Chapter Three

Consolidated Financial Statements: Subsequent to Date of Business

Combination under Purchase Accounting
Subsequent to date of a business combination the parent company accounts for operating
results of subsidiary. That is it accounts for:
 Net income or net loss, and
 Dividends declared paid by subsidiary
In addition, a number of intercompany transactions and event that frequently occur in a Parent-
Subsidiary relationship shall be recorded. All the three basic financial statements must be
consolidated for accounting periods subsequent to the date of purchase type business
combination. The items that must be included in the elimination are:
1. The Subsidiary’s beginning-of-year stockholder’s Equity and its dividends,
2. The parent’s investment, and the parent’s investment income accounts;
3. Unamortized Current Fair Value excesses of the subsidiary’s net assets; and
4. Certain operating expenses of the subsidiary

Methods of Accounting for Investment in Other Firms

A parent company may choose the Equity Method or the Cost Method to account for the
operating results of consolidated purchased subsidiaries.
Before the consolidation balances can be determined, the parent’s investment account must be
adjusted to reflect the application of how investment has been accounted. Accountants can
follow one of the following methods:
1. The Equity Method
2. The Cost Method
3. The Partial Equity Method
1. Equity Method
 The Parent company records its share of subsidiary’s net income or net loss, adjusted for
depreciation and amortization of differences between current fair values and carrying amounts
of a purchased subsidiary’s net asset on the date of business combination, as well as its share of
dividends declared by subsidiary.
 Proponents of the equity method of accounting maintain that the method is consistent with
accrual accounting, because it recognizes increases or decreases in the carrying amounts of
parent company’s investment in the subsidiary when they are realized by the subsidiary as net
income or net loss, not when they are paid by the subsidiary as dividends.
 Proponents claim that it stresses the economic substance of the parent-subsidiary
relationship because the two companies constitute a single economic entity for financial
accounting.
 They also claim that dividends declared by subsidiary are not revenues to the parent (as
claimed by cost methods): instead, they are liquidations (reduction) of investment in subsidiary.
The Equity Method in short
In applying the equity method, we have to account for the investment in subsidiary by:
1. Recording the Investment in Subsidiary on the acquisition date at cost of consideration
given up.

1
 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.

2. Cost Method
 Parent Company accounts for the operations of a subsidiary only to the extent that dividends
are declared by subsidiary.
 Dividends declared by the subsidiary subsequent to the business combination are revenue to
parent company.
 Dividends declared by the subsidiary in excess of post combination net income are reduction
in carrying amount of the investment in subsidiary. (Liquidating Dividend).
 Net income or net loss of subsidiary is not recorded by parent company when the cost
method of accounting is used.
 Supporters argue that the cost method appropriately recognizes legal form of the parent
company – subsidiary relationship.
 Parent company and subsidiary are separate legal entities; accounting for a subsidiary’s
operations should recognize the separateness, according to proponents of cost method.
The Cost Method in short
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.
2. Dividends received from the subsidiary are recorded as Dividend Revenue.
The Partial Equity Method
The Partial Equity Method slightly differs from the Equity method in that the adjustment to the
Fair value balances of assets and liabilities. 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

Continually adjusted to reflect ownership of Income accrued as earned; amortization

EQUITY
acquired company. and other adjustments are recognized.

Cash received recorded as dividend

COST Remains at initially recorded cost.
income.

PARTIAL Adjusted only for accrued income and Income accrued as earned; no other
EQUITY dividends received from acquired company. adjustments recognized.

Choosing between Equity Method and cost method

Consolidated financial statement amounts are the same, regardless of whether a parent company
uses the equity method to account for a subsidiary’s operations. However, the working paper

2
eliminations used in the two methods are different, as illustration in subsequent sections of this
chapter.
The equity method of accounting is appropriate for pooled subsidiary’s as well as purchased
subsidiaries. The cost method, on the other hand, is compatible with purchase accounting only.
In purchase accounting, the parent company’s original investment in the subsidiary is recorded at
cost method may be considered a logical extension of purchase accounting. However, in pooling
accounting the parent company’s investment on the date of the business combination is recorded
at the company’s investment on the date of the business combination is recorded at the parent’s
share of the carrying amount of the subsidiary’s net assets. As a result, the parent company’s
investment is subsidiary common stock ledger account reflects the parent’s equity in the
subsidiary’s net assets on the date of the business combination; there is no cost of a pooled
subsidiary.

