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Consolidation Following an Interim
Acquisition: Illustration (2 of 5)
Parent Company Entries
Peanut records the purchase of Snoopy stock with the following entry:
July 1, 20X1
Investment in Snoopy Stock 320,250
Cash 320,250
Record purchase of Snoopy stock.
During the second half of 20X1, Peanut records its share of Snoopy’s income and
dividends under the equity method:
Cash 15,000
Investment in Snoopy Stock 15,000
Record dividends from Snoopy: $20,000 × 0.75.
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Consolidation Following an Interim
Acquisition: Illustration (3 of 5)
Preacquisition income and dividend elimination entry:
Sales 125,000 ¬ Close preacquisition sales to RE
COGS 50,000 ¬ Close preacquisition COGS to RE
Depreciation Expense 25,000 ¬ Close preacquisition depr. exp. To RE
Other Expense 15,000 ¬ Close preacquisition other expenses to RE
Dividends Declared 8,000 ¬ Close preacquisition dividends to RE
Retained Earnings 27,000 ¬ Preacquisition net increase in RE
After making this worksheet entry to close the preacquisition earnings and dividends
to the Retained Earnings account, the beginning balance in Retained Earnings as of
the date of acquisition is $117,000.
Retained Earnings
90,000 Balance 1/1/20X1
27,000
117,000 Balance 6/30/20X1
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Consolidation Following an Interim
Acquisition: Illustration (4 of 5)
Based on this acquisition date beginning balance, we calculate the postacquisition
changes in book value as follows:
Book Value Calculations:
NCI Peanut Common Retained
25%75%Stock Earnings + = +
July 1, 20X1, balances 91,750) 275,250) 250,000 117,000)
+ Net Income 15,000) 45,000 ) 60,000)
- Dividends (5,000) (15,000)
(20,000)
December 31, 20X1, balances 101,750) 305,250) 250,000 157,000)
This leads to the basic consolidation entry, following the normal procedure (but
based on postacquisition earnings and dividends):
Basic Consolidation Entry
Common Stock 250,000 ¬ Original amount invested (100%)
Retained Earnings 117,000 ¬ Beginning balance in RE
Income from Snoopy 45,000 ¬ Peanut’s share of reported NI
NCI in NI of Snoopy 15,000 ¬ NCI’s share of reported NI
Dividends Declared ¬ 100% of Sub’s dividends declared
20,000 ¬ Net amount of BV left in inv. acct.
Investment in Snoopy ¬ NCI’s share of net book value
305,250
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Consolidation Following an Interim
Acquisition: Illustration (5 of 5)
The following T-accounts illustrate how the basic consolidation entry zeros out the balances in
the Investment in Snoopy and Income from Snoopy accounts:
Acquisition
275,250 45,000 75% Net Income
75% Net Income 15,000 75% Dividends
45,000
45,000 Balance 12/31/X1
305,250 Basic 45,000
Balance 12/31/X1
305,250 0
Again, we include the normal accumulated depreciation consolidation entry based on the
balance in accumulated depreciation on Snoopy’s books on the acquisition date. Assume that this
0 acquisition date.
amount is 65,000 on the
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Learning Objective 10-3
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Allocating the Basis of Assets Acquired
in a Business Combination
In a nontaxable acquisition, the tax bases of the
assets acquired and liabilities assumed will remain
unchanged as a result of the acquisition.
The acquiree’s basis is referred to as carryover basis.
At the time of the acquisition, the acquiring company is
required to identify all assets and liabilities acquired and
their respective fair market values.
The acquiring company must record deferred tax assets or
liabilities that arise from the difference between fair
market value and tax basis when allocating the purchase
price.
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Illustration—Allocating the Basis of Assets
Acquired in a Business Combination (1 of 3)
Assume that Peerless acquires 100 percent of Special Foods’ outstanding stock on
December 31, 20X1, by issuing 10,000 shares of its own no par stock, with a market
value of $34 per share, to Special Foods’ shareholders. This deal is a nontaxable
transaction, thus all assets and liabilities will retain their carryover bases for tax
purposes. The table below summarizes Special Foods’ information at the acquisition
date. Note the Fair Value of all assets and liabilities is given, except for the Deferred
Tax Asset and the Deferred Tax Liability.
