ADMAS UNIVERSITY

CHAPTER SIX CONSOLIDATION OF FINANCIAL STATEMENTS

6.1 Overview of Consolidated Financial Statements

Consolidated financial statements are somewhat similar to the combined
financial statements that consists a home office and its branches. In a
consolidated financial statement, assets, liabilities, revenue, and expenses of the
parent company and its subsidiaries are totaled; intercompany transactions and
balances are eliminated; and the final consolidated amounts are reported in the
consolidated balance sheet, income statement, statement of stockholders'
equity, and statement of cash flows.

Parent Company- Subsidiary Relationships

If the investor acquires a controlling interest in the investee, a parent- subsidiary
relationship is established. The investee becomes a subsidiary of the acquiring parent
company but remains a separate legal entity.
The Parent prepares Parent Financial Statements while the Subsidiary prepares
Subsidiary Financial Statements. However, Consolidated Financial Statements is
prepared by the Parent by combining separate financial statements of the parent and the
subsidiary as the Parent Company is the Reporting Entity.
The consolidated financial statements are pooled from the separate legal entity status of
the parent and subsidiary corporations which necessitates eliminations that generally
are somewhat complex. It must be made clear that the investor need not consolidate all
subsidiaries where it holds more than 50% of the shares.
Consolidation is normally appropriate where one company (parent) controls another
company (subsidiary). An unconsolidated subsidiary should be reported as an investment
on the parent’s balance sheet. However, unconsolidated subsidiaries are relatively rare. A
subsidiary can be excluded from consolidation in only two situations:
1. Control is likely to be temporary.
2. Control does not rest with the majority owner
The Meaning of Controlling Interest
Traditionally, direct or indirect ownership of more than 50% of an investee’s outstanding
common stock is required to evidence controlling interest. But some circumstances may
negate actual control despite existence of stock ownership:
 A subsidiary in liquidation or reorganization in court supervised bankruptcy
proceedings
 A foreign subsidiary in a country having severe production, monetary, or income
tax restrictions

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 Right of minority shareholders to effectively participate in the financial and
operating activities of the subsidiary
The Use of Consolidated Financial Statements:
 Consolidated financial statements provide more meaningful information than
separate statements.
 They more fairly present the activities of the consolidated companies.
 Consolidated financial statements are useful to stockholders and prospective
investors of the parent company.
 Users are provided with comprehensive financial information for the
economic unit represented by the parent company subsidiaries without regard
for legal separateness of the individual companies.
Steps for Consolidation
1. Updating the balances of accounts affected by business combination transaction
2. Record the financial information for both Parent and Subsidiary on the worksheet.
3. Remove the Investment in Subsidiary balance.
4. Remove the Subsidiary’s equity account balances.
5. Remove Intercompany transactions
6. Adjust the Subsidiary’s net assets to CFV.
7. Allocate any excess of cost over CFV to identifiable intangible assets or goodwill
8. Combine all account balances.
Consolidation of Wholly Owned Subsidiary on Date of Business Combination
Once you have grasped the basics of how the investment account will be affected with
the passage of time, we will next see the consolidation of financial statements. To begin
with, we consider the consolidation of financial statements from the parent and subsidiary
as of the date of business combination where the parent holds 100% of the subsidiary’s
stocks. There is no question of control of a wholly owned subsidiary.
Illustration 4.1:
Thus, to illustrate consolidated financial statements for a parent company and a wholly
owned subsidiary, assume that on December 31, 2005, Palm Corporation issued 10,000
shares of its Br. 10 par common stock (current fair value Br. 45 a share) to stockholders
of Starr Company for all the outstanding Br. 5 par common stock of Starr. There was no
contingent consideration.

