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Chapter 7

Consolidated Financial Statements:


Subsequent to Date of PurchaseType Business Combination
ACCT 501

Objectives of this Chapter

Prepare the consolidated financial


statements for the parent company
and its subsidiaries for the years
following business combination for
purchase-type business combination
For wholly owned purchased
subsidiaries
For partially owned purchased
subsidiaries

Accounting for Operating Results of


Wholly Owned Purchased Subsidiaries

A parent company may choose the


equity method or the cost method
in accounting for the operating
results of purchased subsidiaries.

Equity Method

The parent company recognizes its


share of the subsidiarys net income or
loss and adjusted for the depreciation
and amortization of the step up on
purchased subsidiarys net assets.
The parent company also recognizes
its share of dividends declared by the
subsidiary.

Equity Method (contd.)

Thus, the equity method is consistent


with the accrual basis accounting.
Equity method emphasizes the economic
substance of the parent-subsidiary.
Dividends declared by subsidiaries are
not revenue to the parent company,
rather, they are a liquidation of a portion
of the parent companys investment in
the subsidiary.

Cost Method

Under this method, the parent


company accounts for the operations
of a subsidiary only to the extend that
dividends are declared by the
subsidiary.
This method emphasizes the legal
form of the parent-subsidiary
relationship.

Choosing Between Equity Method


and Cost Method

Consolidated financial statement


amounts are the same regardless
of the method used to account for
a subsidiarys operations.
The differences are in the working
paper elimination.

Choosing Between Equity Method


and Cost Method (contd.)

Equity method is appropriate for


both pooled subsidiaries and
purchased subsidiaries.
The cost method is only
appropriate for purchased
subsidiaries.

Example 7.1: Equity Method for holly Owned


Purchased Subsidiary for First Year after
Business Combination (textbook p286-296)

Assumed that Palm Corporation had


used purchase accounting for the
December 31, 1999, business
combination with its wholly owned
subsidiary- Starr Company. Starr had
a net income of $60,000 (income
statement is on p293 of the textbook)
for the year ended December 31, 2000.

Example 7.1: (contd.)

On December 20, 2000, Starrs board


of directors declared a cash dividend
of $0.60 a share on the 40,000
outstanding shares of common stock
owned by Palm. The divided was
payable January8, 2001, to
stockholders recorded December 29,
2000.

Example 7.1: (contd.)

Starrs December 20, 2000, journal entry to


record the dividend declaration is as follows:
12/20
Dividends Declared 24,000
Intercompany Dividend payable 24,000
The intercompany dividend payable account
must be eliminated in the preparation of
consolidated financial statements for the
year 2000.

Example 7.1: (contd.)

Under the equity method, Palm Corp.


prepares the following journal entries to
record the dividend and net income of
Starr for the year ended 12/31/2000:
12/20/00
Intercompany
Dividend Receivable
24,000
Investment in Starr Company Stock
24,000
To record the dividends declared by Starr.

Example 7.1: (contd.)


12/31/00

Investment in
Starr Company Stock
60,000
Intercompany Investment Income

60,000

To record the Palms share (100%) of net income on


Starr under equity method

Adjustment of Purchased
Subsidiarys Net Income

Since Palms acquisition of Starr is


accounted for using the purchase
method, adjustments are needed to
adjust Starrs net income for
depreciation and amortization
attributable to the step up on Starrs
net assets on 12/31/99.

Adjustment of Purchased
Subsidiarys Net Income (contd.)

Assumed that on 12/31/99,


differences between the current fair
values and carrying amounts of
Starrs net assets were as follows
(also see p236 and p241 of chapter 6
of the textbook):

Adjustment of Purchased
Subsidiarys Net Income (contd.)
Inventories (FIFO)
Plant assets (net)
Land
Building(eco. life 10 yrs.)
Machinery(eco. life 10yrs.)
Patent (eco. life 5 yrs.)
Goodwill (eco. life 30 yrs.)
Total

$ 25,000
$15,000
30,000
20,000

65,000
5,000
15,000
$110,000

Adjustment of Purchased
Subsidiarys Net Income (contd.)

Palm prepares the following journal entry to


account for the depreciation and amortization
of the step up on Starrs net assets:
12/31/2000

Intercompany
Investment Income 30,500
Investment in
Starr Company Stock
30,500

Adjustment of Purchased
Subsidiarys Net Income (contd.)

The annual depreciation and amortization of


the step up are as follows:
Inventory (to cost of goods sold)
Building (30,000/15)
Machinery (20,000/10)
Patent (5,000/5)
Goodwill (15,000/30)
Total depr. And amort. For year 2000
(income tax effects are disregarded)

$25,000
2,000
2,000
1,000
500
$30,500

Adjustment of Purchased
Subsidiarys Net Income (contd.)

After the three foregoing journal entries,


Palm Corp.s Investment in Starr Companys
Common Stock and intercompany
Investment Income accounts are as follows:
Investment in Starrs
Common Stock
12/31/99
450,000 a
12/31/99
50,000 b
12/31/00
60,000 d 24,000 c
12/20/00
30,500 e
12/31/00

Adjustment of Purchased
Subsidiarys Net Income (contd.)
a. Issuance of common stock (by Palm) in the
acquisition of Starr.
b. Direct out-of-pocket costs of business
combination.
c. Recognition of dividend declared by the
subsidiary-Starr.
d. Recognition of wholly owned subsidiarys
(Starr) net income.
e. Recognition of depre. and amor. on the stepup of Starrs net assets.

Adjustment of Purchased
Subsidiarys Net Income (contd.)

12/31/00

Intercompany
Investment Income
60,000 a
30,500 b
29,500

12/20/00

Development of the Elimination

Analysis of Investment in Starr Stock


account (for the year ended 12/31/2000)
Carrying
Amount.

Step-up

Total

Beginning Balances $390,000 $110,000 $500,000


(on 12/31/99)
Net Income(Starr)
Amort. On Step-up
Dividends Declared
by Starr
Ending Balance

60,000
(24,000)

60,000
(30,500) (30,500)
(24,000)

$426,000

$79,500 $505,500

Development of the Elimination


(contd.)

Note:
1. The ending balance on the carrying
amount (book value),$426,000,
equals the balance the total
stockholders equity of Starr on
12/31/2000 as follows (see the balance
sheet section of Starr on p293 of
textbook):

Development of the Elimination


(contd.)
Common Stock,$5 par
Additional Paid-in Capital
Retained Earnings
(132,000+60,000-24,000)
Total Stockholders Equity

$200,000
58,000
168,000
$426,000

Development of the Elimination


(contd.)