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Illustration—Allocating the Basis of Assets
Acquired in a Business Combination (2 of 3)
Peerless must allocate the $340,000 purchase price between (1) the book value
of net assets, (2) the fair value differential for all identifiable assets and
liabilities, and (3) any goodwill included is the purchase price. In order to
accomplish this allocation, the Fair Value of the Deferred Tax Asset and the
Deferred Tax Liability must be added to the previous table.
Deferred Tax Asset: The tax basis of the accounts receivable is $10,000 higher than the
book value because Special Foods has a $10,000 allowance for doubtful accounts. This
book-tax difference results in a $3,000 ($10,000 × 30%) deferred tax asset. Since there
is no difference between the book value and fair value of accounts receivable, the fair
value of the deferred tax asset associated with the allowance is also $3,000.
Deferred Tax Liability: Three assets, land, buildings & equipment, and patent, all have
differences between fair value and tax basis that will increase future taxable income and
tax owed. Using the expected 30 percent tax rate, these differences result in a $46,500
deferred tax liability as shown below.
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Illustration—Allocating the Basis of Assets
Acquired in a Business Combination (3 of 3)
With the Fair Value of the Deferred Tax Asset and the Deferred Tax Liability
computed, the total fair value differential for all identifiable assets and
liabilities is $38,500 which implies $1,500 of goodwill is present at
acquisition.
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Allocation of Tax Expense When a
Consolidated Return is Filed (1 of 4)
A parent company and its subsidiaries may file a
consolidated income tax return, or they may
choose to file separate returns.
For a subsidiary to be eligible to be included in a
consolidated tax return, at least 80 percent of its stock
must be held by the parent company or another company
included in the consolidated return.
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Allocation of Tax Expense When a
Consolidated Return is Filed (2 of 4)
Filing a consolidated return: advantages
The losses of one company may be offset against the
profits of another.
Dividends and other transfers between the affiliated
companies are not taxed.
May make it possible to avoid limits on the use of certain
items such as foreign tax credits and charitable
contributions.
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Allocation of Tax Expense When a
Consolidated Return is Filed (3 of 4)
Filing a consolidated return: limitations
Once an election is made to include a subsidiary in the
consolidated return, the company cannot file separate tax
returns in the future unless it receives approval from the
IRS.
The subsidiary’s tax year also must be brought into
conformity with the parent’s tax year.
Can become quite difficult when numerous companies are
involved and complex ownership arrangements exist
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Allocation of Tax Expense When a
Consolidated Return is Filed (4 of 4)
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Allocation of Tax Expense When a Consolidated
Return is Filed: Illustration (1 of 4)
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Allocation of Tax Expense When a Consolidated
Return is Filed: Illustration (2 of 4)
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Allocation of Tax Expense When a Consolidated
Return is Filed: Illustration (3 of 4)
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Allocation of Tax Expense When a Consolidated
Return is Filed: Illustration (4 of 4)
The consolidated income statement for 20X1 shows the following amounts:
Other allocation methodologies may be preferred when affiliates have significantly different tax
characteristics, such as when only one of the companies qualifies for special tax exemptions or
credits.
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Tax Effects of Unrealized Intercompany
Profit Eliminations (1 of 2)
Unrealized profits when a consolidated return is
filed
Intercompany transfers are eliminated in computing both
consolidated net income and taxable income.
Because profits are taxed in the same period they are
recognized for financial reporting purposes, no temporary
differences arise, and no additional tax accruals are
needed in preparing the consolidated financial
statements.
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Tax Effects of Unrealized Intercompany
Profit Eliminations (2 of 2)
Unrealized profits when separate returns are filed
The companies are taxed individually on the profits from
intercompany sales.
No consideration is given to whether the intercompany
profits are realized from a consolidated viewpoint.
The tax expense on the unrealized intercompany profit
must be eliminated when the unrealized intercompany
profit is eliminated in preparing consolidated financial
statements.
This difference in timing of the tax expense recognition
results in the recording of deferred income taxes.