Out-of-pocket costs of the business combination paid by Palm on December 31, 2005,
consisted of the following:
Finder's and legal fees relating to business combination Br. 50,000
Costs associated with registration by SEC 35,000
Total out-of-pocket costs of business combination Br. 85,000

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Assume also that Starr Company was to continue its corporate existence as a
wholly owned subsidiary of Palm Corporation. Both constituent companies had
a December 31 fiscal year and used the same accounting principles and
procedures; thus, no adjusting entries were required for either company prior to
the combination.
Financial statements of Palm Corporation and Starr Company for the year
ended December 31, 2005, prior to consummation of the business combination,
follow:

PALM CORPORATION AND STARR COMPANY

Income Statements (prior to business combination)
For Year Ended December 31, 2005
Palm Starr
Corporation Company
Revenue:
Net sales Br. 990,000 Br. 600,000
Interest revenue 10,000 -
Total revenue Br. 1,000,000 Br. 600,000
Costs and expenses:
Cost of goods sold Br. 635,000 Br. 410,000
Operating expenses 158,333 73,333
Interest expense 50,000 30,000
Income taxes expense 62,667 34,6
67
Total costs and expenses Br. 906,000 Br. 548,000
Net income Br. 94,000 Br. 52,000

PALM CORPORATION AND STARR COMPANY

Statements of Retained Earnings (prior to business combination)
For Year Ended December 31, 2005
Palm Starr
Corporation Company
Beginning Retained earnings Br. 65,000 Br. 100,000
Add: Net income 94,000 52,000
Subtotals Br. 159,000 Br. 152,000
Less: Dividends 25,000 20,000
Retained earnings, end of year Br. 134,000 Br. 132,000

PALM CORPORATION AND STARR COMPANY

Balance Sheets (prior to business combination)
December 31, 2005
Assets Palm Starr
Corporation Company
Cash Br. 100,000 Br. 40,000

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Inventories 150,000 110,000
Other current assets 110,000 70,000
Receivable from Starr Company 25,000 ----
Plant assets (net) 450,000 300,000
Patent (net) ---- 20,000
Total assets Br. 835,000 Br. 540,000
Liabilities and Stockholders' Equity
Payables to Palm Corporation ---- Br. 25,000
Income taxes payable Br. 26,000 10,000
Other liabilities 325,000 115,000
Common stock, Br10 par 300,000 ----
Common stock, Br5 par ---- 200,000
Additional paid-in capital 50,000 58,000
Retained earnings 134,000 132,000
Total liabilities and stockholders' equity Br. 835,000 Br. 540,000

The December 31, 2005, current fair values of Starr Company's identifiable assets
and liabilities were the same as their carrying amounts, except for the three
assets listed below:
Current Fair Values, December
31, 2005
Inventories Br. 135,000
Plant assets 365,000
Patent (net) 25,000

Required
A) Prepare necessary journal entry
B) Compute good will
C) Prepare consolidated balance sheet
D) Prepare working paper for consolidated balance sheet

Solution
a) Palm Corporation recorded the combination as a purchase with the following entries:
Investment in Starr Company Common Stock (10,000 x Br. 45) ………………… 450,000
Common Stock (10,000 x Br. 10)………………………………………………….. 100,000
Paid-in Capital in Excess of par ………………………………………………… 350,000
To record the issuance of 10,000 shares of common stock for all the outstanding common stock of Starr
Company in a business combination.
Investment in Starr Company Common Stock ………………………………………. 50,000
Paid-in Capital in Excess of Par………………………………………………………… 35,000
Cash………………………………………………………………………………… 85,000
To record payment of out-of-pocket costs of business combination with Starr Company.

B) Computation of Good will

Good will=Total cost-Current Fair value of net asset
CFV of total asset –CFV total Liability
CFV of total asset=Br. 40,000 +70,000 +135,000 +365,000 +25,000 =635,000
Less: CFV total Liability = 25,000 + 10,000+115,000 =Br. 150,000
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CFV of net asset-------------------- ………………………………Br. 485,000
Good will=500000-450000 =15000

C) Consolidated Balance Sheet

PALM CORPORATION AND SUBSIDIARY

Consolidated Balance Sheet
December 31, 1999
Assets
Current assets:
Cash (15,000+40,000) 55,000
Inventories (150,000+135,000) 285,000
Other (110,000+70,000) 180,000
Total current assets 520,000
Plant assets (net) (450,000+365,000) 815,000
Intangible assets
Patent (net) (0+25,000) 25,000
Goodwill (net) 40,000
Total assets 1,375,000
Liabilities and Stockholders’ Equity
Liabilities:
Income taxes payable (26,000+10,000) 36,000
Other (325,000+115,000) 440,000
Total liabilities 476,000
Stockholders’ equity
Common stock, $10 par 400,000
Additional paid in capital 365,000
Retained earnings 134,000
Total stockholders’ equity 1,375,000