Illustration 2.1: 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 Br85,000
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:

From previous example (chapter 2 )

PALM CORPORATION AND STARR COMPANY

Income Statements (prior to business combination)
For Year Ended December 31, 2005
PALM CORPORATION AND STARR COMPANY
Statements of Retained Earnings (prior
Palm Corporation to business
Starr Company combination)
For Year Ended December 31, 2005
Revenue:
Net sales Br. 990,000 Br.
Palm600,000
Corporation Starr Company
Interest revenue
Retained earnings, beginning of year 10,000 Br. -65,000 Br. 100,000
TotalAdd:
revenue
Net income Br. 1,000,000 Br. 600,00094,000 52,000
Costs and expenses:
Subtotals Br. 159,000 Br. 152,000
Cost of goods
Less: sold
Dividends Br. 635,000 Br. 410,00025,000 20,000
Operating expenses
Retained earnings, end of year 158,333 73,333
Br. 134,000 Br. 132,000
Interest expense 50,000 30,000
Income taxes expense 62,667 34,667
Total costs and expenses Br. 906,000 Br. 548,000
Net income Br. 94,000 Br. 52,000
3
 PALM CORPORATION AND STARR COMPANY
Balance Sheets (prior to business combination)
December 31, 2005

Palm Corporation Starr Company

Assets
Cash Br. 100,000 Br. 40,000
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 (net) 365,000
Patent (net) 25,000

Because Starr was to continue as a separate corporation and current generally accepted
accounting principles do not sanction write-ups of assets of a going concern, Starr did not
prepare journal entries for the business combination. Palm Corporation recorded the
combination on December 31, 2005, with the following journal 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.

Assume that Palm Corporation had appropriately accounted for the December 31, 2005,
business combination with its wholly owned subsidiary, Starr Company and that Starr had a net

4
income of Br. 60,000 for the year ended December 31, 2006. Assume further that on December
20, 2006, Starr's board of directors declared a cash dividend of Br. 0.60 a share on the 40,000
outstanding shares of common stock owned by Palm (dividends of Br 24,000 are declared on
December 20, 2006). The dividend was payable on January 8, 2007, to stockholders of record
December 29, 2006. Starr's December 20, 2006, journal entry to record the dividend declaration
is as follows:
2006 2 Dividends Declared (40,000 x Br. 0.60) 24,000
December 0 Intercompany Dividends Payable 24,000
To record declaration of dividend payable January 8, 2007, to stock- holders of record December 29, 2006.

Starr's credit to the Intercompany Dividends Payable ledger account indicates that the liability
for dividends payable to the parent company must be eliminated in the preparation of
consolidated financial statements for the year ended December 31, 2006. Under the equity
method of accounting, Palm Corporation prepares the following journal entries to record the
dividend and net income of Starr for the year ended December 31, 2006:
2006
December 2 Intercompany Dividends Receivable 24,000
0
Investment in Starr Company Stock 24,000
To record dividend declared by Starr company, payable January 8, 2007, to stockholders of
record Dec, 29, 2006.
3 Investment in Starr Company Common Stock 60,000
1 Intercompany Investment Income 60,000
To record 100% of Starr Company’s net income for the year ended Dec. 31, 2006.

The parent's first journal entry records the dividend declared by the subsidiary in the
Intercompany Dividends Receivable account and is the counterpart of the subsidiary's journal
entry to record the declaration of the dividend. The credit to the Investment in Starr Company
Common Stock account in the first journal 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 parent's second journal entry records the parent's 100% share of the subsidiary's net income
for 2006. The subsidiary's net income accrues to the parent company under the equity method of
accounting, similar to the accrual of interest on a note receivable or an investment in bonds. In
addition to the two foregoing journal entries, Palm must prepare a third equity-method journal
entry on December 31, 2006, to adjust Starr's net income for depreciation and amortization
attributable to the differences between the current fair values and carrying amounts of Starr's
identifiable net assets on December 31, 2005, the date of the Palm-Starr business combination.
Because such differences were not recorded by the subsidiary, the subsidiary's 2006 net income
is overstated from the point of view of the consolidated entity.

