Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries With No Differential

Chapter 02
Reporting Intercorporate
Investments and
Consolidation of Wholly
Owned Subsidiaries with
No Differential
McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
Understand and explain how

ownership and control can
influence the accounting
for investments in common
stock.
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
Usually equity method
and consolidation
Ownership Percentage
Equity method (but cost method is
or Fair Value also okay here)
Option
No
Significant
significant Control
influence
influence
Why is the cost
0% 20% 50% method okay? 100%
2-5
 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
 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. as an available-for-sale investment.
b. as a consolidated subsidiary.
c. as a trading investment.
d. as an equity method investment.
e. 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. as an available-for-sale investment.
b. as a consolidated subsidiary.
c. as a trading investment.
d. as an equity method investment.
2-9
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.
S
2-11
 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
2-12
 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 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 100,000

Cash 100,000
Record purchase of XYZ Company stock.
Cash 4,000
Dividend Income 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
Under the cost method, a sub’s dividends

would:
a. NOT be eliminated in consolidation.
b. be the parent’s income from investment.
c. decrease the parent’s investment account.
d. increase the parent’s investment account.
2-22
Under the cost method, a sub’s dividends

would:
2-23

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 Income from Sub
Cost
Income Losses Losses Income
Dividends
Adj. Bal. 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 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.
2-27
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

Income from Investee 12,000
Record income from investment in XYZ Company ($60,000 x 0.20).
2-31
Example: The Equity Method
 Recognition of dividends
Cash 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 100,000
Equity Accrual Dividends
(60,000 x 0.20) 12,000 ($20,000 x 0.20) 4,000
Ending Balance 108,000
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
Under the equity method, a sub’s

dividends would:
2-36
Under the equity method, a sub’s

dividends would:
2-37
Under the equity method, a sub’s losses

would:
a. never reduce the parent’s income.
b. normally reduce the parent’s income.
c. always reduce the parent’s income.
d. always be eliminated in consolidation.
2-38
Under the equity method, a sub’s losses

would:
a. never reduce the parent’s income.
b. normally reduce the parent’s income.
c. always reduce the parent’s income.
d. always be eliminated in consolidation.
2-39
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 Original cost Original Cost
investment at date of
acquisition
Usual carrying amount of Original cost Original cost increased
investment subsequent to (decreased) by investor’s share
acquisition of investee’s income (loss) and
decreased by investor’s share of
investee’s dividends
Income recognition by Investor’s share of Investor’s share of investee’s
investor investee’s dividends earnings since acquisition,
declared from earnings whether distributed or not
since acquisition
Investee dividends from Income Reduction of investment
earnings since acquisition by
investor
Investee dividends in excess Reduction of investment Reduction of investment
of earnings since acquisition
by investor
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
Net Loss
500
100
Ending balance
Dividends
400
 What if Net
Parent uses the cost method?
income 50 $500 COST!!!
 What journal entries would Parent make under each method?
200 2-42
Summary of Year 1 Equity Method Entries
Investment in Soup Corp. 500

Cash 500
Record the initial investment in Soup Corp.
Income from Soup Corp. 100

Investment in Soup. Corp. 100
Record Pea Corp.’s 100% share of Soup Corp.’s Year 1 net loss.
Investment in Soup Corp. Income from Soup Corp.

Acquisition Price 500 Net Loss Net Loss 100
100
Ending Balance 400 Dividends Ending Balance 100
2-43
Summary of Year 2 Equity Method Entries

Record Pea Corp.’s 100% share of Soup Corp.’s Year 2 income.
Cash 50
Investment in Soup. Corp. 50
Record Pea Corp.’s 100% share of Soup Corp.’s Year 2 dividends

Beginning Balance 400
Net Income 200 Net Income 200
Dividends
Ending Balance 550 50 Ending Balance 200
2-44
Example: Equity versus Cost Method
2-45
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
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

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 200,000
Cash 200,000
Record purchase of Barclay Company stock.
March1, 20X1
Cash 1,500
Record dividend income from Barclay Company.
March 31, 20X1

Investment in Barclay Stock 7,000
Unrealized Gain on Increase in Value of Barclay Stock 7,000
Record increase in value of Barclay stock. 2-50
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 Partially Owned