D) Working Paper for Consolidated Balance Sheet

Developing the elimination

The parent company’s investment account is similar to the home office’s investment in branch
account. However, the subsidiary is a separate corporation not a branch and has three conventional
stockholders’ equity accounts rather than a single home office reciprocal account used by a
branch. Accordingly, the elimination of the intercompany accounts must decrease the investment
account of the parent company and the three stockholders’ equity accounts of the subsidiary to
zero.
The completed elimination for Palm Corporation and subsidiary (in journal entry format) and the
related working paper for consolidated balance sheet are as follows:
a) Common Stock-Star 200,000
Additional Paid in Capital-Star 58,000
Retained Earnings- Star 132,000
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Inventories- Star (135,000-110,000) 25,000
Plant Assets (net)-Star (365,000-300,000) 65,000
Patent (net)-Star (25,000-20,000) 5,000
Goodwill (net)-Star (500,000-485,000) 15,000
Investment in Star Co Common Stock 500,000
To eliminate intercompany investment and equity accounts of subsidiary

PALM CORPORATION AND SUBSIDIARY

Working Paper for Consolidated Balance Sheet
December 31, 2005
Eliminations
Palm Starr Increase
Corporation Company (Decrease) Consolid
ated
Assets
Cash 15,000 40,000 ----- 55,000
Inventories 150,000 110,000 (a) 25,000 285,000
Other current assets 110,000 70,000 ---- 180,000
Intercompany receivable (payable) 25,000 (25,000) -- -0-
Investment in Starr Company Common Stock 500,000 (a) (500,000) -0-
Plant assets (net) 450,000 300,000 (a) 65,000 815,000
Patent (net) 20 000 (a) 5,000 25,000
Goodwill (a) 15,000 15,000
Total assets 1,250,000 515,000 ( 390,000) 1,375,000

Liabilities and Stockholders' Equity

Income taxes payable 26,000 10,000 36,000
Other liabilities 325,000 115,000 440,000
Common stock, Br10 par 400,000 400,000
Common stock, Br5 par 200,000 (a) (200,000)
Additional paid-in capital 365,000 58,000 (a) (58,000) 365,000
Retained earnings 134,000 132,000 (a) (132,000) 134,000
Total liabilities and stockholders' equity 1,250,000 515,000 (390,000) 1,375,000

From the above consolidated working paper, you need to note the following:
1) The elimination is not entered in either the parent company's or the subsidiary's
accounting records; it is only a part of the working paper for preparation of the
consolidated balance sheet.
2) The elimination is used to reflect differences between current fair values and carrying
amounts of the subsidiary's identifiable net assets because the subsidiary did not write
up its assets to current fair values on the date of the business combination.
3) The Eliminations column in the working paper for consolidated balance sheet reflects
increases and decreases, rather than debits and credits. Debits and credits are not
appropriate in a working paper dealing with financial statements rather than trial
balances.
4) Intercompany receivables and payables are placed on the same line of the working
paper  for consolidated balance sheet and are combined to produce a consolidated
amount of zero.

