Page 571 - Accounting Principles (A Business Perspective)

14. Stock investments

Accounting for income, losses, and dividends of a subsidiary

When a subsidiary is operating profitably, its net assets and retained earnings increase. The subsidiary pays
dividends to both the parent company and minority stockholders. The subsidiary records all transactions in its
accounting records in a normal manner.
As noted earlier, two different methods used by an investor to account for investments in common stock are the
cost and equity methods. A parent company may use either the cost or equity method of accounting for its
investment in a consolidated subsidiary. This choice is allowed because the investment account is eliminated during

the consolidation process; therefore, the results are identical after consolidation. To illustrate the consolidation
process at a date after acquisition, we assume the parent company uses the equity method.
P Company and Subsidiary S Company
Work Sheet for consolidated balance sheet
2010 January 1 (date of acquisition)
P S Eliminations Consolidated
Assets Company Company Debit Credit Amounts
Cash 42,000 12,000 54,000
Notes receivable 5,000 (2)
5,000
Accounts receivable, 24,000 15,000 39,000
net
Merchandise inventory 35,000 30,000 65,000
Investment in S 90,000 (1)
Company 90,000
Equipment, net 41,000 15,000 56,000
Building, net 65,000 35,000 100,000
Land 20,000 10,000 30,000
Goodwill (1) 5,200 5,200
322,000 117,000 349,200
Liabilities and
stockholders' equity
Accounts payable 18,000 6,000 24,000
Notes payable 5,000 (2) 5,000
Common stock 250,000 100,000 (1) 100,000
Paid-in capital excess
Of par value- common 4,000 (1) 4,000 -0-
Retained earnings 54,000 2,000 (1) 2,000 54,000
Minority interest (1) 21,200
21,200
322,000 117,000 116,200 116,200349,200
Exhibit 111: Consolidated balance sheet work sheet (80 per cent of stock acquired at more than book value)
Consolidated financial statements at a date after acquisition
Under the equity method, the investment account on the parent company's books increases and decreases as the
parent records its share of the income, losses, and dividends reported by the subsidiary. Thus, the balance in the

investment account differs after acquisition from its balance on the date of acquisition. Consequently, the amounts
eliminated on the consolidated statements work sheet differ from year to year. As an illustration, assume the
following facts:
• P Company acquired 100 per cent of the outstanding voting common stock of S Company on 2010 January
1. P Company paid USD 121,000 for stockholders' equity totaling USD 106,000. The excess of cost over book
value is attributable to (a) an undervaluation of land amounting to USD 4,000 and (b) the remainder to S
Company's above-average earnings prospects.

• During 2010, S Company earned USD 20,000 from operations.
• On 2010 December 31, S Company paid a cash dividend of USD 8,000.

572