Assume that the December 31, 2005 (date of business combination), differences between the
current fair values and carrying amounts of Starr Company's net assets were as follows:

5
 Difference Inventories (first-in, first-out cost) Br. 25,000
between Current Plant assets (net):
Fair Values and Land Br. 15,000
Carrying Amounts Building (economic life 10 years) 30,000
of Wholly Owned Machinery (economic life 10 years) 20,000 65,000
Subsidiary’s Patent (economic life 5 years) 5,000
Assets on Date of
Goodwill (not impaired as of December 31, 2006) 15,000
Business
Combination Total Br. 110,000

Adjustment of purchased subsidiary’s net income:

Palm must prepare a third equity method journal entry on December 31,2003 to adjust Starr’s net
income for depreciation and amortization attributable to the difference between CFV and
carrying values of Starr’s Company net assets on December 31,2002, the date of combination.
Because such differences were not considered by the subsidiary, the subsidiary’s 2003 net
income is overstated from the point of view of the consolidated entity. Assume that on
December 31, 2002 (date of combination), differences between CFV& carrying values of Starr
company’s net assets were as follow:
December December
31, 2002 31, 2003
Inventories (FIFO)...................................................... Br 25,000 ─
Plant Assets, net:
Land..................................................................... 15,000 15,000
Building (15 Years).............................................. 30,000 28,000
Machinery (10 Years).......................................... 20,000 18,000
Patent (5 Years).......................................................... 5,000 4,000
Goodwill (No Impairment)......................................... 15,000 15,000
Total............................................................................ 110,000 80,000
 Plant Assets, net (December 31, 2002) = 15,000 + 30,000 + 20,000 = Br65,000
 Plant Assets, net (December 31, 2003) = 15,000 + 28,000 + 18,000 = Br61,000
Palm Corporation prepares the following additional equity method journal entry to reflect the
effects of depreciation and amortization of the differences between the CFV and carrying
amounts of Starr Company’s net assets on Starr's net income for the year ended Dec.31.2003.
The amount of amortization, which the difference between CFVs and carrying amounts of
Starr Company’s net assets on December 31, 2003 is determined as follows:
Inventories sold and included in the COGS............. Br25,000
Building - depreciation (30,000 /15)........................ 2,000
Machinery – depreciation (20,000/ 10).................... 2,000
Patent-amortization (5,000/ 5).................................. 1,000
Total......................................................................... 30,000

Corporation prepares the following additional equity-method journal entry to reflect the effects
of depreciation and amortization of the differences between the current fair values and carrying

6
amounts of Starr Company's identifiable net assets on Starr's net income for the year ended
December 31, 2006:

2006
December 3 Intercompany Investment Income 30,000
1
Investment in Starr Company’s Stock 30,000

Investment in Star company common stock

Debit Credit Balance

Dec. Issuance of common stock in 450,000 450,000dr
1999, 31 business
combination
Direct out of pocket costs of 50,000 500,000dr
business
Combination
Dec. Dividend declared by Star 24,000 476,000dr
2000, 31
Net income of Star 60,000 536,000dr
Amortization of different between
Current fair values and carrying 30,000 506,000dr
amounts of Star’s net assets

Intercompany Investment income

Debit Credit Balance

Dec,2006, Net income of Star 60,000 60,000
31
Amortization of
differences between
Current fair values and 30,000 30,000cr
carrying amounts of
Star’s net assets

After we have been introduced to how the investment account be affected with passage of time
as a result of events of the Investee and facts that prevail on the date of business combination, we
show what must be done to facilitate the consolidation. The first step to be done is preparing
the elimination entries.
In our Illustration, the investor, Palm Corporation's use of the equity method of accounting for
its Investment in Starr Company results in a balance in the Investment account that is a mixture
of two components:
1) The carrying amount of Starr's identifiable net assets, and
7
 2) The excess on the date of business combination of the current fair values of the
subsidiary's net assets (including goodwill) over their carrying amounts, net of
depreciation and amortization.