Subsidiary Subsidiary
Investment = Book Value Chapter 2 Chapter 3
Investment > Book Value Chapter 4 Chapter 5
2-52
 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
 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
Net Loss
500
100
Ending balance
Dividends
400
 What accounts need to be eliminated?
Net income 50
 How are they eliminated?
200 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
Additional
Total = Common + Paid-In + Retained
Book Value Stock Capital Earnings

Beginning Book Value 400) 50 450 (100)
+ Net Income 200)
200)
Dividends (50) (50)
Ending Book Value 550) 50 450 50)
Note that the “blue” numbers appear Note that this is a
in the basic elimination entry. deficit balance!
Basic Elimination Entry
Common Stock  Original amount invested (100%)
Additional Paid-in Capital  Original amount invested (100%)
Income from Soup Corp.  Soup Corp.’s reported income
Retained Earnings (BB)  Beginning balance in retained earnings
Dividends Declared  100% of Soup Corp.’s dividends
Investment in Soup Corp.  Net book value in investment account
2-59
Additional
Total = Common + Paid-In + Retained
Book Value Stock Capital Earnings

Beginning Book Value 400) 50 450 (100)
+ Net Income 200)
200)
Dividends (50) (50)
Ending Book Value 550) 50 450 50)
Note that the “blue” numbers appear Note that this is a
in the basic elimination entry. deficit balance!
Common Stock 50  Original amount invested (100%)
Additional Paid-in Capital 450  Original amount invested (100%)
Income from Soup Corp. 200  Soup Corp.’s reported income
Retained Earnings (BB) 100  Beginning balance in retained earnings
Dividends Declared 50  100% of Soup Corp.’s dividends
Investment in Soup Corp. 550  Net book value in investment account
2-60
Basic Elimination Entry: The Equity Method
Common Stock 50
Additional Paid-in Capital 450
Retained Earnings (BB) 100
Dividends Declared 50

Beginning Balance 400
Net Income 200 Net Income 200
Dividends
Ending Balance 550 50 Ending Balance 200

Basic
0 200 0
550 2-61
Prepare a
consolidation
worksheet.
2-62
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)
Net Income 350 200

Beginning Balance 150 (100)
Net Income 350 200
Less: Dividends Declared (100) (50)
Ending Balance 400 50
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700
Li abil ities 300 150

Common Stock 200 50
Additional Paid-in Capital 800 450
Retained Earnings 400 50
Total Liabilities & Equity 1,700 700
2-63
Worksheet: Draw lines
Elimination Entries
Income Statement
Sales 1,200 600
Less: COGS (600) (300)
Net Income 350 200

Beginning Balance 150 (100)
Net Income 350 200
Less: Dividends Declared (100) (50)
Balance Sheet
Cash 250 100
PP&E (net) 900 600

Common Stock 200 50
2-64
Worksheet: Eliminations, Sub-totals, Carry down
Elimination Entries
Income Statement
Sales 1,200 600
Less: COGS (600) (300)
Income from Soup Corp. 200 200
Net Income 350 200

Beginning Balance 150 (100) 100
Net Income 350 200
Less: Dividends Declared (100) (50) 50
Balance Sheet
Cash 250 100
Investment in Soup Corp. 550 550
PP&E (net) 900 600

Common Stock 200 50 50
Additional Paid-in Capital 800 450 450
2-65
Worksheet: Eliminations, Sub-totals, Carry down
Elimination Entries
Income Statement
Sales 1,200 600
Less: COGS (600) (300)
Net Income 350 200 200 0

Net Income 350 200 200 0
Ending Balance 400 50 200 150
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

Retained Earnings 400 50 200 150
Total Liabilities & Equity 1,700 700 700 150
2-66
Worksheet: Add across
Elimination Entries
Income Statement
Sales 1,200 600
Less: COGS (600) (300)
Net Income 350 200 200 0

Net Income 350 200 200 0
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-67
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300)
Net Income 350 200 200 0

Net Income 350 200 200 0
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-68
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0

Net Income 350 200 200 0
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-69
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Less: Other Expenses (450) (100) (550)
Net Income 350 200 200 0