The $79,500 balance on the Step-up


column represents the unamortized
excess amount (the difference
between the current fair value of net
assets and the carrying amount). The
details are in the following table:

Development of the Elimination


(contd.)
Inventories
Plant assets(net):
Land
Building
Machinery
Total plant
assets
Patent
Goodwill

Balances,
Dec.31,1999
$ 25,000

Amort. for
Balances,
Year 2000 Dec. 31,2000
$(25,000)

$ 15,000
30,000
20,000

$ (2,000)
(2,000)

$15,000
28,000
18,000

$ 65,000

$ (4,000)

$61,000

$ (1,000)
(500)

$ 4,000
14,500

5,000
15,000

Palm Corp. and Subsidiary Working Paper


Elimination (on 12/31/2000)

All three basic financial statements (the


income statement, the statement of
retained earnings and the balance
sheet) must be consolidated for
accounting period following the date of
a purchase-type business
combination.The items that must be
included in the elimination are:

Palm Corp. and Subsidiary Working Paper


Elimination (on 12/31/2000) (contd.)
1)The subsidiarys beginning balance of
stockholders equity accounts and its
dividends and parents investment account;
2)the parents intercompany investment
income ;
3)unamortized current fair value excess of the
subsidiary;
4)certain operating expense of the subsidiary.

Palm Corp. and Subsidiary Working Paper


Elimination (on 12/31/2000) (contd.)

Assuming that Starr allocates machinery


depreciation and patent amortization entirely
to cost of goods sold, goodwill amortization
entirely to operating expense and building
depreciation 50% each to cost of goods sold
and operating expenses, the working paper
elimination (in journal entry format) for Palm
and subsidiary on 12/31/2000 is as follows:

Palm Corp. and Subsidiary Working Paper


Elimination (on 12/31/2000) (contd.)
Common Stock-Starr
Additional Paid-in Capital-Starr
Retained Earnings-Starr
Investment Income-Palm
Plant Assets (net)-Starr

200,000
58,000
132,000
29,500

Patent (net)-Starr ($5,000-1,000)


Goodwill (net)-Starr ($15,000-500)
Cost of Goods Sold-Starr
Operating Expenses-Starr

4,000
14,500
29,000
1,500

($65,000-4,000)

61,000

Palm Corp. and Subsidiary Working Paper


Elimination (on 12/31/2000) (contd.)

Note:
1. Income tax effects are disregarded
2. the computation of cost of goods
sold and operating expense are as
follows:

Palm Corp. and Subsidiary Working Paper


Elimination (on 12/31/2000) (contd.)
Cost of
Operating
Goods Sold Expenses
Inventories sold
Building depreciation
Machinery depreciation
Patent amortization
Goodwill amortization
Totals

$25,000
1,000
2,000
1,000
$29,000

$1,000

500
$1,500

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (on p293 of textbook)
PALM CORPORATION AND SUBSIDIARY
Working paper for Consolidated Financial Statements
For Year Ended December 31,2000
Income Statement

Palm
Corporation

Starr
Company

Eliminations Consolidated
Increase

Revenue:
Net Sales
Intercompany investment
income
Total revenue

1,100,000

680,000

29,500

1,780,000
(a)(29,500)

1,129,500

680,000

(29,500)

1,780,000

Cost of good sold

700,000

450,000

(a) 29,000

1,179,000

Operating expenses

217,667

130,000

(a) 1,500

349,167

Costs and expenses:

Interest expenses

49,000

Income taxes expense

53,333

49,000
40,000

93,333

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (contd.)
PALM CORPORATION AND SUBSIDIARY
Working paper for Consolidated Financial Statements
For Year Ended December 31,2000

Statement of
Palm
Starr
Eliminations Consolidated
Retained Earnings Corporation Company Increase
Retained earnings,
beginning of year

134,000

Net income

109,500

60,000

(60,000)

109,500

243,500

192,000

(192,000)

243,500

24,000 (a) (24,000)+

30,000

Subtotal
Dividends
declared
Retained earnings,
end of year

30,000
213,500

132,000 (a) (132,000)

168,000

(168,000)

134,000

213,500

(Continued)

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (contd.)
PALM CORPORATION AND SUBSIDIARY
Working paper for Consolidated Financial Statements
For Year Ended December 31,2000
Balance/Assets

Palm
Corporation

Starr
Company

Eliminations Consolidated
Increase

Cash

15,900

72,100

Intercomapny receivable
(payable)

24,000

(24,000)

136,000

115,000

251,000

88,000

131,000

219,000

Inventories
Other current assets
Investment in Starr
Company common stock
Plant assets (net)
Patent (net)
Goodwill (net)

505,500

88,000

(a) (505,500)

3,500,000

340,000

(a)

61,000

841,000

440,000

16,000

(a)

4,000

20,000

(a)

14,500

14,500

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (contd.)
PALM CORPORATION AND SUBSIDIARY
Working paper for Consolidated Financial Statements
For Year Ended December 31,2000

Liabilities
Palm
Starr
&Stockholders Equity Corporation Company
Income taxes payable

Eliminations Consolidated
Increase

40,000

20,000

60,000

Other liabilities

190,900

204,100

395,000

Common stock,$10par

400,000

Common stock, $5 par

400,000
200,000

(a) (200,000)

Additional paid-in
capital

365,000

58,000

(a) (58,000)

365,000

Retained earnings

213,500

168,000

(168,000)

213,500

Total liabilities
& stockholders

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (contd.)

Notes:
1.The intercompany receivable and
payable, placed in adjacent columns
on
the same line, are offset without a formal
elimination.
2. The FIFO methods used by Starr; thus,
the $25,000 difference attributable to
the
beginning inventories of Starr is
allocated
to the cost of goods sold for
year 2000.

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (contd.)
3. The step up (current fair value
excess on Starrs net assets) is
only included in the consolidated
balance sheet for the unamortized
balance.
4. Step- up on land is not subject to
amortization.

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (contd.)
5. The use of equity method results in:
Parent

company net income =


consolidated net income
Parent company retained earnings =
consolidated retained earnings
These equalities exist when the equity
method is used and no intercompany
profits accounted for in the
determination
of consolidated net assets.

Equity Method: Wholly Owned Subsidiary


Subsequent to Date of Purchase-type Business
Combination (contd.)
6. Consolidated financial statements

provide more information than those of


the parent company despite the
equalities in the net income and
retained earnings.
7. The retained earnings of Palm on
12/31/2000 includes only $29,500 share
of the subsidiarys adjusted net income for
the year ended 12/31/2000.

Consolidated Financial Statements


(for example 7.1)

The consolidated income statement,


statement of retained earnings and
balance sheet of Palm corp. and
subsidiary for the year ended
December 31, 2000 are as follows: (on
p294 and 295 of textbook)

Consolidated Financial Statements


(contd.)
PALM CORPORATION AND SUBSIDIARY
Consolidated Income Statement
For Year Ended December 31,2000

Net Sales
Costs and expenses:
Costs and goods sold
Operating expenses
Interest expense
Income taxes expense
Total costs and
expenses
Net income

$1,780,000

$1,179,000
349,167
49,000
93,333
1,670,000
$109,500

Consolidated Financial Statements


(contd.)
PALM CORPORATION AND SUBSIDIARY
Consolidated Statement of Retained Earnings
For Year Ended December 31,2000

Retained earnings,
beginning of year:
Add: Net income
Subtotals
Less: Dividends($0.75 a share)
Retained earnings,
end of year

$ 134,000
109,500
$ 243,500
30,000
$ 213,500

Consolidated Financial Statements


(contd.)
PALM CORPORATION AND SUBSIDIARY
Consolidated Balance Sheet
For Year Ended December 31,2000
Assets

Current assets:
Cash
Inventories
Other
Total current assets
Plant assets (net)
Intangible assets:
Patent(net)

88,000
251,000
219,000
$ 558,000
841,000
$20,000

Consolidated Financial Statements


(contd.)
PALM CORPORATION AND SUBSIDIARY
Consolidated Balance Sheet
For Year Ended December 31,2000
Liabilities $ Stockholders Equity

Liabilities:
Income taxes payable
Other
Total liabilities
Stockholders equity:
Common stock, $10 par
Additional paid-in capital
Retained earnings

60,000
395,000
$ 455,000
$ 400,000
365,000
213,500

978,500

Closing Entries for Example 7.1

Closing entries should be prepared for both


the parent company and the subsidiary at
the end of the fiscal year after the financial
statements[1] being prepared.
The closing entries for the subsidiary are
prepared in the usual fashion.
The closing entries for the parent company
are prepared in the usual fashion except for
the closing of the income summary to the
retained earnings.