Developing the Elimination Journal Entries:

The working paper eliminations are as follows:
A. Removing Subsidiary’ Equity Account and Increase in Assets
Common stock–Starr Company...................................200,00
0
Add paid in capital–Starr Company............................. 58,00
0
Retained Earnings–Starr Company..............................132,00
0
Inter-company Investment Income.............................. 30,00
0
Plant asset, net–Starr Company................................... 61,00
0
Patent (net)–Starr Company......................................... 4,00
0
Goodwill (net)–Starr Company.................................... 15,00
0
COGS–Starr Company................................................. 25,00
0
Operating Expenses–Starr Company........................... 5,00
0
Investment in Starr Company....................... 506,000
Dividends–Starr Company........................... 24,000

Working Paper for Consolidated Financial Statements

We continue to apply the equity method to illustrate the preparation of consolidated financial
statements using a working paper. The working paper follows the discussion of the components
and their computation. We start with the balance sheet of a year ago that we used form Palm
Corporation and Starr Company. The intercompany receivable and payable is the Br. 24,000
dividend payable by Starr to Palm on December 31, 2006. (The advances by Palm to Starr that
were outstanding on December 31, 2005, were repaid by Starr on January 2, 2006.). The
following aspects of the working paper for consolidated financial statements of Palm
Corporation and subsidiary should be emphasized:
1. The intercompany receivable and payable, placed in adjacent columns on the same line, are
offset without a formal elimination.
2. The elimination cancels all intercompany transactions and balances not dealt with by the
offset described in above.
3. The elimination cancels the subsidiary's retained earnings balance at the beginning of the
year (the date of the business combination), so that each of the three basic financial
statements may be consolidated in turn. (All financial statements of a parent company and a
subsidiary are consolidated for accounting periods subsequent to the business combination.)

8
4. The first-in, first-out method is used by Starr Company to account for inventories; thus, the
Br. 25,000 difference attributable to Starr's beginning inventories is allocated to cost of
goods sold for the year ended December 31, 2006.
5. Income tax effects are ignored in the process.
6. One of the effects of the elimination is to reduce the differences between the current fair
values and the carrying amounts of the subsidiary's net assets, except land and goodwill, on
the business combination date. The effect of the reduction is as follows:

Total difference on date of business combination (Dec. 31, 2005) Br. 110,000
Less: Reduction in elimination (a) (Br. 29,000 + Br. 1,000) 30,000
Unamortized difference, Dec, 31, 2006 (Br. 61,000 + Br. 4,000 + Br. 15,000) Br. 80,000

The joint effect of Palm Corporation's use of the equity method of accounting and the
annual elimination will be to extinguish Br. 50,000 of the Br. 80,000 difference above
through Palm's Investment in Starr Company Common Stock ledger account. Remember
that the Br. 15,000 balance applicable to Starr's land will not be extinguished; the Br.15,000
balance applicable to Starr's goodwill will be reduced only if the goodwill in         subsequently
impaired
7. 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
8. The equalities exist when the equity method of accounting is used and intercompany profits
and sales are ignored. Despite the equalities indicated above, consolidated financial
statements are superior to parent company financial statements for the presentation of
financial position and operating results of parent and subsidiary companies. The effect of the
consolidation process for Palm Corporation and subsidiary is to reclassify Palm's
Br.30,000 share of its subsidiary's adjusted net income to the revenue and expense
components of that net income. Similarly, Palm's Br. 506,000 investment in the subsidiary
is replaced by the assets and liabilities comprising the subsidiary's net assets.
9. Purchase accounting theory requires the exclusion from consolidated retained earnings of a
subsidiary's retained earnings on the date of a business combination. Palm Corporation's use
of the equity method of accounting meets this requirement. Palm's ending retained earnings
amount in the working paper, which is equal to consolidated retained earnings, includes only
Palm's Br. 30,000 share of the subsidiary's adjusted net income for the year ended December
31, 2006, the first year of the parent- subsidiary relationship.