Net Income 350 200 200 0
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-70
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Income from Soup Corp. 200 200 0
Net Income 350 200 200 0

Net Income 350 200 200 0
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-71
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-72
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Beginning Balance 150 (100) 100 150
Net Income 350 200 200 0
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-73
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-74
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Less: Dividends Declared (100) (50) 50 (100)
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-75
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-76
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-77
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
Investment in Soup Corp. 550 550 0
PP&E (net) 900 600
Total Assets 1,700 700 0 550

2-78
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550

2-79
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850

2-80
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850
Li abil ities 300 150 450

2-81
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850

Common Stock 200 50 50 200
2-82
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850

Additional Paid-in Capital 800 450 450 800
2-83
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850

Retained Earnings 400 50 200 150 400
2-84
Elimination Entries
Income Statement
Sales 1,200 600 1,800
Less: COGS (600) (300) (900)
Net Income 350 200 200 0 350

Net Income 350 200 200 0 350
Ending Balance 400 50 200 150 400
Balance Sheet
Cash 250 100 350
PP&E (net) 900 600 1,500
Total Assets 1,700 700 0 550 1,850

Total Liabilities & Equity 1,700 700 700 150 1,850
2-85
The Equity Method: Things to Remember in
Consolidation
 Consolidated net income EQUALS the
parent’s net income.
Parent Consolidated
$350 = $350
 Consolidated retained earnings EQUALS

the parent’s retained earnings.
Parent Consolidated
$400 = $400
2-86
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
Income from Smith, Inc. 36,000 on 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
Less: Dividends Declared (108,000) (12,000) 12/31/11.
Ending Balance 180,000 96,000
• Prepare a
Balance Sheet consolidation
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
2-87
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
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 Note that the “blue”
 Eliminate equity method accounts of Parent. numbers appear in the
basic elimination entry.
= +
Original Book Value 132,000) 60,000 72,000)
+ Net Income 36,000)
36,000)
Dividends (12,000) (12,000)
Ending Book Value 156,000) 60,000 96,000)
Common Stock
Retained Earnings (BB)
Income from Smith, Inc.
Dividends Declared
Investment in Smith, Inc.
2-89
Objective:
 Eliminate equity accounts of Sub
 Eliminate equity method accounts of Parent.
= +
Original Book Value 132,000) 60,000 72,000)
+ Net Income 36,000)
36,000)
Dividends (12,000) (12,000)
Ending Book Value 156,000) 60,000 96,000)
Common Stock 60,000
Retained Earnings (BB) 72,000

Income from Smith, Inc. 36,000
Dividends Declared 12,000
Investment in Smith, Inc. 156,000 2-90
The optional accumulated depreciation elimination entry:
Accumulated Depreciation 20,000

Buildings and Equipment 20,000
Property, Plant & Equipment Accumulated Depreciation

20,000
210,000
2-91
The optional accumulated depreciation elimination entry:
Accumulated Depreciation 20,000

Buildings and Equipment 20,000
Property, Plant & Equipment Accumulated Depreciation

20,000
210,000
20,000 20,000
0
190,000
Shows the Buildings and Equipment “as if” they have been
recorded on the Sub’s books as new assets at book value.
2-92
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

Beginning Balance 132,000 72,000 72,000
Net Income 156,000 36,000 36,000 0
Less: Dividends Declared (108,000) (12,000) 12,000
Ending Balance 180,000 96,000 108,000 12,000
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
Accounts Payable 168,000 84,000

Common Stock 12,000 60,000 60,000
Retained Earnings 180,000 96,000 108,000 12,000
Total Liabilities & Equity 720,000 384,000 168,000 12,000
2-93
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

Beginning Balance 132,000 72,000 72,000 132,000
Net Income 156,000 36,000 36,000 0 156,000
Less: Dividends Declared (108,000) (12,000) 12,000 (108,000)
Ending Balance 180,000 96,000 108,000 12,000 180,000
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
Accounts Payable 168,000 84,000 252,000