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Unrealized Profits When Separate
Returns are Filed (1 of 2)
If Special Foods sells inventory costing $23,000 to Peerless
Products for $28,000, and none is resold before year-end, the
entry to eliminate the intercorporate transfer in the
consolidated statements is:
Sales 28,000
Cost of Goods Sold 23,000
Inventory 5,000
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Unrealized Profits When Separate
Returns are Filed (2 of 2)
An adjustment to tax expense also is required in preparing
consolidated statements if Special Foods files a separate tax
return.
With a 40 percent corporate income tax rate, the following
consolidation entry adjusts income tax expense of the
consolidated entity downward by $2,000 to reflect the
reduction of reported profits:
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Unrealized Profit in Separate Tax Return
Illustrated (1 of 8)
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Unrealized Profit in Separate Tax Return
Illustrated (3 of 8)
If Peerless accounts for its investment in Special
Foods using the fully adjusted equity method,
Peerless would make the following journal entries
on its books:
Investment in Special Foods 24,000
Income from Special Foods 24,000
Record Peerless’s 80 percent share of Special Foods’ 20X1 reported income.
Cash 24,000
Investment in Special Foods 24,000
Record Peerless’s 80percent share of Special Foods’20X1 dividend.
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Unrealized Profit in Separate Tax Return
Illustrated (4 of 8)
Peerless also defers its 80 percent share of the
unrealized profit on intercompany upstream sales
(net of taxes).
Thus, the $5,000 of unrealized profit ($28,000 –
$23,000) net of 40 percent taxes is $3,000 ($5,000 ×
0.60).
Thus, the deferral of Peerless’s relative share of the
unrealized gross profit is $2,400 ($3,000 × 0.80).
Income from Special Foods 2,400
Investment in Special Foods 2,400
Eliminate unrealized gross profit (net of taxes) on inventory purchases
from Special Foods.
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Unrealized Profit in Separate Tax Return
Illustrated (5 of 8)
To prepare the basic consolidation entry, we first analyze the book value
of Special Foods’ equity accounts and the related 80 percent share
belonging to Peerless and the 20 percent share belonging to the NCI
shareholders:
Calculations for Basic Consolidation Entry:
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Unrealized Profit in Separate Tax Return
Illustrated (6 of 8)
We note that the book value calculations form the basis for the basic
consolidation entry, but Peerless’s share of income and its investment
account must be adjusted for the equity-method entry previously made
for $2,400.
In addition, the NCI share of income and net assets is adjusted for the 20
percent share of the unrealized gross profit (net of 40 percent taxes),
$600.
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Unrealized Profit in Separate Tax Return
Illustrated (7 of 8)
The following T-accounts illustrate how this entry eliminates the balances
in the Investment in Special Foods and Income from Special Foods
accounts:
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Unrealized Profit in Separate Tax Return
Illustrated (8 of 8)
The consolidation worksheet entry to correct for the intercompany sale is
identical to the preceding entry:
Sales 28,000
Cost of Goods Sold 23,000
Inventory 5,000
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Subsequent Profit Realization When
Separate Returns are Filed
When unrealized intercompany profits at the end of one period
subsequently are recognized in another period, the tax effects of the
temporary difference must again be considered.
If income taxes were ignored, the following consolidation entry would be
used in preparing consolidated statements as of December 31, 20X2,
assuming that Special Foods had $5,000 of unrealized inventory profit on
its books on January 1, 20X2, and the inventory was resold in 20X2:
Investment in Special Foods 4,000
NCI in NA of Special Foods 1,000
Cost of Goods Sold 5,000
Eliminate beginning inventory profit.
On the other hand, when the 40 percent tax rate is considered, the
consolidation entry would be modified as follows:
Investment in Special Foods 2,400
NCI in NA of Special Foods 600
Income Tax Expense 2,000
Cost of Goods Sold 5,000
Eliminate beginning inventory profit:
$2,400 = ($5,000 – $2,000) × 0.80
$600 = ($5,000 – $2,000) × 0.20
$2,000 = $5,000 × 0.40.
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PRACTICE EXERCISE: Unrealized Profit in
Separate Tax Return Illustrated (1 of 5)
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PRACTICE EXERCISE: Unrealized Profit in
Separate Tax Return Illustrated (2 of 5)
Snoopy sells inventory costing $75,000 to Peanut Products for $100,000, and
resold $60,000 of this inventory before year-end. Assume 40 percent tax
rate.
