Page 575 - Accounting Principles (A Business Perspective)

14. Stock investments

Notes payable 15,000 5,000 (4) 5,000 15,000
Common stock 250,000 100,000 (3) 100,000 250,000
Retained earnings 75,000 18,000 75,000*
359,000 125,000 154,000 154,000 361,600*

*Totals are determined vertically, not horizontally
Exhibit 113: Consolidated work sheet one year after acquisition

Entry 2: When S Company paid its cash dividend, P Company debited Cash and credited the investment
account for USD 8,000 (the second December 31 journal entry). Entry 2 restores the investment account to its
balance before the dividends from S Company were deducted. That is, P Company debits its investment account
and credits S Company's dividends account for USD 8,000. On a consolidated basis, a company cannot pay a
dividend to itself.
Entry 3: Entry 3 eliminates the original investment account balance (USD 121,000) and the subsidiary's
stockholders' equity accounts as of the date of acquisition (retained earnings of USD 6,000 and common stock of

USD 100,000). The entry also establishes goodwill of USD 11,000 and increases land by USD 4,000 to account for
the excess of acquisition cost over book value.
Entry 4: Entry 4 eliminates the intercompany debt of USD 5,000.
After the first three entries have been made, the investment account contains a zero balance from the viewpoint
of the consolidated entity.
After making the eliminations, P Company combines the corresponding amounts and places them in the
Consolidated Amounts column. Notice that certain totals in the first two columns do not add across to the total in
the Consolidated Amounts column. For instance, consolidated net income is USD 31,000, not USD 31,000 plus
USD 20,000. The firm carries the net income row in the Income Statement section forward to the net income row

in the Statement of Retained Earnings section. Likewise, it carries the ending retained earnings row in the
Statement of Retained Earnings section forward to the retained earnings row in the Balance Sheet section. P
Company uses the final work sheet column to prepare the consolidated income statement (Exhibit 114), the
consolidated statement of retained earnings (Exhibit 115), and the consolidated balance sheet (Exhibit 116).

Uses and limitations of consolidated statements
Consolidated financial statements are of primary importance to stockholders, managers, and directors of the
parent company. The parent company benefits from the income and other financial strengths of the subsidiary.
Likewise, the parent company suffers from a subsidiary's losses and other financial weaknesses.
Consolidated financial statements are of limited use to the creditors and minority stockholders of the subsidiary.
The subsidiary's creditors have a claim against the subsidiary alone; they cannot look to the parent company for

payment. Minority stockholders in the subsidiary do not benefit or suffer from the parent company's operations.
These minority stockholders benefit from the subsidiary's income and financial strengths; they suffer from the
subsidiary's losses and financial weaknesses. Thus, the subsidiary's creditors and minority stockholders are more
interested in the subsidiary's individual financial statements than in the consolidated statements. Because of these
factors, annual reports always include the financial statements of the consolidated entity, and sometimes include
the financial statements of certain subsidiary companies alone, but never include the parent company's financial
statements alone.

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