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5) The respective corporations are identified in the working paper elimination.
6) The consolidated paid-in capital amounts are those of the parent company only.
Subsidiaries' paid-in capital amounts always are eliminated in the process of
consolidation.
7) Consolidated retained earnings on the date of a business combination include only the
retained earnings of the parent company. This treatment is consistent with the theory
that purchase accounting reflects a fresh start in an acquisition of net assets (assets
less liabilities).
8) The amounts in the consolidated column of the working paper for consolidated
balance sheet reflect the financial position of a single economic entity comprising two
legal entities, with all intercompany balances of the two entities eliminated.
6.5 Consolidation of Partially Owned Subsidiary on Date of Purchase
Type Business Combination
The consolidation of a parent company with its partially owned subsidiary differs from a
consolidation of wholly owned subsidiary in one major respect- the recognition of
minority interest.
Minority interest is a term applied to the claims of stockholders other than the parent
company to the net income or losses and net assets of the subsidiary. The minority
interest in the subsidiary’s net income or loss is displayed in the consolidated income
statement, and the minority interest in the subsidiary’s net assets is displayed in the
consolidated balance sheet.
Nature of Minority Interest
Two concepts for consolidated financial statements have been developed to account for
minority interest: the parent company concept and the economic unit concept.
The parent company concept apparently treats the minority interest in net assets of a
subsidiary as a liability. This liability is increased by an expense representing the
minority’s share of the subsidiaries net income (or decreased by the minority’s share of
net loss). Dividends declared to minority shareholders decrease the liability to them.
The economic unit concept displays the minority interest in the subsidiary’s net assets
stockholders’ equity section of the consolidated balance sheet. The consolidated income
statement displays the minority interest in the subsidiary’s net income as a subdivision of
total consolidated net income.
Note that there is no ledger account for minority interest in net assets of subsidiary, in
either parent company’s or the subsidiary’s accounting records.
To illustrate, assume that on December 31, 1999, Post Corporation
issued 57,000 of its $1 par common stock (current fair value $20 a
share)to stockholders of Sage Company in exchange for 38,000 of the

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40,000 outstanding shares of $10 par common stock in a purchase type
business combination. Thus, Post acquired 95% (38,000/40,000)
interest in Sage, which became its subsidiary. There was no contingent
consideration. Out of pocket costs are:
Finder’s and legal fees 52,250
Costs associated with SEC registration 72,750
Total 125,000
Financial statements of Post and Sage just prior to combination were as
follows:
POST CORPORATION AND SAGE COMPANY
Separate income Statements (prior to purchase-type business combination)
For Year Ended December 31, 1999
Post Sage
Net sales 5,500,000 1,000,000
Costs and expenses
Cost of goods sold 3,850,000 650,000
Operating expenses 925,000 170,000
Interest expense 75,000 40,000
Income taxes expense 260,000 56,000
Total 5,110,000 916,000
Net income 390,000 84,000
Statement of Retained Earnings
Post Sage
Retained earnings, beginning 810,000 290,000
Add: Net income 390,000 84,000
1,200,000 374,000
Less: Dividends 150,000 40,000
Retained earnings, ending 1,050,000 334,000

Balance Sheet
Assets
Post Sage
Cash 200,000 100,000
Inventories 800,000 500,000
Other current assets 550,000 215,000

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Plant assets (net) 3,500,000 1,100,000
Goodwill (net) 100,000
Total assets 5,150,000 1,915,000
Liabilities and Stockholders’ Equity
Income taxes payable 100,000 16,000
Other liabilities 2,450,000 930,000
Common stock, $1 par 1,000,000
Common stock, $10 par 400,000
Additional paid in capital 550,000 235,000
Retained earnings 1,050,000 334,000
Total liab & stockholders’ equity 5,150,000 1,915000
The December 31, 1999, current fair values of Sage Company’s identifiable assets and
liabilities were the same as their carrying amounts except for the following:
Inventories 526,000
Plant assets (net) 1,290,000
Leasehold 30,000
Sage Company does not prepare journal entries related to the business as it is continuing
as a separate legal entity.
But Post Corporation prepares the following entries:
Investment in Sage Common Stock
(57,000*20) 1,140,000
Common Stock (57,000*1) 57,000
Paid in Capital in Excess of Par 1,083,000
To record issuance of 57,000 shares of common to acquire 38,000 of Sage
Company’s outstanding 40,000 shares
Investment in Sage Common Stock 52,250
Paid in Capital in Excess of Par 72,750
Cash 125,000
To record payment of out of pocket expenses associated with business
combination
Working Paper for Consolidated Balance Sheet
It is advisable to use a working paper for preparation of a consolidated
balance sheet for a parent company and its partially owned subsidiary
due to complexities caused by the minority interest.

