CHAPTER 6
CONSOLIDATION: SUBSEQUENT TO DATE OF BUSINESS COMBINATION
Subsequent to the date of business combination, the parent company must account for the operating
results of the subsidiary: the net income or net loss and dividends declared and paid by the subsidiary.
Intercompany transactions must also be recorded.
Accounting for Operating Results of Wholly Owned Purchased Subsidiaries
There are two alternative methods for this purpose: the equity method and the cost method of
accounting.
Equity Method
Under this method, the parent company recognizes its share of the subsidiary’s net income or net loss,
adjusted for depreciation and amortization of differences between current fair values and carrying
amounts of purchased subsidiary’s net assets on the date of the business combination, as well as its share
of dividend declared by the subsidiary.
The equity method is said to be consistent with the accrual basis of accounting as it recognizes increases
or decreases in the carrying amount of parent company’s investment in the subsidiary as net income or
net loss, not when they are paid as dividends. Thus, proponents claim, the equity method stresses the
economic substance of the parent subsidiary relationship. Dividends declared by the subsidiary do not
constitute revenue the parent company but are a liquidation of a portion of the parent company’s
investment in the subsidiary.
If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor
ordinarily should discontinue applying the equity method.
Cost Method
Under this method, the parent company accounts for the operation of a subsidiary only to the extent that
dividends are declared by the subsidiary. Dividends declared by the subsidiary from net income
subsequent to the business combination are recognized as revenue by the parent company; dividends
declared by the subsidiary in excess of post-combination net income constitute a reduction of the
carrying amount of the parent company’s investment in the subsidiary. Net income or net loss of the
subsidiary is not recognized by the parent company.
Supporters claim that this method appropriately recognizes the legal form of parent subsidiary
relationship. Thus, a parent company realizes revenue when the subsidiary declares dividend, not when
it reports net income.
Illustration of Equity Method for Wholly Owned Purchased Subsidiary for First Year afte r
Business Combination
Assume you have given the following financial statements for Palm corporation (the parent company)
and Star Company(wholly owned subsidiary) for the year ended December 31,2000 a year subsequent to
date of combination.
Page 1 of 11
Palm Star
Corporation Company
Income Statement
Revenue:
Net Sales 1,100,000 680,000
Intercompany investment income 29,500
Total revenue 1,129,500 680,000
Costs and expenses:
cost of goods sold 700,000 450,000
Operating expenses 217,667 130,000
Interest expense 49,000
Income taxes expense 53,333 40,000
Total costs and expenses 1,020,000 620,000
Net income 109,500 60,000
Statement of Retained Earnings
Retained earnings, beginning 84,000 132,000
Net income 109,500 60,000
Sub total 193,500 192,000
Dividends declared 30,000 24,000
Retained earnings, ending 163,500 168,000
Balance Sheet
Assets
Cash 15,900 72,100
Dividend receivable 24,000
Inventories 136,000 115,000
Other current assets 88,000 131,000
Investment in Star Co common stock 505,500
Plant assets (net) 440,000 340,000
Patents (net) 16,000
Total assets 1,209,400 674,100
Liabilities & Stockholders' Equity
Dividend Payable 24,000
Income taxes payable 40,000 20,000
Other liabilities 190,900 204,100
Common stock, $10 par 400,000
Common stock, $5 par 200,000
Additional paid in capital 415,000 58,000
Retained earnings 163,500 168,000
Total liab & stockholders' equity 1,209,400 674,100
Additional information:
1. The revaluation of assets on the date of the business combination was not included in the accounts of
star (Subsidiary).
2. Differences between current fair values and carrying amounts of Star Company’s net assets were as
follows;
Inventories (FIFO) 25,000
Page 2 of 11
Plant assets (net)
Land 15,000
Building (economic life 15 years) 30,000
Machinery (economic life 10 years) 20,000 65,000
Patent (economic life 5 years) 5,000
Goodwill 15,000
Total 110,000
3. The amount of goodwill impaired during year 2000 was 500.
4. Assume that depreciation, amortization and impairment of the excess of CFV over carrying amounts
allocated as follows
Machinery depreciation and patent amortization to cost of goods sold
Goodwill impairment (amortization) to operating expenses
Building depreciation 50% each to cost of goods sold and operating expenses
Required:
1. Pass the journal entries to record the amount of dividend declared by Star Company and to adjust
Star’s net income for depreciation, amortization and Impairment attributable to the difference
between the current fair values and carrying amounts of Star’s net assets on the date of the business
combination-December 31, 1999.