Closing Entries (contd.)

Palm Corporation prepares the closing


entries on 12/31/2000, after the
consolidated financial statements have
been prepared, as follows:
Note: Palm closes its income statement
accounts, not the consolidated I/S
accounts.

Closing Entries (contd.)


[1] Consolidated financial statements for the
parent company and the regular F/S for the
subsidiary.
The parent and subsidiary are two separate
legal entities. When consolidated F/S are
prepared using the equity method, the
economic substance of the parentsubsidiary relationship is being emphasized
rather than their legal form.

Closing Entries (contd.)


Net Sales
Intercompany
Invest. Income

1,100,000
29,500

Income Summary
Income Summary 1,020,000

1,129,500

Cost of Goods Sold


Operating Expense
Interest Expense
Income Taxes Expense

700,000
217,667
49,000
53,333

Closing Entries (contd.)


Income Summary
Retained Earnings of
Subsidiarya
Retained Earnings b
Retained Earnings
Dividends Declared

109,500
5,500
104,000
30,000
30,000

Closing Entries (contd.)


a.The portion of retained earnings which is
contributed by the subsidiary. The computation
is $29,500 (adjusted net income of subsidiary)
24,000 (dividends declared by the
subsidiary).
This amount of retained earnings is NOT
available for dividends to Palms stockholders.
b.The portion of retained earnings which is
contributed by the operation of the parent
company.

Closing Entries (contd.)

After the foregoing closing entries, the


balances of Palm Corp.s Retained Earnings
and Retained Earnings of subsidiary ledger
accounts are as follows:
Retained Earnings
134,000 Beg.Balance
104,500 Close net income
available for dividends
to stockholders of
Palm

Close dividends
declared

30,000

Closing Entries (contd.)


Retained Earnings of Subsidiary
5,500
Close net income not
available for dividends
to stockholders of
Palm

Closing Entries (contd.)

The balance of the retained earnings of


subsidiary is equal to the net increase in the
balance of Palms investment in Starr
Company Stock account as shown below:
$505,500 ( the balance of the Investment
account on 12/31/2000)
- 500,000 ( the balance of the Investment
account on 12/31/99)
$5,500

Example 7.2: Equity Method for Wholly Owned


Purchased Subsidiary for Second Year After
Business Combination (textbook p297-300)

The Palm-Starr example is continued to be


used to illustrate the application of the equity
method for a wholly owned purchased
subsidiary for the second year after a
business combination.
On December 17, 2001, Starr declared a
dividend of $40,000, payable January 6,
2002, to Palm Corp., the stockholder of
record on December 28, 2001. For the year
ended 12/31/2001, Starr had a net income
of $90,000.

Example 7.2: Equity Method for Wholly Owned


Purchased Subsidiary for Second Year After
Business Combination (contd.)

After the posting of appropriate journal


entries for 2001 under the equity method,
selected ledger accounts for Palm Corp. are
as follows:

Investment in Starrs Common Stock


12/31/99
450,000 a
12/31/99
50,000 b
12/31/00
60,000 d
24,000 c
12/20/00
30,500 e
12/31/00
12/31/01
90,000 f
40,000 g
12/17/01
5,500 h
12/31/01

Example 7.2 :(contd.)


a.Issuance of common stock (by Palm) in the
acquisition of Starr.
b.Direct out-of-pocket costs of business
combination.
c.Recognition of dividend declared by the
subsidiary-Starr for year 2000.
d.Recognition of wholly owned subsidiarys
(Starr) net income for 2000.
e.Recog. of depre. and amor. on the step-up
of Starrs net assets for 2000.

Example 7.2 :(contd.)


f.Recognition of wholly owned subsidiarys
(Starr) net income for 2001.
g.Recognition of dividend declared by the
subsidiary-Starr for year 2001.
h.Recog. of depre. and amor. on the step-up
of Starrs net assets for 2001.

Example 7.2: (contd.)


Intercompany Investment Income
60,000 a
12/31/00
30,500 b
12/31/00
29,500 d
29,500 c
0
90,000 e
12/31/00
5,500 f
84,500

12/20/00
12/21/00
12/31/00
12/31/01
12/31/01

Example 7.2: (contd.)


a. Palm Corp.s share in the net income of Starr for
the year ended 12/31/00
b. The adjustment for the amort. and depre. of step-up
in net assets of Starr for year 2000.
c. Palm Corp.s share in the adjusted net income of
Starr.
d. Closing entry prepared on 12/31/00 to close the
intercompany Investment income balance to zero.
e. Plam Corps share in the net income of Starr for the
year ended 12/31/01.
f. The adjustment for the amort. and derp. of step-up
in net assets of Starr for the year of 2001.

Developing the Elimination for the


Second Year Subsequent to the
Business
Combination
(Example
7.2)
The working
paper elimination
for December

31, 2001, is similar to that for December 31,


2000, as follows:
Common Stock-Starr
Additional Paid-in Capital
Starr
Retained Earnings-Starr
Retained Earnings of
Subsidiary-Palm
Investment Income-Palm
Plant Assets (net)-Starr

200,000
58,000
162,500a
5,500
84,500
57,000

Developing the Elimination for the


Second Year Subsequent to the
Business
Combination
(contd.)
Patent (net)- Starr
3,000
($4,000-1,000)

Goodwill (net)- Starr


($14,500-500)

14,000

Cost of Goods Sold-Starr


Operating Expense-Starr
Investment in Starr
Common Stock

4,000 b
1,500 b

Dividends Declared-Starr
a. 168,000-5,500

550,000
40,000

Developing the Elimination for the


Second Year Subsequent to the
Business
(contd.)
b.The depre.Combination
and amor. on differences

between current fair value and carrying


amount of Starrs net assets for year 2001
are as follows:

Cost of
Operating
Goods Sold
Exp.