9
 PALM CORPORATION AND SUBSIDIARY
Working Paper for Consolidated Financial Statements
For Year Ended December 31, 2006
Elimination
Palm Starr Increase
Corporation Company (Decrease) Consolidated
Income Statement
Revenue:
Net sales 1,100,000 680,000 ---- 1,780,000
Inter-company Investment Income 30,000 (a) (30,000) ----
Total revenue 1,130,000 680,000 (30,000) 1,780,000
Costs and expenses:
Cost of Goods sold 700,000 450,000 (a) 30,000 1,180,000
Operating expenses 217,667 130,000 347,667
Interest expense ---- 49,000 ---- 49,000
Income taxes expense 53,333
Total costs and exp 1, 020,000 620,000 30,000* 1,670,000
Net income 110,000 60,000 (60,000) 110,000

Statement of Retained Earnings

Beginning Retained earnings 134,000 132,000 (a) 134,000

(132,000)
Net Income 110,000 60,000 (60,000) 110,000
Sub total 244,000 192,000 (192,000) 244,000
Dividends declared 30,000 24,000 (a) 30,000
(24,000)**
Ending Retained earnings 214,000 168,000 (168,000) 214,000

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 Starr Co. Common Stock 506,000 ---- (a) ----
(506,000)
Plant assets (net) 440,000 340,000 (a) 61,000 841,000
Patent (net) 16,000 (a) 4,000 20,000
Goodwill (a) 15,000 15,000
Total assets 1,209,900 650,100 (426,000) 1,434,000

Liabilities and Stockholder’s Equity

Income taxes payable 40,000 20,000 ---- 60,000
Other liabilities 190,900 204,100 ---- 395,000
Common stock, Br. 10 par 400,000 400,000
Common stock, Br. 5 par 200,000 (a) (200,000)
Additional Paid-in Capital 365,000 58,000 (a) (58,000) 365,000
Retained earnings 214,000 168,000 (168,000) 214 000
Total Liabilities and Stockholders’ Equity 1,209,900 650,100 (426,000) 1,434,000

* an increase in total costs and expenses and a decrease in net income

**a decrease in dividends and an increase in retained earnings

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The above working paper is a tool to facilitating the preparation of consolidated financial
statements. The consolidated income statement, statement of retained earnings, and balance sheet
of Palm Corporation and subsidiary for the year ended December 31, 2006, are as follow. The
amounts in the consolidated financial statements are taken from the consolidated column of the
above working paper.

PALM CORPORATION AND SUBSIDIARY

Consolidated Income Statement
For Year Ended December 31, 2006
Net sales ……………………………………….................. Br.
Costs and expenses: 1,780,000
Cost of goods sold……………………………………….. Br. 1, 180,000
Operating expenses ……………………………………... 347,667
Interest expense …………………………………………. 49,000
Income taxes expense……………………………………. 93,333
Total costs and expenses ……………………………. 1,670,000
Net income ………………………………………………… Br. 110,000

Basic Earnings per share of common stock (40,000 shares

outstanding) Br. 2.75

PALM CORPORATION AND SUBSIDIARY

Consolidated Statement of Retained Earnings
For Year Ended December 31, 2006
Retained earnings, beginning of year Br. 134,000
Add: Net income 110,000
Subtotal Br. 244,000
Less: Dividends (Br. 0.75 a share) 30,000
Retained earnings, end of year Br. 214,000
PALM CORPORATION AND SUBSIDIARY
Consolidated Balance Sheet
December 31, 2006

Assets
Current assets:
Cash Br. 88,000
Inventories 251,000
Other 219,000
Total current assets Br. 558,000
Plant assets (net) 841,000
Intangible assets:
Patent (net) Br. 20,000
Goodwill 15,000 35,000
Total assets Br. 1,434,000

Liabilities and Stockholders' Equity

Liabilities:
Income taxes payable Br. 60,000

11
 Other current liabilities 395,000
Total liabilities Br. 455,000
Stockholders' equity:
Common stock, Br. 10 par Br. 400,000
Additional paid-in capital 365,000
Retained earnings 214,000 979,000
Total liabilities and stockholders' equity Br. 1,434,000