2. Develop the elimination Journal entries.
3. Prepare consolidated working paper on December 31, 2000 a year after consolidation.
4. Prepare consolidated financial statements on December 31, 2000 a year after consolidation.
Solution
1. Star had a net income of 60,000 for the year ended December 31, 2000. On December 20, 2000,
Star’s BODs declared a cash dividend of $0.60 a share on the 40,000 shares ($200,000 $5/share)
outstanding shares.
Dec. 20: Star’s journal entry to record dividend declaration is:
To record declaration of dividend Dividends Declared ($0.6x40,000) 24,000
Intercompany Dividends Payable 24,000
Under the equity method of accounting, Palm Corporation prepares the following journal entries to
record the dividend and net income of Star.
To record dividend declared by Star 1) Intercompany Dividend Receivable 24,000
Company Investment in Star Co. Common Stock 24,000
To record 100% of Star Company’s net 2) Investment in Star Company Common Stock 60,000
income Intercompany Investment Income 60,000
The credit to investment in subsidiary account in the first entry reflects an underlying premise of the
equity method of accounting: dividends declared by a subsidiary represent a return of a portion of the
parent company’s investment in the subsidiary.
The second entry records the parents 100% share of the subsidiary’s net income. The subsidiary’s net
income accrues to the parent company under the equity method of accounting.
Page 3 of 11
Adjustment of Purchased Subsidiary’s Net Income
Continuing with the Palm Corporation-Star Company business combination, Palm must prepare a third
journal entry to adjust Star’s net income for depreciation and amortization attributable to the
difference between the current fair values and carrying amounts of Star’s net assets on the date of the
business combination-December 31,1999. Because such differences were not recorded by the
subsidiary, its net income is overstated from the point of view of the consolidated entity.
Palm Corporation prepares the following journal entry to reflect the effects of depreciation and
amortization on the above differences on the net income of Star Company for the year ended December
31, 2000:
Intercompany Investment Income 30,500
Investment in Star Co Common Stock 30,500
To amortize differences between current fair value and carrying amounts
Inventories- to cost of goods sold 25,000
Building- depreciation (30,000/15) 2,000
Machinery-depreciation (20,000/10) 2,000
Patent-Amortization (5,000/5) 1,000
Goodwill- impairment 500
Total 30,500
2. Developing the Elimination
Palm Corporation’s use of equity method of accounting for its investment in Star Company results in a
balance in investment account that is a mixture of two components:
The carrying amount of Star’s net assets
The excess of current fair values over the carrying amount of Star’s identifiable net assets,
including goodwill, on the date of business combination
All three basic financial statements must be consolidated for accounting periods subsequent to the date
of purchase type business combination and hence the elimination working paper must include accounts
that appear in the constituent companies’ income statement, statement of retained earnings and balance
sheets.
The items that must be included in elimination are:
1. The subsidiary’s beginning of year stockholder’s equity and its dividends, and the parent’s investment
2. The parent’s intercompany investment income
3. Unamortized current fair value excess of the subsidiary
4. Certain operating expenses of the subsidiary
The working paper elimination in working paper format is as follows with the component items numbered in
accordance with the foregoing breakdown:
Common stock-Star 200,000 (1)
Additional Paid in Capital-Star 58,000 (1)
Retained Earnings-Star 132,000 (1)
Intercompany Investment Income-Palm 29,500 (2)
Plant Assets (net)-Star (65,000-4,000) 61,000 (3)
Patent-Star (net) (5,000-1,000) 4,000 (3)
Goodwill-Star (net) (15,000-500) 14,500 (3)
Cost of Goods Sold-Star 29,000 (4)
Operating Expenses-Star 1,500 (4)
Investment in Star Co Common Stock-Palm 505,500 (1)
Dividend Declared-Star 24,000 (1)
Page 4 of 11
To carry out the following:
a) Eliminate intercompany investment and equity accounts of subsidiary at beginning of
year and subsidiary dividend
b) Provide for depreciation and amortization on difference between current fair values and
carrying amounts
c) Allocate unamortized differences to proper accounts
Working Paper for Consolidated Financial Statements
The following aspects of the working paper should be emphasized:
The intercompany receivable and payable are placed on the same line and offset without formal
elimination
The elimination cancels the subsidiary’s retained earnings balance at the date of business
combination, so that each of the three basic financial statements may be consolidated in turn.