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The differences between the carrying amounts of identifiable assets and
liabilities of the subsidiary with the current fair vales must be reflected
by means of elimination.
Common stock-Sage 400,000
Additional Paid in Capital-Sage 235,000
Retained earnings-Sage 334,000
Inventories-Sage (526,000-500,000) 26,000
Plant Assets (net) (1,290,000-1,100,000) 190,000
Leasehold 30,000
Investment in Sage Common Stock-Post 1,192,250
The debit side of the above entry represents the current fair values of
Sage Company’s identifiable tangible and intangible assets (1,215,000)
while the credit side represents Post’s total investment 1,192,250. Two
items should be recorded to complete the elimination: minority interest
and goodwill.
Computation of Minority Interest
Current fair value of Sage’s identifiable net assets 1,215,000
Minority interest (100-95) 0.05
Minority interest (1,215,000*.05) 60,750
This is recorded as credit as it represents claim on the net assets.
Computation of goodwill
Cost of Post Corporation’s 95% interest 1,192,250
Less: Current fair vale of identifiable net assets acquired
(1,215,000*.95) 1,154,250
Goodwill 38,000
The completed elimination in journal entry format would be:
Common stock-Sage 400,000
Additional Paid in Capital-Sage 235,000
Retained earnings-Sage 334,000
Inventories-Sage (526,000-500,000) 26,000
Plant Assets (net) (1,290,000-1,100,000) 190,000
Leasehold 30,000
Goodwill 38,000
Investment in Sage Common Stock-Post 1,192,250
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Minority Interest 60,750

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Post Corporation and Subsidiary
Working Paper for Consolidated Balance Sheet
December 31, 1999

Post Sage Elimination Consolidated

Assets
Cash 75,000 100,000 175,000
Inventories 800,000 500,000 a 26,000 1,326,000
Other current assets 550,000 215,000 765,000
Investment in Sage Co 1,192,250 a (1,192,250)
Plant assets (net) 3,500,000 1,100,000 a 190,000 4,790,000
Leasehold a 30,000 30,000
Goodwill (net) a 38,000 138,000
Total assets 6,217,250 1,915,000 (908,250) 7,224,000
Liabilities & Stockholders’ Equity
Income taxes payable 100,000 16,000 116,000
Other liabilities 2,450,000 930,000 3,380,000
Minority interest a 60,750 60,750
Common stock, $1 par 1,057,000 1,057,000
Common stock, $5 par 400,000 a (400,000)
Additional paid in capital 1,560,250 235,000 a (235,000) 1,560,250
Retained earnings 1,050,000 334,000 a (334,000) 1,050,000
Total 6,217,250 1,915,000 (908,250) 7,224,000

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CONSOLIDATION OF SUBSEQUENT TO DATE OF PURCHASE-TYPE
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.
Methods of Accounting for Investment in Other Firms
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.
 The investor’s investment account increases as the investee earns and reports
income.
Also, the investor recognizes investment income using the accrual method—that
is, in the same time period as the investee earns it.
 The investor’s investment account is decreased whenever a dividend is collected.
Because distribution of cash dividends reduces the book value of the investee
company, the investor mirrors this change by recording the receipt as a decrease
in the carrying value of the investment rather than as revenue.
 Investment income consists of the investor’s proportionate share of the investee’s
net income
In applying the equity method, we have to account for the investment in
subsidiary by:
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1. Recording the investment in subsidiary on the acquisition date at cost of
consideration given up.
2. Recognizing the receipt of dividends from the subsidiary reducing the
investment.
3. Recognizing a share of the subsidiary’s income (loss) as addition to or
reduction from the investment balance.
4. Adjusting the assets and liabilities to reflect the fair value methods.

Cost Method
Under this method investment income consists only of dividends received.
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.
Under this method a long-term investment is originally recorded and reported at cost.
Ordinary cash dividends received from the investee are recorded as investment revenue.
This method is appropriate when an investor owns only a small portion (for example, less
than 20%) of the total outstanding common stock of an investee so that the investor has
little or no influence over the investee. In this case, the investor cannot influence the
investee’s dividend policy, and the only portion of the investee’s dividend policy, and the
only portion of the investee’s income that reaches the investor is the dividends paid by
the investee
If the cost method is used by the parent company to account for the investment,
then the consolidation entries will change only slightly. The difference between
the cost method and the equity method includes:
1. No adjustments are recorded in the Investment account for current year
operations, dividends paid by the subsidiary, or amortization of purchase
price allocations.
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2. Dividends received from the subsidiary are recorded as Dividend
Revenue.
To summarize the above differences in the accounting methods for the
investment account and the income from the investment under the three
methods, we have the following table:
Method Investment Account Income Account
Income accrued as earned;
Continually adjusted to reflect
Equity amortization and other
ownership of acquired company.
adjustments are recognized.