CLOSING ENTRIES:
After consolidated financial statements have been completed, both the parent company and its
subsidiaries prepare closing entries and post to ledger accounts, to complete the accounting cycle
for the year. The subsidiary’s closing entries are prepared in the usual fashion. However, the
parent company’s use of equity method of accounting necessitates specialized closing entries.
The equity method of accounting disregards legal form in favor of economic substance.
However, state corporation laws generally require separate accounting for retained earnings
available for dividends to stockholders.
For the Parent Company (Palm Corporation), the December 31, 2003 closing entries under the
Equity method of accounting for purchased subsidiary are as follows:
To close revenue accounts:
Net Sales................................................................................1,100,00
0
Investment Income from subsidairy........................... 30,00
0
Income Summary....................................................... 1,130,000

To close expense accounts:

Income Summary...................................................................
1,020,000
Cost of Goods Sold..................................................... 700,000
Operating Expenses..................................................... 217,667
Interest Expense.......................................................... 49,000
Income Tax Expense................................................... 53,333
To close income summary accounts; to transfer net income legally available for dividends to
retained earnings; and to segregate 100% share of adjusted net income of subsidiary not
distributed as dividends by the subsidiary:
Income Summary..................................................................................
109,00
0
Retained Earnings of Subsidiary (29,000 – 24,000)................. 5,000
Retained Earnings (109,000- 5,000)......................................... 104,000
To close dividends declared accounts:
Retained Earnings 30,000
Dividend 30,000

12
Accounting for Operating Results of partially Owned purchased Subsidiaries
Subsequent to Date of Business Combination
This requires computation of the minority interest in net income or net loss of the subsidiary.
Under the parent concept of the consolidated financial statements, the consolidated income
statement of a parent company and its partially owned subsidiary includes an expense: minority
interest in net income (loss) of subsidiary. In the consolidated balance sheet, the minority
interest in net assets of subsidiary is displayed among liabilities.

Illustration of Equity method for partially owned purchases subsidiary for first year after
Business Combination (Continuing with Post-Sage company relationship)
Example 5.6: Assume that on December 5, 2004 Sage Company declared dividend of Br 1 per
Share Payable on December 19, 2004 and net income of Sage for the year was Br 90,000.
Sage records the following journal entries.
December 5, 2004: To record declaration of dividend payable
Dividends Declared (40,000 @ 1)........................................................40,000
Dividends Payable (Br 40,000 @ 0.05).................................... 2,000
Intercompany Dividends Payable (40,000 @ 0, 95)................. 38,000
December 19, 2004: To record payment of dividend declared
Dividends Payable................................................................................ 2,00
0
Intercompany Dividends Payable.........................................................38,00
0
Cash................................................................................... 40,000
...........................................................................................
Post Corporation record the following journal entries for 2004, under the equity method in
relation with subsidiary
1. December 5, 2004: to record dividend declared by Sage Company for proportionate
Share of Dividend
Intercompany Dividend Receivable......................................................38,000
Investment in Sage Company.......................................... 38,000

2. December 19, 2004: To record receipt of dividend from Sage Company

Cash.......................................................................................................38,000
Intercompany Dividend Receivable................................. 38,000
(Proportionate Share of Dividend)

3. December 31, 2004:

Investment in Sage Company................................................................ 85,50
0
Intercompany Investment Income (95% @ 90,000 =85,500)..... 85,500
To record 95% of net income of sage company for the year ended dec.31, 2004 Adjustment of
purchased Subsidiary’s net income. Assume the following CFV and carrying values:
Excess Dec.31,

13
 Cost Expens Balance
e
Inventories (FIFO) ..................................... 26,000 (26,000) ─
Plant Assets, net:
Land...................................................... 60,000 ─ 60,000
...............................................................
Building (20 Years)............................... 80,000 (4,000) 76,000
...............................................................
Machinery (5 Years)............................. 50,000 (10,000) 40,000
Leasehold (6Years)............................... 30,000 (5,000) 25,000
Total............................................................ 246,000 (45,000) 201,000
Plant Assets, net (December 31, 2003) = 60,000 + 80,000 + 50,000 = 190,000
Plant Assets, net (December 31, 2004) = 60,000 + 76,000 + 40,000 = 176,000

4. Post Corporation prepares the following additional entry to record the amortization of excess
cost:
Intercompany Investment Income (95% @ 45,000)............................. 42,750
...............................................................................................................
...............................................................................................................
Investment in Sage Company Common Stock......................... 42,750

The Investment in Sage Company

Investment in Sage Company
1,192,250 38,000 Dividend
85,500 42,750 Amortization of Excess Cost

1,197,000

Note: Goodwill in a business combination involving a partially owned subsidiary is attributable

to the parent company in a partially owned subsidiary rather than the subsidiary. Consequently,
amortization of goodwill is debited to the amortization Expense ledger account of the parent
company.