The FIFO method is used to account for inventories by Star Company. Thus, the difference of
25,000 attributable to beginning inventories is allocated to cost of goods sold.
One effect of the elimination is to reduce the difference between the carrying amounts and current
fair values by the amount of amortization. (110,000-30,500=79,500)
The parent company’s use of the equity method of accounting results in the equalities described
below:
Parent company net income = consolidated net income
Parent company retained earnings = consolidated retained earnings
Closing Entries
To complete the accounting cycle closing entries are prepared in the usual fashion by both the parent
company and the subsidiary. State corporate laws generally require separate accounting for retained
earnings available for dividends to stockholders. Accordingly, net income legally available for Palm’s
stockholders as dividends and adjusted net income of the subsidiary not distributed as dividend by the
subsidiary are segregated. Hence, the entry to close income summary is:
Income Summary (104,000+5,500) 109,500
Retained Earnings of Subsidiary (29,500-24,000) 5,500
Retained Earnings parent 104,000
PALM CORPORATION AND SBSIDIARY
WORKING PAPER FOR CONSOLIDATED FINANCIAL STATEMENTS
FOR YEAR ENDED DECEMBER 31, 2000
Elimination
Palm Star Increase
Corporation Company (Decrease) Consolidated
Income Statement
Revenue:
Net Sales 1,100,000 680,000 1,780,000
Intercompany investment income 29,500 a) (29,500)
Total revenue 1,129,500 680,000 (29,500) 1,780,000
Costs and expenses:
cost of goods sold 700,000 450,000 a) 29,000 1,179,000
Operating expenses 217,667 130,000 a) 1,500 349,167
Interest expense 49,000 49,000
Income taxes expense 53,333 40,000 93,333
Total costs and expenses 1,020,000 620,000 30,500 1,670,500
Net income 109,500 60,000 (60,000) 109,500
Page 5 of 11
Statement of Retained Earnings
Retained earnings, beginning 84,000 132,000 a) (132,000) 84,000
Net income 109,500 60,000 (60,000) 109,500
Sub total 193,500 192,000 (192,000) 193,500
Dividends declared 30,000 24,000 a) (24,000) 30,000
Retained earnings, ending 163,500 168,000 (168,000) 163,500
Balance Sheet
Assets
Cash 15,900 72,100 88,000
Intercompany receivable(payable) 24,000 (24,000)
Inventories 136,000 115,000 251,000
Other current assets 88,000 131,000 219,000
Investment in Star Co common stock 505,500 a) (505,500)
Plant assets (net) 440,000 340,000 a) 61,000 841,000
Patents (net) 16,000 a) 4,000 20,000
Goodwill (net) a) 14,500 14,500
Total assets 1,209,400 650,100 (426,000) 1,433,500
Liabilities & Stockholders' Equity
Income taxes payable 40,000 20,000 60,000
Other liabilities 190,900 204,100 395,000
Common stock, $10 par 400,000 400,000
Common stock, $5 par 200,000 a) (200,000)
Additional paid in capital 415,000 58,000 a) (58,000) 415,000
Retained earnings 163,500 168,000 (168,000) 163,500
Toatal liab & stockholders' equity 1,209,400 650,100 (426,000) 1,433,500
3.2 Accounting for Operating Results of Partially Owned Purchased Subsidiaries
Requires computation of minority interest in net income or net loss of the subsidiary
Under the parent company concept, the minority interest in net income or net loss of a subsidiary is
included as expense in the consolidated income statement
Illustration:
The Post Corporation- Sage Company consolidated entity is used to illustrate. Post owns 95% of the outstanding
common stock of Sage and minority stockholders own the remaining 5%.
You are provided the following financial statements for Post corporation (the parent company) and Sage
Company(partially owned subsidiary) for the year ended December 31,2000 a year subsequent to date of
combination.