Cash received recorded as

Cost Remains at initially recorded cost.
dividend income.

Illustration of Equity Method for Wholly Owned Purchased Subsidiary for First
Year after Business Combination
Example
X Company acquired 10% of Y Company’s outstanding common stock at the beginning
of 2002 for Br. 300, 000. Y Company reported net income of Br. 200, 000 on December
31, 2002 and paid cash dividends of Br. 250, 000 on January 10, 2003
The Journal entries to record the above transactions using cost method
(1) To record acquisition of the common stock
Investment in Y Company common stock 300, 000
Cash 300, 000
(2) To record cash dividends received on January 10, 2003
Total cash dividend received by X Company = 0.10 x 250, 000 = Br. 25, 000
Post-acquisition earnings, share of X Company = 0.10 x 200, 000 = 20, 000
Liquidating dividend Br. 5, 000
Cash 25, 000
Dividend revenue 20, 000
Investment in Y Company common stock 5, 000

Illustration of Equity Method for Wholly Owned Purchased Subsidiary for First
Year after Business Combination
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To illustrate, assume that Big Company owns a 20 percent interest in Little Company
purchased on January 1, 2010, for $200,000. Little then reports net income of $200,000,
$300,000, and $400,000, respectively, in the next three years while paying dividends of
$50,000, $100,000 and $200,000.
Therefore, in its financial records, Big Company records the following journal entries to
apply the equity method as January 1, 2010
Investment in Little Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Equity in Investee Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
To accrue earnings of a 20 percent owned investee ($200,000 _ 20%).
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
Investment in Little Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
To record receipt of cash dividend from little Company ($50,000 _ 20%
Do for 2011 and 2012 in the same way
Example 2 Assume that Palm Corporation had used purchase accounting for business
combination with its wholly owned subsidiary, Star Company, and the 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 outstanding shares.
Dec. 20: Star’s journal entry to record dividend declaration is:
Dividends Declared 24,000
Intercompany Dividends Payable 24,000
To record declaration of dividend
Under the equity method of accounting, Palm Corporation prepares the following journal
entries to record the dividend and net income of Star.
1) Intercompany Dividend Receivable 24,000
Investment in Star Common Stock 24,000
To record dividend declared by Star Company
2) Investment in Star Company Common Stock 60,000
Intercompany Investment Income 60,000
To record 100% of Star Company’s net income
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.
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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.
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
ILLUSTRATION
The following transactions were occurred in the years 2002 and 2003:
Jan. 5, 2002, CABU Company acquired 24, 000 shares (20% of BATU Company
common stock) at a cost of Br. 10 a share.
Dec. 31, 2002, BATU Company reported net income of Br. 100, 000
Jan. 20, 2003, BATU Company announced and paid a cash dividend of Br. 60, 000
Dec. 31, 2003, BATU Company reported a net loss of Br. 30, 000.
Required:
Present the Journal entries required to account for the investment in the books of CABU
Company, using
 ADMAS UNIVERSITY
a. Cost method of accounting
b. Equity method or accounting

Solution
a) Cost method b) Equity method
(1) Jan. 5, 2002
Investment in BATU Company Investment in BATU Company
Common stock (24, 000 x 10) 240, 000 Common stock 240, 000
Cash 240, 000 Cash 240, 000
(2) Dec. 31, 2002
No entry Investment in BATU Company
Common stock (20% x Br. 100, 000) 20, 000
Investment income 20, 000
(3) Jan. 20, 2003
Cash (20% x Br. 60, 000) 12, 000 Cash 12, 000
Investment income 12, 000 Invst in BATU in Co c/s 12, 000
(4) Dec. 31, 2003
No entry Loss on investment (20% x 30, 000) 6, 000
Inve’st in BATU c/s 6, 000

Advanced Financial Accounting Page 1