Developing the Elimination Entries

 Post Corporation uses the equity method of accounting for its investment in Sage
Company results in balance the Investment ledger account that is a mixture of three
components.
i. The carrying amount of Sage's identifiable net assets
ii. the "current fair value excess or Excess Cost over CFV: which is attributable to
Sage's identifiable assets: and
iii. the goodwill acquired by post in the business combination with Sage

A. The Eliminations column of the working paper is presented below:

Common Stock –Sage Company...................................................400,000
Add paid in capital – Sage Company.............................................235,000
Retained Earning – Sage Company...............................................334,000
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 Investment Income from the Subsidiary........................................42,750
Plant Assets (net) – Sage Company...............................................176,000
Leasehold – Sage Company...........................................................25,000
Goodwill – Sage Company............................................................ 38,000
CGS – Sage Company....................................................................26,000
Operating Expenses- Sage Company.............................................19,000
Investment in Sage Company......................................... 1,197,000
Dividends – Sage Company........................................... 40,000
Minority Interest in Net Asses of the sub....................... 58,750
* Minority interest in dividend declared by the subsidiary Br 40,000 @ 0.05 = Br 2000. Thus the
Minority Interest in Net Assets of the Subsidiary would be 60,750 – 2000 = Br58,750.
**For year 2004 depreciation and amortization on differences between CFVs and carrying
amounts of Sage’s net assets are as follows:
Operating
B. COGS
Expenses
Inventories Sold...................................................... 26,000
Building Depreciation............................................. 4,000
Machinery Depreciation.......................................... 10,000
Leasehold Amortization.......................................... 5,000
Total........................................................................ 26,000 19,000
Minority Interest in Net Income and Net Assets
Minority Interest in Net Income of Subsidiary..................................... 2,250
Minority Interest in Net Assets of Subsidiary..................... 2,250
Minority interest in subsidiary's adjusted net income for year 2000 is computed as
follows:
Net Income of Subsidiary .......................................................................Br 90,000
Net reduction of elimination (A) (43,000 + 2000)................................... (45,000)
Adjusted Net Income of subsidiary.......................................................... 45,000
Minority Interest in Adjusted Income (45,000 x 0.05)............................ (2,250)

Post Corporation and Subsidiary

Working paper for consolidated Financial statements
For year Ended Dec.31,2004
Post
Corporatio Sage Elimination Consolidated
  n Company
Income Statement      
Revenue:      
1,089,00
Net Sales...................................................................
5,611,000 0   6,700,000
Intercompany Investment Income............................. 42,750   a (42,750)  
1,089,00
Total Revenue..........................................................
5,653,750 0 (42,750) 6,700,000
Cost of goods sold.....................................................
3,925,000 700,000 a 26,000 4,651,000
Operating expenses...................................................
556,000 129,000 a 19,000 704,000