Page 6 of 11
Post Corporation Sage Company
Income Statements
Revenue:
Net Sales 5,611,000 1,089,000
Intercompany investment income 42,750
Total revenue 5,653,750 1,089,000
Costs and expenses:
cost of goods sold 3,925,000 700,000
Operating expenses 556,950 129,000
Interest & tax expense 710,000 170,000
Total costs and expenses 5,191,950 999,000
Net income 461,800 90,000
Statement of Retained Earnings
Retained earnings, beginning 997,750 334,000
Net income 461,800 90,000
Sub total 1,459,550 424,000
Dividends declared 158,550 40,000
Retained earnings, ending 1,301,000 384,000
Balance Sheet
Assets
Inventories 861,000 439,000
Other current assets 639,000 371,000
Investment in Sage Co common stock 1,200,800
Plant assets (net) 3,600,000 1,150,000
Goodwill (net) 95,000
Total assets 6,395,800 1,960,000
Liabilities & Stockholders' Equity
Liabilities 2,420,550 941,000
Common stock, $1 par 1,057,000
Common stock, $10 par 400,000
Additional paid in capital 1,617,250 235,000
Retained earnings 1,301,000 384,000
Total liab & stockholders' equity 6,395,800 1,960,000
Additional information:
1. The revaluation of assets on the date of the business combination was not included in the accounts of
sage (Subsidiary).
2. Differences between current fair values and carrying amounts of Sage Company’s net assets were as
follows;
Assume that the difference was allocated to Sage’s identifiable assets as follows:
Inventories (FIFO) 26,000
Plant assets:
Land 60,000
Building (economic life 20 yrs) 80,000
Machinery (economic life 5 yrs) 50,000 190,000
Leasehold (economic life 6 yrs) 30,000
Total 246,000
3. The amount of goodwill impaired during year 2000 was 950 which is allocated to operating
expenses.
Page 7 of 11
4. Assume that depreciation, amortization and impairment of the excess of CFV over carrying amounts
allocated as follows
Machinery depreciation and leasehold amortization entirely to cost of goods sold
Building depreciation 50% each to cost of goods sold and operating expenses
Required:
1. Pass the journal entries to record the amount of dividend declared by Sage Company and to
adjust Sages’s net income for depreciation, amortization and Impairment attributable to the
difference between the current fair values and carrying amounts of Sage’s net assets on the date
of the business combination-December 31, 1999.
2. Developing the elimination journal entries.
3. Prepare consolidated working paper on December 31, 2000 a year after consolidation.
4. Prepare consolidated financial statements on December 31, 2000 a year after consolidation.
Solution
1. Sage Company declared and paid dividend of 1 a share and had a net income of 90,000 for the year
ended 31 December 2000. Sage prepares the following entries for the declaration and payment of the
dividend:
To record declaration of dividend Dividends Declared (40,000*$1) 40,000
Dividends Payable (40,000*.05) 2,000
Intercompany Dividends Payable (40,000*.95) 38,000
To record payment of dividend Dividends Payable 2,000
declared Intercompany Dividends Payable 38,000
Cash 40,000
Post’s journal entries with regards to Sage’s operating results include the following:
To record dividend declared by Sage Intercompany Dividends Receivable 38,000
Company Investment in Sage Co Common Stock 38,000
To record receipt of dividend from Sage Cash 38,000
Company Intercompany Dividends Receivable 38,000
To record 95% of net income of Sage Investment in Sage Co Common Stock (90,000*.95) 85,500
Company for the year ended Dec 31, 2000 Intercompany Investment Income 85,500
Post Corporation prepares the following journal entry on December 31, 2000 to reflect the effect of the
differences between the current fair values and carrying amounts of partially owned subsidiary’s identifiable net
assets:
To amortize differences between current fair values Intercompany Investment Income 42,750
and carrying amounts of Sage Company’s Investment in Sage Co Common Stock 42,750
identifiable net assets on Dec 31,1999
Inventories to cost of goods sold 26,000
Building – Dep. (80,000/20) 4,000
Machinery – Dep. (50,000/5) 10.000
Lease hold – Amrt. (30,000/6) 5,000
Total difference applicable to 2000 45,000
Amortization for 2000 (45,000*.95) 42,750