Building Depre.
Machinery Depre.
Patent Amort.
Goodwill Amort.
Totals

$1,000
2,000
1,000
$4,000

$1,000

500
$1,500

Working Paper for Consolidated Financial Statement


for the Second Year following the Business
Combination (Equity Method: Wholly Owned PurchaseType Business Combination)-example 7.2

The following is a partial working paper


for consolidated financial statement.
The net income and dividends for Palm
Corp. are assumed.(on textbook p299)

Working Paper for Consolidated Financial Statement


for the Second Year following the Business
Combination (Equity Method: Wholly Owned PurchaseType Business
Combination)
PALM CORPORATION AND SUBSIDIARY

Partial Working paper for Consolidated Financial Statements


For Year Ended December 31,2001
Statement of
Palm
Starr
Eliminations Consolidated
Retained Earnings Corporation Company Increase

Retained earnings,
beginning of year

208,000

Net income

244,500

90,000

(90,000)*

244,500

452,500

258,000

(252,500)

458,000

40,000 (a) (40,000)+

60,000

Subtotal
Dividends
declared

60,000

168,000 (a) (162,500)

213,500

Retained earnings,
* end
Decrease
in intercompany
investment218,000
income($84,500),
plus total increase
of
year
392,500
(212,500)
398,000
in costs and expenses ($4,000 +$1,500), equals $90,000.
+ A decrease in dividends and an increase in retained earnings. (Continued)

Working Paper for Consolidated Financial Statement


for the Second Year following the Business
Combination (Equity Method: Wholly Owned PurchaseType Business
Combination)
PALM CORPORATION AND SUBSIDIARY

Partial Working paper for Consolidated Financial Statements


For Year Ended December 31,2001
Balance Sheet

Common Stock,
$10 par

Palm
Corporation

Starr
Company

Eliminations
Increase

400,000

Common Stock, $5 par

Consolidated
400,000

200,000

(a)(200,000)

Additional paid-in
capital

365,000

58,000

(a) (58,000)

365,000

Retained earnings

392,500

218,000

(212,500)

398,000

Retained earnings
of subsidiary

5,500

Total stockholders
equity
Total liabilities &
stockholders

(a) (5,500)

1,163,000

476,000

(476,000)

1,163,000

x,xxx,xxx

xxx,xxx

(476,000)

x,xxx,xxx

Closing Entries for Example 7.2

The closing entries for Palm are


prepared in the usual way except for
the closing of the income summary to
retained earnings.
As in the first year, the portion of
retained earnings contributed by Starr
should be reported separated from
other retained earnings contributed by
Plam.

Closing Entries for Example 7.2 (contd.)

The closing entries pertaining the


income summary are as follows:

Income Summary
244,500
Retained Earnings of
44,500
Subsidiaries a
Retained Earnings b
200,000

Closing Entries (contd.)


a.The portion of retained earnings contributed
by the subsidiary and is NOT available for
dividends to Palms stockholders. The
computation is as follows:
$ 84,500the adjusted net income of Starr
- 40,000declared dividend by Starr
$ 44,500
b.the portion of retained earnings contributed
by Palm ($244,500 44,500)

Closing Entries (contd.)

Thus, the parent companys ledger


accounts for retained earnings are as
follows after the closing entries:

Retained Earnings
134,000 Bal. On 12/31/99
104,500 R/E contributed by
Palm in Year 2000

Div. of 2000

30,000
200,000 R/E contributed by
Palm in Year 2001

Div. of 2001

60,000
348,000 Bal. On 12/31/2001

Closing Entries (contd.)


Retained Earnings of Subsidiary
5,500 R/E contributed by Starr
in year 2000, not
available for dividends.

44,500 R/E contributed by Starr


in year 2001, not
available for dividends.

50,000 Bal. On 12/31/2001

Accounting for Operating Results of


Partially Owned Purchased Subsidiaries

The minority interest in net income (or


net loss) needs to be computed and
reported in the consolidated income
statement as an expense: minority
interest in income (or loss) of
subsidiary.
In the balance sheet statement, the
minority interest in net assets of
subsidiary is reported as a liability.

Example 7.3: Equity Method for Partially


Owned Purchased Subsidiary for First Year
after Business Combination

Continued with the Post CorporationSage Company consolidated equity


example of Chapter 6a , assumed that
Sage Company declared a $1 a share
dividend on 11/24/2000, payable
12/16/2000 to stockholders of record
12/1/2000.
a. Example 6.2 in the PowerPoint notes
or on pages 244 to 245 of the textbook.

Example 7.3: (contd.)

Also, Sage had a net income of


$90,000 for the year-ended 12/31/2000
Note: Post owns 95% of the
outstanding shares of Sage Corp.

Example 7.3: (contd.)

Sages journal entries pertaining the


declaration and payment of the dividend are
as follows:
Journal Entries for Sage (Year 2000)

11/24 Dividends Declared (40,000 x $1)


Dividends Payable
($40,000 x 0.05)

Intercompany
Dividends Payable
($40,000 x 0.95)

To record declaration of dividend


payable Dec. 16,2000, to
stockholders of record Dec. 1,2000

40,000

2,000
38,000

Example 7.3: (contd.)

Journal Entries for Sage(Year 2000) (contd.)

12/16 Dividends Payable

Intercompany Dividends
Payable
Cash
To record payment of dividend
declared Nov. 24, 2000, to
stockholders of record Dec. 1, 2000

2,000
38,000
40,000

Example 7.3: (contd.)

Following the equity method, Posts journal


entries for year 2000 include the following:
Journal Entries for Post (Year 2000)

11/24 Intercompany Dividends


Receivable
Investment in Sage
Company Common
Stock
To record dividend declared by
Sage Company, payable Dec. 16,
2000, to stockholders of record
Dec. 1,2000.

38,000
38,000

Example 7.3: (contd.)

Journal Entries for Post(Year 2000) (contd.)

12/16 Cash

2,000
Intercompany
Dividends Receivable

38,000

To record receipt of dividend from


Sage Company

12/31 Investment in Sage Company


Common Stock ($90,000 x 0.95)
Intercompany Investment
Income
To record 95% of net income of
Sage Company for the year ended
Dec. 31,2000(Income tax effects are

85,500
85,500

Example 7.3: (contd.)

Similar to the adjustment on the wholly


owned subsidiarys net income, the net
income of the partially owned subsidiary
also needs to be adjusted for the
depreciation of the assets step-up a and
the amortization of goodwill.b The
assets step-up for Sage on 12/31/99 is
as follows:
a.$246,000; see p64 of Chapter 6 notes.
b.$38,000; see p68 of Chapter 6 notes.

Example 7.3: (contd.)


Inventories(FIFO cost)
Plant assets (net):
Land
Building (economic
life 20 years)
Machinery (economic
life 5 years)
Leasehold (economic
life 6 years)

$ 26,000
$ 60,000
80,000
50,000

190,000
30,000

Example 7.3: (contd.)

The goodwill of for the purchase of 95%


of Sage is calculated as follows:

Cost of Post Corporations 95%


interest in Sage Company
Less:95% of $1,215,000
aggregate current fair values of
Sages identifiable net assets
Goodwill acquired by Post (to be
amortized over 40 years)

$1,192,250

1,154,250
$

38,000

Example 7.3: (contd.)


Therefore, Post Corp. prepares the following
journal entry on 12/31/2000 to reflect the
effects of the depreciation on the assets
step-up under the equity method:
Journal Entry for Post (12/31/2000)
Intercompany Investment
Income
42,750
Investment in Sage
Company Common
Stock
42,750

Example 7.3: (contd.)

To amortize differences between current fair


values and carrying amounts of Sage
Companys identifiable net assets on Dec.
31,1999, as follows:

Inventories to cost of goods sold


Buildingdepreciation ($80,000/20)
Machinerydepreciation ($50,000/5)
Leaseholdamortization ($30,000/6)
Total difference applicable to 2000
Amortization for 2000($45,000 x 0.95)
(Income tax effects are disregarded.)

