Question

Inferring consolidation entries from consolidated financial statements—Cost method
Assume a parent company acquired a subsidiary on January 1, 2012. The purchase price was $1,312,000 in excess of the subsidiary’s book value of Stockholders’ Equity on the acquisition date, and that excess was assigned to the following [A] assets:

[A] Asset	Original Amount	Original Useful Life
Property, plant and equipment (PPE), net	$300,000	20 years
Patent	432,000	12 years
Goodwill	580,000	Indefinite
	$1,312,000

The parent company uses the cost method of pre-consolidation Equity Investment bookkeeping. The Goodwill asset has been tested annually for impairment and has not been found to be impaired. Selected accounts from the parent, subsidiary, and consolidated financial statements for the year ended December 31, 2016, are as follows:

	Parent	Subsidiary	Consolidated
Income statement
Sales	$9,075,000	$2,000,000	11,075,000
Cost of goods sold	(6,534,000)	(1,188,000)	(7,722,000)
Gross profit	2,541,000	812,000	3,353,000
Investment income	60,800	-	-
Operating expenses	(1,361,280)	(514,800)	(1,927,080)
Net income	$1,240,520	$297,200	$1,425,920
Statement of retained earnings
BOY retained earnings	6,328,440	1,043,000	6,594,440
Net income	1,240,520	297,200	1,425,920
Dividends	(306,440)	(60,800)	(306,440)
Ending retained earnings	$7,262,520	$1,279,400	$7,713,920
Balance sheet
Assets
Cash	1,709,760	531,200	2,240,960
Accounts receivable	2,686,800	459,600	3,146,400
Inventory	3,520,200	589,800	4,110,000
Equity investment	2,182,000	-	-
Property, plant & equipment	12,752,640	1,091,400	14,069,040
Patent list			252,000
Goodwill	-	-	580,000
	$22,851,400	$2,672,000	$24,398,400
Liabilities and stockholders' equity	-	-
Accounts payable	1,328,640	188,760	1,517,400
Accrued liabilities	1,578,840	246,840	1,825,680
Long-term liabilities	5,550,000	660,000	6,210,000
Common stock	845,520	132,000	845,520
APIC	6,285,880	165,000	6,285,880
Retained earnings	7,262,520	1,279,400	7,713,920
	$22,851,400	$2,672,000	$24,398,400

a. For the year ended December 31, 2016, explain how the parent’s pre-consolidation investment income of $60,800 was determined.

Under the cost method, investment income equals the dividends received from the subsidiary.

Under the cost method, investment income equals equity income minus dividends received from the subsidiary.

Under the cost method, investment income equals equity income plus dividends received from the subsidiary.

b. Explain how the parent’s December 31, 2016 pre-consolidation Equity Investment balance of $2,182,000 was determined.

Under the cost method, it is the original purchase price plus dividends received by the subsidiary since acquisition.

Under the cost method, it is the original purchase price for the subsidiary.

Under the cost method, it is the original purchase price plus equity income and minus dividends received by the subsidiary since acquisition.

c. For the year ended December 31, 2016, reconcile the parent company’s pre-consolidation net income of $1,240,520 to the consolidated balance of $1,425,920.

Do not use negative signs with your answers.

Parent Income (cost method)
Deduct: p% of subsidiary dividends
p% of subsidiary net incomep% of AAP amortization for year
p% of subsidiary net incomep% of AAP amortization for year
Parent Income (equity method)

d. What was the subsidiary’s retained earnings balance on the acquisition date? You should assume the Common Stock and APIC have not changed since the acquisition date. (Hint: You will need to use an account that does not change after the acquisition date.)

$Answer

e. Why aren’t the Stockholders’ Equity accounts of the subsidiary reflected in the consolidated balance sheet?

The subsidiary’s stockholders’ equity is not held by a party outside of the economic entity represented in the consolidated financial statements and, as a result, should not be included in the consolidated stockholders’ equity.

The subsidiary’s stockholders’ equity is held by a party outside of the economic entity represented in the consolidated financial statements and, as a result, should not be included in the consolidated stockholders’ equity.

The subsidiary’s stockholders’ equity is held by a party outside of the economic entity represented in the consolidated financial statements and, as a result, is reflected in the Equity Investment account on the consolidated balance sheet rather than be included in the consolidated stockholders’ equity.

f. Provide the consolidation entries for the year ending December 31, 2016.

Consolidation Journal
	Description	Debit	Credit
[ADJ]	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
[C]	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
[E]	Common Stock
	APIC
	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
[A]	PPE, net
	Patent
	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
[D]	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
	BOY Retained Earnings - ParentBOY Retained Earnings - SubsidiaryDividendsEquity investmentGoodwillInvestment incomeOperating expensesPPE, net
	Patent

Answer 1

a. Under the cost method, investment income equals the dividends received from the subsidiary as this is the only amount thats received by holding company as income and no amount will be recorded as income for fair value changes.

b. it was given in the question that parent follows cost method,Under the cost method,investment in subsidary should be recorded at original purchase price for the subsidiary.

c.the following table gives reco between standalone income and consolidated net income

parent-Net income	1,240,520
subsidary- Net income	297,200
deduct:
adjustment for dividend	60,800
Amortisation of ppe @5% of costs	15,000
Amortisation of patent @8.33% of costs	36,000
parent income equity method	$1,425,920

d.the below table gives subsidaries retained earnings as on date of acquisition

Particulars	Amount
BOY retained earnings
Parent-a	6,328,440
Subsidiary-b	1,043,000
Consolidated-c	6,594,440
a+b-c	777,000
Add:Adjustment for
Amortisation of ppe @5% of costs for 5 years	75,000
Amortisation of patent @8.33% of costs for 5 years	180,000
opening retained earnings of subsidary	$1,032,000

e. The subsidiary’s stockholders’ equity is not held by a party outside of the economic entity represented in the consolidated financial statements and, as a result, should not be included in the consolidated stockholders’ equity.

f. entry for 2016 for Profit/ loss will be as follows

1.. Retained earnings 60800

Dividend income (60800)

2. Amortisation of PPE, PATENT 50100

ppe, patent (50100)