Long-term Debt 360,000 144,000 504,000
Common Stock 12,000 60,000 60,000 12,000
Retained Earnings 180,000 96,000 108,000 12,000 180,000
Total Liabilities & Equity 720,000 384,000 168,000 12,000 948,000
2-94
Appendix 2B
Consolidation and
the Cost Method.
2-95
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

Beginning Balance $ 250 $ (100)
Net Income 200 200
Less: Dividends Declared 100 50
Ending Balance $ 350 $ 50
Balance Sheet
Cash $ 250 $ 100
Investment in Sub 500
Property, Plant, & Equipment 900 600
Total Assets $ 1,650 $ 700
Liabilities $ 300 150

Common Stock 200 50
Total Liabilities & Equity $ 1,650 700
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 50
Additional Paid-in Capital 450
Investment in Sub 500
 Under the cost method, we also eliminate dividends from
sub to parent.
Dividend Income 50
Dividends Declared 50
2-97
Complete the Worksheet
Elimination Entries
Income Statement
Sales $ 1,200 $ 600
Less: COGS 600 300
Dividend Income 50 50
Net Income $ 200 $ 200 50

Net Income 200 200 50
Less: Dividends Declared 100 50 50
Ending Balance $ 350 $ 50 50 50
Balance Sheet
Cash $ 250 $ 100
Investment in Sub 500 500
Property, Plant, & Equipment 900 600 0
Total Assets $ 1,650 $ 700 0 500

Total Liabilities & Equity $ 1,650 700 550 50
2-98
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300
Net Income $ 200 $ 200 50

Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-99
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50

Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-100
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Less: Expenses 450 100 550
Net Income $ 200 $ 200 50

Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-101
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-102
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Beginning Balance $ 250 $ (100) $ 150
Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-103
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-104
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Less: Dividends Declared 100 50 50 100
Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-105
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100
Total Assets $ 1,650 $ 700 0 500

2-106
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Total Assets $ 1,650 $ 700 0 500

2-107
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Property, Plant, & Equipment 900 600 0 1,500
Total Assets $ 1,650 $ 700 0 500

2-108
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Total Assets $ 1,650 $ 700 0 500 $ 1,850

2-109
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Total Assets $ 1,650 $ 700 0 500 $ 1,850
Liabilities $ 300 150 $ 450

2-110
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Total Assets $ 1,650 $ 700 0 500 $ 1,850

2-111
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Total Assets $ 1,650 $ 700 0 500 $ 1,850

2-112
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Total Assets $ 1,650 $ 700 0 500 $ 1,850

2-113
Elimination Entries
Income Statement
Sales $ 1,200 $ 600 $ 1,800
Less: COGS 600 300 900
Net Income $ 200 $ 200 50 $ 350

Net Income 200 200 50 350
Ending Balance $ 350 $ 50 50 50 $ 400
Balance Sheet
Cash $ 250 $ 100 $ 350
Total Assets $ 1,650 $ 700 0 500 $ 1,850

Total Liabilities & Equity $ 1,650 700 550 50 $ 1,850
2-114
Group Exercise 1: Cost Method Consolidation
Elimination Entries
Income Statement
Sales $ 840,000 $ 300,000
Less: COGS (516,000) (156,000)
Less: Expenses (204,000) (108,000)
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
• What is the maximum
Inventory 204,000 90,000 dividend the parent could
Investment in Sub 60,000
Property & Equipment 336,000 210,000
declare ($84,000 or
Accumulated Depreciation (144,000) (30,000) $180,000) if cash were
Total Assets $ 624,000 $ 384,000 available?
Payables & Accruals $ 168,000 84,000
Total Liabilities & Equity $ 624,000 384,000
2-115
Elimination Entries
Income Statement
Sales $ 840,000 $ 300,000
Less: COGS (516,000) (156,000)
Less: Expenses (204,000) (108,000)
Dividend Income 12,000 Basic Elimination Entry
Net Income $ 132,000 $ 36,000
Investment elimination entry
Balances, 1/1/X3 $ 60,000 $ 72,000 Common Stock 60,000
Add: Net Income 132,000 36,000 Investment in Sub
Less: Dividends (108,000) (12,000) 60,000
Balances, 12/31/X3 $ 84,000 $ 96,000
Balance Sheet Dividend elimination entry