$26,000
4,000
10,000
5,000
$45,000
$42,750

Example 7.3: (contd.)


In addition, Post also prepares the following
entry to recognize the amortization of
goodwill:
Journal Entry for Post (12/31/2000)
Amortization Expense ($38,000/40)
950
Investment in Sage
Company Common Stock
950

To amortize goodwill acquired in


business combination with partially
owned purchased subsidiary over an
economic life of 40 years.

Example 7.3: (contd.)

Note: goodwill in a business


combination involving partially owned
subsidiary is attributed to the parent
company rather than to the subsidiary
under the FASB recommended
treatment. This technique avoids
charging any portion of the goodwill
amortization to the minority interest,
which did not acquire any goodwill.

Example 7.3: (contd.)

After posting the foregoing entries,


Post Corporations Investment in
Sage Company Common Stock and
Intercompany Investment Income
ledger accounts are as follows:

Example 7.3: (contd.)


Investment in Sage Company Common Stock

Date
Explanation
1999
12/31 Issuance of common stock
in business combination
31 Direct out-of-pocket costs of
business combination
2000
11/24 Dividend declared by Sage
12/31 Net income of Sage
31 Amortization of differences
between current fair values
and carrying amounts of

Debit

Credit

Balance

1,140,000

1,140,000 dr

52,250

1,192,250 dr

38,000 1,154,250 dr
85,500
1,239,750 dr

Example 7.3: contd.)


Intercompany Investment Income

Date
Explanation
Debit Credit Balance
2000
12/31 Net Income of Sage
85,500 85,500 cr
31 Amortization of
differences between
current fair values and
carrying amounts of
Sages identifiable net
assets
42,750
42,750 cr

Example 7.3: (contd.)

The $42,750 balance of Post


Corporations Intercompany Investment
Income account represents 95% of the
$45,000 adjusted net income ($90,000$45,000) of Sage Company for the year
ended 12/31/2000.

Developing the eliminations for


Example 7.3

Using the equity method to account for


the investment in Sage results in a
balance in the Investment ledger account
with three components:
(1) the carrying amount of Sages
identifiable net assets;(2)the current fair
value excess , which is attributable to
Sages identifiable net assets; and (3) the
goodwill acquired by Post in the business
combination with Sage. These
components are analyzed as follows:

Developing the eliminations for


Example 7.3 (contd.)

Post Corporation
Analysis of Investment in Sage Company Common Stock
Ledger Account (For Year Ended December 31,2000)

Carrying Current Goodwill


Amount Fair Value
Excess

Beginning balances
Net income of Sage
($90,000 x 0.95)

Amortization of
differences between
current fair values
and carrying
amounts of Sages
identifiable net

Total

$920,550 $233,700 $38,000 $1,192,250


85,500

85,500

Developing the eliminations for


Example 7.3 (contd.)

Contd.

Carrying Current Goodwill


Amount Fair Value
Excess
Amortization of
goodwill
Dividend declared by
Sage ($40,000 x 0.95)
Ending balances

(950)
(38,000)

Total

(950)
(38,000)

$968,050 $190,950 $37,050 $1,196,050

Developing the eliminations for


Example 7.3 (contd.)

The minority interest in Sages net


assets (which is not recorded in a
ledger account) is analyzed similarly,
except that there is not goodwill
attributable to the minority interest:

Developing the eliminations for


Example 7.3 (contd.)

Post Corporation
Analysis of Minority Interest in Net Assets of Sage Company
For Year Ended December 31,2000

Carrying Current
Amount Fair Value
Excess

Beginning balances
Net income of Sage($90,000 x 0.05)
Amortization of differences
between current fair values
and carrying amounts of
Sages identifiable net assets

$48,450
4,500

($45,000 x 0.05)

Dividend declared by Sage


($40,000 x 0.05)

(2,000)

Total

$12,300

$60,750
4,500

(2,250)

(2,250)
(2,000)

Developing the eliminations for


Example 7.3 (contd.)

The sum of the ending balances of the


carrying amount columns of the above two
tables equals $1,019,000 ($968,050 +
$50,950).This amount agrees with the total
stockholders equity of Sage Company on
12/31/2000 as follows:
Common stock,$10 par
Additional paid-in capital
Retained earnings
Total stockholders equity

$ 400,000
235,000
384,000
$1,019,000

Developing the eliminations for


Example 7.3 (contd.)

Also, the sum of the ending balances of


the carrying fair value excess columns
of the above two tables equals
$201,000 ($190,950 +$10,050). This
amount represents the unamortized
identifiable assets step-up as follows:

Developing the eliminations for


Example 7.3 (contd.)
Balances, Amortization Balances,
Dec.31,1999 for Year 2000 Dec.31,2000
(p.302)
(p.302)
Inventories
Plant assets(net):
Land
Building
Machinery
Total plant
assets
Leasehold

$ 26,000

$ (26,000)

$ 60,000
80,000
50,000

$ (4,000)
(10,000)

$ 60,000
76,000
40,000

$190,000
$ 30,000

$ (14,000)
$ (5,000)

$176,000
$ 25,000

Developing the eliminations for


Example 7.3 (contd.)

Assuming that Sage Company


allocates machinery depreciation and
leasehold amortization entirely to cost
of goods sold and building depreciation
50% each to cost of goods sold and
operating expense, the working paper
eliminations for Post Corp. and
subsidiary on 12/31/200 are as follows:

Developing the eliminations for


Example 7.3 (contd.)
POST CORPORATION AND SUBSIDIARY
Working Paper Eliminations
December 31,2000
(a)Common StockSage

400,000(1)

Additional Paid-in CapitalSage

235,000(1)

Retained Earnings-Sage

334,000(1)

Intercompany Investment Income-Psot

42,750(2)

Plant Assets(net)-Sage($190,000-$14,000) 176,000(3)


Leasehold(net)-Sage ($30,000-$5,000)

25,000(3)

Goodwill (net)-Post($38,000-$950)

37,050(3)

Cost of Goods Sold-Sage

43,000(4)

Operating Expenses-Sage

2,000(4)

Developing the eliminations for


Example 7.3 (contd.)

Contd.
Investment in Sage Company
Common Stock-Post

1,196,050(1)

Dividends Declared-Sage

40,000(1)

Minority Interest in Net Assets of


Subsidiary ($60,750 - $2,000)[See(d)]

58,750(1)

Developing the eliminations for


Example 7.3 (contd.)
The above eliminations are to carry out the
following:
(1) Eliminate intercompany investment and
equity accounts of subsidiary at the
beginning of year,and subsidiary dividends.
(2) Provide for Year 2000 depreciation and
amortization on differences between
current fair values and carrying amounts
of Sage's identifiable net assets as
follows:

Developing the eliminations for


Example 7.3 (contd.)
Cost of
Operating
Goods Sold Expenses
Inventories sold
Building depreciation

$ 26,000
2,000

Machinery depreciation

10,000

Leasehold amortization

5,000

Totals

$ 43,000

$ 2,000

$ 2,000

Developing the eliminations for


Example 7.3 (contd.)
(3) Allocate unamortized differences
between combination date current fair
values and carrying amounts to
appropriate assets.
(4) Establish minority interest in net assets
of subsidiary at beginning of year ($60,750),
less minority interest share of dividends
declared by subsidiary during year
($40,000 x 0.05=$2,000).
(Income tax effects are disregarded.)