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 Interest and income tax expense...............................
710,000 170,000 880,000
Minority Interest in the net income of Sub................................ b 2,250 2,250
Total costs and Expenses........................................ 5,191,000 999,000 *47,250 6,237,250
Net income................................................................
462,750 90,000 (90,000) 462,750
Statement of Retained Earrings 
Retained Earnings Jan.1.2004................................... 1,050,000 334,000 a (334,000) 1,050,000
Net income for the year............................................. 462,750 90,000 (90,000) 462,750
Subtotal..............................................................1,512,750 424,000 (424,000) 1,512,750
Dividend Declared..................................................... 158,550 40,000 **a ( 40,000) 158,550
Retained Earnings end of year.................................. 1,354,200 384,000 (384,000) 1,354,200
Balance Sheet
Assets:
Inventories.................................................................
861,000 439,000   1,300,000
Other Current Assets................................................. 639,000 371,000 1,010,000
Investment in Sage Company CS............................. 1,197,000   a (1,197,000)  
1,150,00
Plant asset( net).........................................................
3,600,000 0 a 176,000 4,926,000
Leasehold(net)........................................................... a 25,000 25,000
Goodwill ( net)..........................................................
95,000   a 38,000 133,000
1,960,00
Total Asset.................................................................
6,392,000 (958,000) 0
7,394,000
Liability and SHE:      
Liabilities.................................................... 2,420,550 941,000   3,361,550
Minority Interest in the Net Asset a 58,750
Subsidiary.................................................................. b 2,250 61,000
Common stock Br 1 par............................................ 1,057,000     1,057,000
Common stock Br 10 par.......................................... 400,000 a (400,000)  
Additional paid-in capital..........................................
1,560,250 235,000 a (235,000) 1,560,250
Retained Earnings.....................................................
1,354,200 384,000 (384,000) 1,354,200
1,960,00
Total Liability & SHE...............................................
6,392,000 0 (958,000) 7,394,000
* An increase in total costs and expenses and a decrease in net income ** A decrease in
dividends and an increase in retained earnings

Consolidated Financial statements

The consolidated income statement, statement of retained earnings and balance sheet of Post
Corporation and subsidiary for the year ended Dec.31, 2004 are shown below:
 Income Statement
Post Corporation and Subsidiary Sage Company
Consolidated Income statement
For the year ended December 31, 2004
Net Sales ............................................................................................... Br 6,700,000
Costs and Expenses:
Cost of Goods Sold............................................................................... 4,651,000
Operating Expense................................................................................ 704,000
Interest and Income Tax Expense......................................................... 880,000

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 Minority Interest in Net Income of The Subsidiary.............................. 2,250
Total Costs and Expenses...................................................................... (6,237,250)
Net Income............................................................................................ Br462,750
Earning per share of common stock (462,750 / 1,057,000 shares) Br 0.44
 Retained Earning Statement
Post Corporation and Subsidiary Sage Company
Consolidated Retained Earning Statement
For year ended Dec.31 2004
Retained earnings, beginning of the year..................................................................... Br 1,050,000
Add: Net income.......................................................................................................... 462,750
Subtotal......................................................................................................................... 1,512,750
Less: Dividends (Br 0.15 a share)................................................................................ (158,550)
Retained Earnings, Ending of the Year........................................................................ 1,354,200
 Balance Sheet
Post Corporation and Subsidiary Sage Company
Consolidated Balance Sheet
For year ended Dec.31, 2004
Assets:
Inventories............................................................................................... 1,300,000
Other Assets............................................................................................ 1,010,000
Plant Assets, net....................................................................................... 4,926,000
Leasehold, net.......................................................................................... 25,000
Goodwill, net........................................................................................... 133,000
Total assets.............................................................................................. 7,394,000
Liabilities and Stockholders' Equity:
Liabilities:
Liabilities Other Than Minority Interest.................................................. 3,361,550
Minority interest in net assets of subsidiary............................................. 61,000
Stockholders' Equity:
Common stock, Br 1par........................................................................... 1,057,000
Additional Paid In Capital....................................................................... 1,560,250
Retained Earnings.................................................................................... 1,354,200
Total liabilities and stockholders' equity.................................................. 7,394,000

CLOSING ENTRIES:
Parent's Dec.31 2004 closing entries under the Equity method of accounting for purchased
subsidiary are as follows:
To close revenue accounts
Net Sales................................................................................ 5,611,000
Intercompany investment income.......................................... 42,750
Income summary................................................... 5,653,750
To close expense accounts:
Income Summary................................................................... 5,191,000
Cost of Goods Sold................................................ 3,925,000
Operating Expenses 556,000
Interest and Income tax expense............................ 710,000

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To close income summary accounts; 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:
Income Summary............................................................................ 462,75
0
Retained Earnings of Subsidiary (42,750 – 38,000)....... 4,750
........................................................................................
Retained Earnings (462,750 – 4,750)............................. 458,000
To close dividends declared accounts:
Retained Earnings.................................................................. 158,550
Dividend Declared................................................. 158,550

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