Cash $ 54,000 $ 48,000
Inventory 204,000 90,000 Dividend Declared
Investment in Sub 60,000 12,000
Property & Equipment 336,000 210,000
Accumulated Depreciation (144,000) (30,000)
Total Assets $ 624,000 $ 384,000
Payables & Accruals $ 168,000 84,000

Total Liabilities & Equity $ 624,000 384,000
2-116
Solution
Elimination Entries
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

Balances, 1/1/X3 $ 60,000 $ 72,000 $ 132,000
Add: Net Income 132,000 36,000 12,000 156,000
Less: Dividends (108,000) (12,000) 12,000 (108,000)
Balances, 12/31/X3 $ 84,000 $ 96,000 12,000 12,000 $ 180,000
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
Payables & Accruals $ 168,000 84,000 $ 252,000

Long-term Debt 360,000 144,000 504,000
Common Stock 12,000 60,000 60,000 12,000
Retained Earnings 84,000 96,000 12,000 12,000 180,000
Total Liabilities & Equity $ 624,000 384,000 72,000 12,000 $ 948,000
2-117
The Cost Method: Things to Remember in
Consolidation
 Consolidated net income does NOT equal the parent’s net
income.
P S Sub’s Div CONS

$200 + $200  $50 = $350
 Consolidated retained earnings does NOT equal the parent’s

retained earnings.
P S CONS
$350 + $50 = $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 holds
true for all three statements.
Equity Cost
=
Method Method
Consolidated Consolidated
Statements Statements
2-119
PCO Statements: Presented in Notes to the
Consolidated Statements
 Retained Earnings Available for
Dividends:
 Based on the parent’s G/L amount—not on the
consolidated retained earnings amount.
 Use of the equity method in PCO statements
produces identical retained earnings amounts.
 Use of the cost method in PCO statements
creates confusion.
2-120
Conclusion
The
The End
End

Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries With No Differential

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Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries With No Differential

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Chapter 02

Understand and explain how

The method used to account for investments in

If Company A purchases 45% of the

If Company A purchases 45% of the

Prepare journal entries

 Record the investment at “cost.”

sub declares a dividend.

has been impaired.

 The cost method is a one-way street!

Although the parent can manipulate its

 Used when the investor lacks the ability

 At the time of purchase, the investor records its

Investment in XYZ Company Stock 100,000

 Changes in the number of shares held

Under the cost method, a sub’s dividends

Under the cost method, a sub’s dividends

Prepare journal entries

 The equity method is accrual basis driven:

The equity method is a two-way street!

 The equity method is intended to reflect the

 APB Opinion No. 18 (as amended) requires that the

 Investor’s equity in the investee

Reported by Investee Effect on Investor’s Accounts

Investment in XYZ Company Stock 12,000

 Carrying amount of the investment

Investment in XYZ Common Stock

Ending Balance 108,000

 Acquisition at Interim Date

 Purchases of additional shares

Under the equity method, a sub’s

Under the equity method, a sub’s

Under the equity method, a sub’s losses

Under the equity method, a sub’s losses

Understand and explain

Item Cost Method Equity Method

Investment in Soup Corp. 500

Income from Soup Corp. 100

Investment in Soup Corp. Income from Soup Corp.

Investment in Soup Corp. 200

Investment in Soup Corp. Income from Soup Corp.

Ending Balance 550 50 Ending Balance 200

On 1/1/X4, Phillip invested $650,000 in Sleeper (100%

On 1/1/X4, Phillip invested $650,000 in Sleeper (100%

Prepare journal entries

March 31, 20X1

Make calculations and

 Chapter 2 introduces the most simple setting for a

Wholly Owned Partially Owned

Investment = Book Value Chapter 2 Chapter 3

Investment > Book Value Chapter 4 Chapter 5

 The objective is to combine the financial statements

 In the consolidation worksheet, the three

 What needs to be eliminated?

Book Value Stock Capital Earnings

Book Value Stock Capital Earnings

Investment in Soup Corp. Income from Soup Corp.

Ending Balance 550 50 Ending Balance 200

Statement of Retained Earnings

Li abil ities 300 150

Statement of Retained Earnings

Li abil ities 300 150

Statement of Retained Earnings