Developing the eliminations for


Example 7.3 (contd.)
(b)Minority Interest in Net
Income of Subsidiary
Minority Interest in
Net Assets of
Subsidiary

2,250
2,250

Developing the eliminations for


Example 7.3 (contd.)

To establish minority interest in subsidiarys


adjusted net income for Year 2000 as
follows:
Net income of subsidiary
Net reduction of
elimination (a) ($43,000 +$2,000)

$ 90,000

(45,000)

Adjuste net income of


subsidiary
Minority interest share
($45,000 x 0.05)

$45,000
$

2,250

Notes to the elimination entries for


Example 7.3 (contd.)

1. The working paper eliminations at the time of business combination is as follows


(i.e., 12/31/1999 or 1/1/2000):

Common Stock
400,000
Add. Paid-in Cap.
235,000
Retained Earnings
334,000
Plant Assets
190,000
Leashold
30,000
Inventory
26,000
Goodwill
38,000 b
Investment in Sage
Minority Interest

1,192,250
60,750 a

Notes (contd.)
2. The working paper eliminations for Post
Corporation and subsidiary on 12/31/2000
are doing the follows:
a. Eliminate stockholders equity of subsidiary
as of 1/1/2000.
b. Increase the assets (i.e., plant assets and
Leashold) of the subsidiary to the fair value
on the business combination date adjusted
for depreciation,

Notes (contd.)
c. The recognition of additional
depreciation expense due to asset step
up and the recognition of additional
cost of goods sold due to inventory
step-up (assuming FIFO).
d. The recognition of goodwill adjusted
for the goodwill amortization,

Notes (contd.)
e. Elimination of intercompany investment
income post (due to income of Post
and Sage will be consolidated in the
consolidated income statement).
(all the above accounts are debited in the
elimination entries)
(the following accounts are credited in the
elimination entries)

Notes (contd.)
f. Elimination of investment in sage account
balance (due to the assets and liabilities of
both companies are to be combined in the
consolidated balance sheet statement).
g. Recognize minority interest as a liability
($60,750- $2,000 div. for subsidiary).
h. Elimination of dividends declared by Sage
($40,000= 38,000+2000).

Notes :(contd.)
The balance of investment account is $1,196,050. The
components of this balance include:
1,192,250 (beg. Balance)
+ 42,750 a

950 b
38,000 c
1,196,050
a.Posts share of net increase in Sages income of 2000 after adjusting
for depreciation exp., etc. (i.e., 85,500 - 42,750). b.amor. of goodwill
c.Posts share of dividends.

Working Paper for Example 7.3:


Consolidated Financial Statements for year
Ended 12/31/2000
POST CORPORATION AND SUBSIDIARY
Working Paper for Consolidated Financial Statements
For Year Ended Dec. 31,2000

Income Statement

Post
Corp.

Sage
Eliminations Consolidated
Company Inc. (Dec.)

Revenue:
Net Sales
Intercompany investment income
Total revenue

5,611,000 1,089,000
42,750

6,700,000
(a) (42,750)

5,653,750 1,089,000

(42,750)

6,700,000
4,668,000

Costs and expenses:


Costs of goods sold

3,925,000

700,000

(a) 43,000

Operating expenses

556,950*

129,000

(a)

710,000

170,000

Interest and income taxes


expense
Minority interest in net income of
subsidiary

2,000

687,950
880,000

(b) 2,250

2,250

Working Paper for Example 7.3:


Consolidated Financial Statements for year
Ended
12/31/2000 (contd.)
Contd.

Statement of
Retained Earnings
Retained earnings,
beginning of year

Post
Corp.
1,050,000

Sage
Eliminations Consolidated
Company Inc. (Dec.)
334,000 (a) (334,000)

1,050,000

Net income

461,800

90,000

(90,000)

461,800

Subtotal

1,511,800

424,000

(424,000)

1,511,800

40,000 (a) (40,000)

158,550

Dividends declared

158,550

Retained earnings,
end of year

1,353,250

384,000

(384,000)

1,353,250

Working Paper for Example 7.3:


Consolidated Financial Statements for year
Ended
12/31/2000 (contd.)
Contd.

Balance Sheet/
Assets

Post
Corp.

Sage
Eliminations Consolidated
Company Inc. (Dec.)

Inventories

861,000

439,000

1,300,000

Other current
assets

639,000

371,000

1,010,000

Investment in Sage
Company common
stock

1,196,050

Plant assets (net)

3,600,000 1,150,000 (a)

176,000

4,926,000

(a)

25,000

25,000

(a)

37,050

132,050

(958,000)

7,393,050

Leasehold (net)
Goodwill (net)
Total assets

95,000
6,391,050 1,960,000

(a)(1,196,050)

Working Paper for Example 7.3:


Consolidated Financial Statements for year
Ended
12/31/2000 (contd.)
Contd.

Liabilities
&Stockholders Equity
Liabilities

Post
Corp.
2,420,550

Sage
Company
941,000

Minority interest in
net assets of
subsidiary
Common stock,$1 par

Eliminations
Inc. (Dec.)

3,361,550
(a)
(b)

58,750
2,250

1,057,000

Common stock, $10 par

Consolidated

61,000
1,057,000

400,000

(a) (400,000)

Additional paid-in
capital

1,560,250

235,000

(a) (235,000)

1,560,250

Retained earnings

1,353,250

384,000

(384,000)

1,353,250

Total liabilities
& stockholders

Consolidated Financial Statements


for Example 7.3

The consolidated income statement,


statement of retained earnings, and
balance sheet of Post Corporation and
subsidiary for the year ended
December 31, 2000, are as follows (the
amounts are from the consolidated
column in the previous working paper):

Consolidated Financial Statements


for Example 7.3 (contd.)
POST CORPORATION AND SUBSIDIARY
Consolidated Income Statement
For Year Ended December 31,2000
Net Sales
$ 6,700,000

Costs and expenses:


Costs and goods sold

$4,668,000

Operating expenses

687,950

Interest and income taxes


expense

880,000

Minority interest in net income of


subsidiary
Total costs and expenses
Net income

2,250
6,238,200
$ 461,800

Consolidated Financial Statements


for Example 7.3 (contd.)
POST CORPORATION AND SUBSIDIARY
Consolidated Statement of Retained Earnings
For Year Ended December 31,2000

Retained earnings,
beginning of year:
Add: Net income
Subtotals
Less: Dividends ($0.15 a share)
Retained earnings,
end of year

$ 1,050,000
461,800
$1,511,800
158,550
$ 1,353,250

Consolidated Financial Statements


for Example 7.3 (contd.)
POST CORPORATION AND SUBSIDIARY
Consolidated Balance Sheet
For Year Ended December 31,2000
Assets

Current assets:
Inventories
Other
Total current assets
Plant assets (net)
Intangible assets:
Leasehold (net)
Goodwill (net)

$ 1,300,000
1,010,000
$ 2,310,000
4,926,000
$

25,000
132,050

157,050

Consolidated Financial Statements


for Example 7.3 (contd.)