Total = Resold + Ending Inventory
Sales 100,000 60,000 40,000
COGS 75,000 45,000 30,000
Gross Profit 25,000 15,000 10,000
Gross Profit % 25%
Sales 100,000
Cost of Goods Sold 90,000
Inventory 10,000
With a 40 percent income tax rate, the following consolidation entry adjusts
income tax expense of the consolidated entity downward by $4,000 ($10,000
× 0.40) to reflect the reduction of reported profits:
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PRACTICE EXERCISE: Unrealized Profit in
Separate Tax Return Illustrated (3 of 5)
If Peanut accounts for its investment in Snoopy using the fully adjusted equity
method, Peanut would make the following journal entries on its books:
Cash 15,000
Investment in Snoopy 15,000
Record Peanut’s 75 percent share of Snoopy’s 20X1 dividend.
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PRACTICE EXERCISE: Unrealized Profit in
Separate Tax Return Illustrated (5 of 5)
We note that the book value calculations form the basis for the basic
consolidation entry, but Peanut’s share of income and its investment account
must be adjusted for the equity-method entry previously made for $4,500. In
addition, the NCI share of income and net assets is adjusted for the 25
percent share of the unrealized gross profit (net of 40 percent taxes):
Basic Investment Account Consolidation Entry:
Common Stock 250,000 Common stock balance
Retained Earnings 150,000 Beginning balance in RE
Income from Subsidiary 22,500 Peanut’s % of NI with Adjustments
NCI in NI of Subsidiary 7,500 NCI % of NI with Adjustments
Dividends Declared 20,000 100% of sub’s dividends declared
Investment in Subsidiary 307,500 Net BV with Adjustments
NCI in NA of Subsidiary 102,500 NCI % of BV with Adjustments
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PRACTICE EXERCISE: Subsequent Profit
Realization When Separate Returns Are Filed
If income taxes were ignored, the following eliminating entry would be
used in preparing consolidated statements as of December 31, 20X2,
assuming that Snoopy had $10,000 of unrealized inventory profit on its
books on January 1, 20X2, and the inventory was resold in 20X2:
Investment in Snoopy 7,500
NCI in NA of Snoopy 2,500
Cost of Goods Sold 10,000
Eliminate beginning inventory profit.
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Learning Objective 10-4
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Consolidated Earnings Per Share
Consolidated earnings per share (EPS) is calculated
in the same way that earnings per share is
calculated for a single corporation.
Basic consolidated EPS is calculated by deducting
income to the noncontrolling interest and any
preferred dividend requirement of the parent
company from consolidated net income.
The resulting amount is then divided by the weighted-
average number of the parent’s common shares
outstanding during the period.
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Computation of Diluted Consolidated
Earnings Per Share (1 of 2)
The following formula can be used in computing
diluted consolidated EPS:
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Computation of Diluted Consolidated
Earnings Per Share (2 of 2)
The parent’s share of consolidated net income
normally is the starting point in the computation of
diluted consolidated EPS.
It then is adjusted for the effects of parent and
subsidiary dilutive securities.
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Practice Quiz Question #2
Consolidated EPS is calculated:
a. as the sum of the subsidiary’s and the
parent’s individual EPS numbers.
b. by adding the subsidiary’s and the parent’s
net income numbers and dividing by the
subsidiary’s shares owned by the parent.
c. by deducting the NCI in net income and
preferred dividends from consolidated net
income and dividing by the parent’s
weighted-average shares.
d. as the parent’s net income divided by the
combined weighted shares outstanding of
the parent and subsidiary.
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Practice Quiz Question #2 Solution
Consolidated EPS is calculated:
a. as the sum of the subsidiary’s and the
parent’s individual EPS numbers.
b. by adding the subsidiary’s and the parent’s
net income numbers and dividing by the
subsidiary’s shares owned by the parent.
c. by deducting the NCI in net income and
preferred dividends from consolidated net
income and dividing by the parent’s
weighted-average shares.
d. as the parent’s net income divided by the
combined weighted shares outstanding of
the parent and subsidiary.
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Conclusion
The End