CHAPTER 4
CONSOLIDATED FINANCIAL STATEMENTS AFTER ACQUISITION
Revise the section on page 119 “Complete Equity Method on Books of Investor” as follows:
Complete Equity Method on Books of Investor
The complete equity method is usually required to report common stock investments in
the 20% to 50% range, assuming the investor has the ability to exercise significant influence
over the operating activities of the investee. In addition, a parent company may use the
complete equity method to account for investments in subsidiaries that will be consolidated.
This method is similar to the partial equity method up to a point, but it requires additional
entries in most instances.
Continuing the illustration above, assume additionally that the $800,000 purchase price
exceeded the book value of the underlying equity of S Company by $100,000; and that the
difference was attributed half to goodwill ($50,000) and half to an excess of market over book
values of depreciable assets ($50,000). Under new FASB regulations, goodwill would be
capitalized and not amortized. The additional depreciation expense implied by the difference
between market and book values, however, must still be accounted for. The depreciation of
the excess, if spread over a life of ten years, would result in a charge to earnings of $5,000 per
year. This charge has the impact of lowering the equity in subsidiary income, or increasing
the equity in subsidiary loss, recorded by the parent.
The entries for the first three years under the complete equity method are:
GRAY BOX for Parent Company Entries
Year 1 – P’s Books
Investment in S Company
Cash
To record the initial investment.
Investment in S Company
Equity in Subsidiary Income .9($90,000)
To record equity in subsidiary income.
800,000
800,000
81,000
81,000
Equity in Subsidiary Income
5,000
Investment in S Company ($50,000/10)
To adjust equity in subsidiary income for the excess depreciation
Cash
Investment in S Company
To record dividends received .9($30,000).
5,000
27,000
27,000
Note: The entries to record equity in subsidiary income and dividends received may be
combined into one entry, if desired.
Year 2 – P’s Books
Equity in Subsidiary Loss
Investment in S Company
To record equity in subsidiary loss .9($20,000).
18,000
18,000
Equity in Subsidiary Income
5,000
Investment in S Company ($50,000/10)
To adjust equity in subsidiary loss for excess depreciation
5,000
Cash
Investment in S Company
To record dividends received .9($30,000).
27,000
27,000
Year 3 – P’s Books
Investment in S Company
Equity in Subsidiary Income
To record equity in subsidiary income .9($10,000).
9,000
9,000
Equity in Subsidiary Income
5,000
Investment in S Company ($50,000/10)
To adjust equity in subsidiary income for excess depreciation
Cash
Investment in S Company
To record dividends received .9($30,000).
5,000
27,000
27,000
After these entries are posted, the investment account will appear as follows:
INVESTMENT IN S COMPANY (COMPLETE EQUITY METHOD)
Year 1 Cost
Year 1 Equity in subsidiary income
800,000
81,000
Year 1 Balance
849,000
Year 1 Additional depreciation
Year 1 Share of dividends declared
5,000
27,000
Year 2 Equity in Subsidiary Loss
18,000
Year 2 Additional depreciation
5,000
Year 2 Share of dividends Declared 27,000
Year 2 Balance
Year 3 Equity in Subsidiary Income
799,000
9,000
Year 3 Balance
776,000
Year 3 Additional depreciation
5,000
Year 3 Share of Dividends Declared 27,000
The additional entry to adjust the equity in subsidiary income for the additional
depreciation in Year 1 may be viewed as reversing out a portion of the income recognized; the
result is a net equity in subsidiary income for Year 1 of $76,000 ($81,000 minus $5,000). In
Year 2, however, since the subsidiary showed a loss for the period, the additional depreciation
has the effect of increasing the loss from the amount initially recorded ($18,000) to a larger
loss of $23,000.
A solid understanding of the entries made on the books of the investor (presented above)
will help greatly in understanding the eliminating entries presented in the following sections.
In some sense these entries may be viewed as “undoing” the above entries. It is important to
realize, however, that the eliminating entries are not “parent only” entries. In many cases an
eliminating entry will affect certain accounts of the parent and others of the subsidiary. For
example, the entry to eliminate the investment account (a parent company account) against the
equity accounts of the subsidiary affects both parent and subsidiary accounts. Some accounts
do not need eliminating because the effects on parent and subsidiary are offsetting. For
example, in the entries above, we saw that the parent debited cash when dividends were
received from the subsidiary. We know that cash on the books of the subsidiary is credited
when dividends are paid. The net effect on cash of the consolidated entry is thus zero. No
entry is made to the cash account in the consolidating process. See Figure 4-1 for a
comparison of the three methods on the books of the parent.
Insert Figure 4-1 here
Figure 4-1
Comparison of the Investment T accounts
(Cost vs. Partial Equity vs. Complete Equity Method)
Cost Method
Investment in S Company - Cost Method
Year 1 Acquisition cost
Year 1 and 2 Balance
800,000
800,000
Year 3 Subsidary liquidating dividend
Year 3 Balance
791,000
9,000
Partial Equity Method
Investment in S Company - Partial Equity Method
Year 1 Acquisition cost
Year 1 Equity in subidary income
Year 1 Balance
Year 2 Balance
Year 3 Equity in subidiary income
800,000
81,000 Year 1 Share of dividends declared
854,000
Year 2 Equity in subidiary loss
Year 2 Share of dividend declared
809,000
9,000 Year 3 Share of dividend declared
Year 3 Balance
791,000
27,000
18,000
27,000
27,000
Complete Equity Method
Investment in S Company - Complete Equity Method
Year 1 Acquisition cost
Year 1 Equity in subidary income
Year 1 Balance
Year 2 Balance
Year 3 Equity in subidary income
Year 3 Balance
800,000
81,000 Year 1 Additional Depreciation
Year 1 Share of dividend declared
849,000
Year 2 Equity in subidary loss
Year 2 Additional Depreciation
Year 2 Share of dividend declared
799,000
9,000 Year 3 Additional Depreciation
Year 3 Share of dividend declared
776,000
5,000
27,000
18,000
5,000
27,000
5,000
27,000
End of Chapter 4 Exercises:
Modify Exercise 4-1, as follows:
Exercise 4-1 Parent Company Entries; Liquidating Dividend
Percy Company purchased 80% of the outstanding voting shares of Song Company at the
beginning of 1999 for $387,000. At the time of purchase, Song Company's total stockholders'
equity amounted to $475,000. Income and dividend distributions for Song Company from
1999 through 2001 are as follows:
1999
2000
2001
Net income (loss)
Dividend distribution
$63,500
25,000
$52,500
50,000
($55,000)
35,000
Required:
Prepare journal entries on the books of Percy Company from the date of purchase through
2001 to account for its investment in Song Company under each of the following
assumptions:
A. Percy Company uses the cost method to record its investment.
B. Percy Company uses the partial equity method to record its investment.
C. Percy Company uses the complete equity method to record its investment. The difference
between cost and the book value of equity acquired was attributed solely to an excess of
market over book values of depreciable assets, with a remaining life of ten years.
Note: The solution to this exercise should be the same as in the 1st edition Solutions Manual,
except that “amortization of goodwill” notations are replaced by “excess depreciation.”