Contd.

Liabilities & Stockholders Equity

Liabilities
Other than minority
interest

$3,361,550

Minority interest in net


assets of subsidiary
Total liabilities
Stockholders equity:
Common stock, $1 par
Additional paid-in capital
Retained earnings

61,000
$3,422,550
$1,057,000
1,560,250
1,353,250

3,970,500

Closing Entries for Example 7.3

Post Corporation Closing Entries on 12/31/2000


Net Sales
5,611,000
Intercompany Investment
Income
42,750
Income Summary

5,653,750

To close revenue accounts.

Income Summary
5,191,950
Cost of Goods Sold
3,925,000
Operating Expenses
556,950
Interest and Income
Taxes Expense
710,000

Closing Entries for Example 7.3 (contd.)


Contd.
Income Summary
Retained Earnings of
Subsidiary ($42,750-$38,000)

461,800
4,750

Retained Earnings

457,050

($461,800-$4,750)

To close Income Summary account; to


transfer net income legally available for
dividends to retained earnings; and to
segregate 95% share of adjusted net
income of subsidiary not distributed as
dividends.

Retained Earnings
Dividends Declared

158,550
158,550

Closing Entries for Example 7.3 (contd.)

After posting the above closing entries,


Posts Retained Earnings and Retained
Earnings of Subsidiary ledger accounts
are as follows:

Closing Entries for Example 7.3 (contd.)


Retained Earnings
Date
Explanation
1999
12/31 Balance
2000
12/31 Close net income
available for dividends
31 Close Dividends
Declared account

Debit

Credit

Balance
1,105,000 cr

457,050 1,507,050 cr
158,550

1,348,500 cr

Closing Entries for Example 7.3 (contd.)


Retained Earnings of Subsidiary
Date
Explanation
2000
12/31 Close net income not
available for dividends

Debit

Credit

4,750

Balance

4,750 cr

Closing Entries for Example 7.3


The retained earnings of subsidiary account
balance can be reconciled to the increase
in Posts investment ledger account as
follows:

Closing Entries for Example 7.3


Reconciliation of Undistributed Earnings of
Subsidiary
Undistributed earnings of subsidiary,
year ended Dec. 31, 2000 $4,750
Less: Amortization of goodwill acquired
by parent company in business
combination
950
Increase in balance of Investment in
Sage Company Common Stock ledger
account during 2000
$3,800

Closing Entries for Example 7.3


In addition, the total ending balances of
Post is equal to consolidated retained
earnings as showed below:

Closing Entries for Example 7.3


Total of Parent Companys Two Retained
Earnings Account Balances Equals
Consolidated Retained Earnings
Balances, Dec. 31, 2000:
Retained earning $1,348,500
Retained earning of subsidiary
4,750
Total $1,353,250

Example 7.4 Equity Method for Partially


Owned Purchased Subsidiary for Second
Year after Business Combination

Continued with the Post CorporationSage Company example, assuming


that on 11/22/2001 (the second year
after business combination), Sage
company declared a dividend of
$50,000, payable 12/17/2001, to
stockholders of record 12/1/2001.

Example 7.4 Equity Method for Partially


Owned Purchased Subsidiary for Second
Year after Business Combination (contd.)

Sage had a net income of $105,000 for


the year ended 12/31/2001.
Based on 95% of ownership, Posts
share in net income and dividend were
$99,750 and $47,500, respectively.
Selected ledger accounts for Post Corp.
are as follows after posting subsidiary
related income and dividends:

Example 7.4 Equity Method for Partially


Owned Purchased Subsidiary for Second
Year after Business Combination (contd.)
Investment in Sage Company Stock

Date

Explanation

Debit

Credit

Balance

1999

12/31 Issuance of common


stock in business
combination
31 Direct out-of-pocket
costs of business
combination

1,140,000

1,140,000 dr

52,250

1,192,250 dr

Example 7.4 Equity Method for Partially


Owned Purchased Subsidiary for Second
Year
after
Business
Combination
(contd.)
Contd.

Date

Explanation

Debit

Credit

Balance

2000

11/24 Dividend declared by


Sage

12/31

Net income of Sage

38,000
85,500

1,154,250 dr
1,239,750 dr

31 Amortization of

differences between
current fair values and
carrying amounts of
Sages identifiable net
assets

31 Amortization of
goodwill

42,750 1,197,000 dr

950 1,196,050 dr

Example 7.4 Equity Method for Partially


Owned Purchased Subsidiary for Second
Year
after
Business
Combination
(contd.)
Contd.

Date

Explanation

Debit

Credit

Balance

2001

11/22 Dividend declared by


Sage

12/31

Net income of Sage

47,500
99,750

1,148,550 dr
1,248,300 dr

31 Amortization of

differences between
current fair values and
carrying amounts of
Sages identifiable net
assets

31 Amortization of
goodwill

18,050* 1,230,250 dr

950 1,229,300 dr

Example 7.4 Equity Method for Partially


Owned Purchased Subsidiary for Second
Year afterIntercompany
Business Investment
Combination
(contd.)
Income
Date

Explanation

Debit

Credit

Balance

2000

12/31

Net income of Sage

85,500

85,500 cr

31 Amortization of

differences between
current fair values and
carrying amounts of
Sages identifiable net
assets

31

Closing entry

42,750
42,750

42,750 cr
-0-

Example 7.4 Equity Method for Partially


Owned Purchased Subsidiary for Second
Year
after
Business
Combination
(contd.)
Contd.

Date

Explanation

Debit

Credit

Balance

2001

12/31

Net income of Sage

99,750

99,750 cr

31 Amortization of

differences between
current fair values and
carrying amounts of
Sages identifiable net
assets

* Building depreciation($80,000/20)

18,050*

81,700 cr
$ 4,000

Machinery depreciation ($50,000/5)

10,000

Leasehold amortization ($30,000/6)

5,000

Total amortization applicable to 2001


Post Corporations share 9$19,000 x 0.95)

$ 19,000
$ 18,050

Developing the Elimination

The working paper eliminations for


12/31/2001, are developed in the
similar way as for the eliminations for
12/31/2000. The are as follows:

Developing the Elimination (contd.)


Post corporation and Subsidiary
Working Paper Eliminations
December 31,2001
(a)Common StockSage

Additional Paid-in CapitalSage


Retained Earnings-Sage($384,000-$4,750)

400,000

235,000
379,250

Retained Earnings of Subsidiary-Post

4,750

Intercompany Investment Income-Post

81,700

Plant Assets(net)-Sage($176,000-$14,000)

162,000

Leasehold(net)-Sage ($25,000-$5,000)

20,000

Goodwill (net)-Post($37,050-$950)

36,100

Cost of Goods Sold-Sage

17,000

Operating Expenses-Sage

2,000

Developing the Elimination (contd.)

Contd.
Investment in Sage Company
Common Stock-Post

1,229,300

Dividends Declared-Sage

50,000

Minority Interest in Net Assets of


Subsidiary ($61,000 - $2,500)

58,500

Developing the Elimination (contd.)