Next, the following entry is prepared to amortize the goodwill (or goodwill impairment) acquired by
Post in the business combination with Sage:
Impairment loss 950
Investment in Sage Co Common Stock 950
Page 8 of 11
2. Developing the Elimination
Post Corporation’s use of equity method of accounting for its investment in Star Company results in a
balance in investment account that is a mixture of two components:
The carrying amount of Sage’s net assets
The excess of current fair values over the carrying amount of Sage’s identifiable net assets,
including goodwill, on the date of business combination
The following is the working paper elimination in journal entry format
Common Stock-Sage 400,000
Additional Paid in Capital-Sage 235,000
Retained Earnings-Sage 334,000
Intercompany Investment Income-Post 42,750
Plant Assets-Sage (190,000-14,000) 176,000
Leasehold (net) (30,000-5,000) 25,000
Goodwill (net)(42,750-950) 41,800
Cost of Goods Sold-Sage 43,000
Operating Expenses-Sage 2,000
Investment in Sage Co Common Stock-Post 1,200,800
Dividends Declared-Sage 40,000
NCI in Net Assets of Sub (60,750-2,000) 58,750
To carry out the following:
a) Eliminate intercompany investment and amortization on differences combination date current fair
values and carrying amounts to appropriate assets
b) Provide for year 2000 depreciation and amortization on differences between current fair values and
carrying amounts of Sage’s identifiable net assets:
CGS Operating Expense
Inventories sold 26,000
Building Dep. 2,000 2,000
Machinery Dep. 10,000
Leasehold Amort 5,000
Total 43,000 2,000
c) Allocate unamortized differences between combination date current fair values and carrying
amounts to appropriate assets
d) Establish minority interest of subsidiary at beginning of year (60,750), less minority interest share
of dividends declared by subsidiary during the year (40,000*.05=2,000)
To establish NCI in subsidiary’s b) NCI Net income of Sub 2,250
adjusted net income NCI in net assets of sub 2,250
Net income of subsidiary 90,000
Net reduction (43,000+2,000) 45,000
Adjusted Net Income 45,000
NCI (45,000*.05) 2,250
Page 9 of 11
The NCI is:
Sage Company’s total Stockholders’ Equity 1,019,000
Add: Unamortized Difference (246,000-45,000) 201,000
Sage’s Adjusted Stockholders’ Equity 1,220,000
NCI 5% of 1,220,000 61,000
PALM CORPORATION AND SBSIDIARY
WORKING PAPER FOR CONSOLIDATED FINANCIAL STATEMENTS
FOR YEAR ENDED DECEMBER 31, 2000
Elimination
Post Sage Increase
Corporation Company (Decrease) Consolidated
Income Statement
Revenue:
Net Sales 5,611,000 1,089,000 6,700,000
Intercompany investment income 42,750 a) (42,750)
Total revenue 5,653,750 1,089,000 (42,750) 6,700,000
Costs and expenses:
cost of goods sold 3,925,000 700,000 a) 43,000 4,668,000
Operating expenses 556,950 129,000 a) 2,000 687,950
Interest & tax expense 710,000 170,000 880,000
NCI in net income of sub b) 2,250 2,250
Total costs and expenses 5,191,950 999,000 47,250 6,238,200
Net income 461,800 90,000 (90,000) 461,800
Statement of Retained Earnings
Retained earnings, beginning 997,750 334,000 a) (334,000) 997,750
Net income 461800 90,000 (90,000) 461,800
Sub total 1,459,550 424,000 (424,000) 1,459,550
Dividends declared 158,550 40,000 a) (40,000) 158,550
Retained earnings, ending 1,301,000 384,000 (384,000) 1,301,000
Page 10 of
PALM CORPORATION AND SBSIDIARY
WORKING PAPER FOR CONSOLIDATED FINANCIAL STATEMENTS
FOR YEAR ENDED DECEMBER 31, 2000
Balance Sheet
Assets
Inventories 861,000 439,000 1,300,000
Other current assets 639,000 371,000 1,010,000
Investment in Sage Co common stock 1,200,800 a) (1,200,800)
Plant assets (net) 3,600,000 1,150,000 a) 176,000 4,926,000
Leasehold (net) a) 25,000 25,000
Goodwill (net) 95,000 a) 41,800 136,800
Total assets 6,395,800 1,960,000 (958,000) 7,397,800
Liabilities & Stockholders' Equity
Liabilities 2,420,550 941,000 3,361,550
NCI in net assets of sub a) 58,750 61,000
b) 2,250
Common stock, $1 par 1,057,000 1,057,000
Common stock, $10 par 400,000 a) (400,000)
Additional paid in capital 1,617,250 235,000 a) (235,000) 1,617,250
Retained earnings 1,301,000 384,000 (384,000) 1,301,000
Total liab & stockholders' equity 6,395,800 1,960,000 (958,000) 7,397,800
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