The elimination is to carry out the


following:
(a) Eliminate intercompany investment,
equity accounts of subsidiary at the
beginning of year, and subsidiary
dividend.
(b) Provide for Year 2000 depreciation and
amortization on differences between current
fair values and carrying amounts of Sage's
identifiable net assets as
follows:

Developing the Elimination (contd.)


Cost of
Goods Sold

Building depreciation

$ 2,000

Machinery depreciation

10,000

Leasehold amortization

5,000

Totals

$ 17,000

Operating
Expenses

$ 2,000

$ 2,000

Developing the Elimination (contd.)


(c) Allocate unamortized differences of the
asset step-up.
(d) Establish minority interest in net assets
of subsidiary at beginning of year ($61,000),
less minority interest share of dividends
declared by subsidiary during year
($50,000 x 0.05=$2,500).
(Income tax effects are disregarded.)

Developing the Elimination (contd.)


(b)Minority Interest in Net Income
of Subsidiary
Minority Interest in Net Assets
of Subsidiary

4,300
4,300

To establish minority interest in subsidiarys


adjusted net income for Year 2001 as
follows:
Net income of subsidiary

Net reduction in elimination (a)


($17,000+ $2,000)

Adjusted net income of


subsidiary
Minority interest share
($86,000 x 0.05)

$105,000

(19,000)
$ 86,000
$

4,300

Working Paper for Consolidated


Financial Statements

The eliminations for Post Corp. and


subsidiary described above are
illustrated in the following partial
working paper for consolidated financial
statements. The amounts presented
for Post Corp. are assumed.

Working Paper for Consolidated


Financial Statements (contd.)
POST CORPORATION AND SUBSIDIARY
Partial Working Paper for Consolidated Financial Statements
For Year Ended Dec. 31,2001
Statement of
Post
Sage
Eliminations Consolidated
Corp.
Company Inc. (Dec.)
Retained Earnings
Retained earnings,
beginning of year

1,348,500

384,000

(a) (379,250)

1,353,250

Net income

352,600

105,000

(105,000)*

352,600

Subtotal

1,701,100

489,000

(484,250)

1,705,850

158,550

50,000

(a)(50,000)

158,550

1,542,550

439,000

(434,250)

1,547,300

Dividends declared

Retained earnings,
end of year

* Decrease in intercompany investment income ($81,700), plus total


increase in costs and expenses ($17,000 + $2,000 + $4,300),
equals $ 105,000.
A decrease in dividends and an increase in retained earnings.

Working Paper for Consolidated


Financial Statements (contd.)

Contd.

Balance Sheet

Post Corp.

Sage
Company

Minority interest in net assets


of subsidiary
Total liabilities
Common stock,$1 par

x,xxx,xxx

Retained earnings

Retained earnings of
subsidiary
Total stockholders
equity

Total liabilities
& stockholders
equity

Consolidated

(a) 58,5000
(b)
4,300

62,800

62,800

xxx,xxx

xxx,xxx

1,057,000

Common stock, $10 par

Additional paid-in
capital

Eliminations Inc.
(Dec.)

1,057,000
400,000

(a) (400,000)

1,560,250

235,000

(a) (235,000)

1,560,250

1,542,550

439,000

(434,250)

1,547,300

4,750

(a)

(4,750)

4,164,550

1,074,000

(1,074,000)

4,164,550

x,xxx,xxx

x,xxx,xxx

(1,011,200)

xxxx,xxx

Working Paper for Consolidated


Financial Statements (contd.)

The 12/31/2001 balance of the minority


interest in net assets of subsidiary may be
verified as follows:
Sage Companys total stockholders
equity, Dec. 31, 2001

$1,074,000

Add: Unamortized difference between


combination date current fair values
and carrying amounts of Sages
identifiable net assets ($162,000+ $20,000)

182,000

Sages adjusted stockholders equity,


Dec. 31,2001

$1,256,000

Minority interest in net assets of


subsidiary ($1,256,000 x 0.05)

62,800

Closing Entries

Post Corp.s share of the undistributed


earnings of Sage Company for 2001 is
$34,200, computed as follows:
Adjusted net income of Sage
Company recorded by Post
Corporation in Intercompany
Investment Income ledger account
(p.632)

Less : Posts share of dividends


declared by Sage ($50,000 x 0.95)
Posts share of amount of Sages
adjusted net income not distributed
as dividends

$ 81,700
47,500
$ 34,200

Closing Entries (contd.)

The following are the partial closing


entries of Post on 12/31/2001:
Income Summary

Retained Earnings
of Subsidiary
(81,700-47,500)

Retained earnings
(352,600-34,200)

461,800

34,200
318,400

Closing Entries (contd.)

Following the posting of the closing


entries, the two ledger accounts of
retained earnings of Post are as
follows:

Closing Entries (contd.)


Retained Earnings
Date

Explanation

Debit

Credit

Balance

1999
12/31

Balance

1,050,000 cr

2000

12/31 Close net income

available for dividends

31 Close Dividends

Declared account

457,050
158,550

1,507,050 cr
1,348,500 cr

2001

12/31 Close net income

available for dividends

31 Close Dividends

Declared account

318,400
158,550

1,666,900 cr
1,508,350 cr

Closing Entries (contd.)


Retained Earnings of Subsidiary
Date

Explanation

Debit

Credit

Balance

2000

12/31 Close net income not

available for dividends

4,750

4,750 cr

34,200

38,950 cr

2001

12/31 Close net income not

available for dividends

Closing Entries (contd.)

The total balances of these two


retained earnings is equal to
consolidated retained earnings
( $1,508,350+38,950= $1,547,300).
Also, the $38,950 balance of retained
earnings of subsidiary represents
Posts share of the undistributed
earnings of Sage since 12/31/99.

Closing Entries (contd.)

The undistributed earnings of Sage may be


reconciled to the increase in Posts
Investment ledger account balance as
follows:
Undistributed earnings of subsidiary

Less : Amortization of goodwill


acquired in business combination
($950 x 2)

Increase in balance of Investment in


Sage Company Common Stock
ledger account since Dec. 31, 1999,
date of business combination
($1,229,300 - $1,192,250)

$ 38,950

1,900

$ 37,050

Comments on Equity Method of


Accounting

The equity method of accounting for a


subsidiarys operation is preferable to
the cost method for the following
reasons:
1. The equity method emphasizes
economic substance of the parent
subsidiary relationship. The cost
method emphasizes the legal form of
the relationship.

Comments on Equity Method of


Accounting (contd.)
2. The equity method allows the use of
parent company journal entries to
reflect many items that must be
included only in working paper
elimination in the cost method.
3. The equity method facilitates
issuance of separate financial
statements for the parent company.

Comments on Equity Method of


Accounting (contd.)
4. Except when intercompany
profits (gains) or losses exist in
assets or liabilities to be
consolidated, the parent
companys net income and
combined retained earnings
account balances are identical in
the equity method for the related
consolidated amounts.

Comments on Equity Method of


Accounting (contd.)
5. the cost method is not considered
appropriate for accounting for a
pooled subsidiarys operations.
Thus, this textbook emphasizes the
equity method of accounting for a
subsidiarys operations.
Note: Regardless whether the cost
method or the equity method is used,
consolidated financial statement
amounts are the same.

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