Appendix 3A. The Cost Method

Transcription

1 Appendix 3A The Cost Method 1

2 2 APPENDIX 3A THE COST METHOD When the parent uses the cost method of accounting, a third consolidation entry (in addition to the basic elimination entry and the intercompany dividend elimination entry that were explained in Chapter 2) is needed. This additional entry establishes the proper amounts in the Consolidated column for the NCI; it also prevents dividends paid to the NCI from being summed with the parent s dividends in the statement of retained earnings. To illustrate, we assume that (1) Subbco was created on December 31, 2005, (2) the parent (Parrco) invested $45,000 cash for a 75% equity interest, (3) outside investors invested $15,000 cash for a 25% equity interest, and (4) Subbco issued no-par common stock (thus the Additional Paid-in Capital account is not needed). We also assume that Subbco subsequently reported the following items for 2006 and 2007: Net Income Dividends Declared $24,000 $ 4, ,000 12,000 The three entries required in consolidation at December 31, 2006, and December 31, 2007 (under the cost method), follow: 1. The basic elimination entry: Common Stock ,000 45,000 Investment in Subsidiary ,000 45, The intercompany dividend elimination entry: Dividend income (from subsidiary) ,000 9,000 Dividends Declared ,000 9, The NCI display entry (all amounts are at 25% of Subbco s accounts): Common Stock ,000 15,000 Retained Earnings, 1/1/06 and 1/1/ ,000 NCI in Net Income ,000 8,000 Dividends Declared ,000 3,000 NCI in Net Assets ,000 25,000 Illustration 3A-1 shows a consolidation worksheet at December 31, 2007, using the related three consolidation entries at this date.

3 APPENDIX 3A THE COST METHOD 3 ILLUSTRATION 3A-1 THE COST METHOD: SECOND YEAR SUBSEQUENT TO DATE OF CREATION Parrco and Subbco Consolidation Worksheet as of December 31, %-OWNED CONSOLIDATION ENTRIES PARRCO SUBBCO DR. CR. CONSOLIDATED Income Statement (2007) Sales , , ,000 Cost of sales (390,000) (130,000) (520,000) Expenses (210,000) (120,000) (330,000) Dividend income (from Subbco)... 9,000 9, Net Income ,000 32,000 9, ,000 a NCI in net income ,000 3 (8,000) CI in net income , ,000 Statement of Retained Earnings b Balances, 1/1/ ,000 20,000 5, ,000 + Net income ,000 32,000 17, ,000 Dividends declared (85,000) (12,000) 2 9,000 (85,000) 3 3,000 } Balances, 12/31/ ,000 40,000 22,000 12, ,000 Balance Sheet Cash ,000 31, ,000 Accounts receivable ,000 43, ,000 Inventory ,000 82, ,000 Investment in Subbco , ,000 0 Land ,000 30, ,000 Buildings and equipment , , ,000 Accumulated depreciation (360,000) (26,000) (386,000) Total Assets , ,000 45, ,000 Liabilities , , ,000 NCI in net assets ,000 25,000 c Common stock ($1 par) ,000 10,000 Add l paid-in capital , ,000 Common stock (no-par) ,000 45, ,000 3 } Retained earnings ,000 40,000 22,000 12, ,000 Total Liabilities and Equity , ,000 82,000 37, ,000 Proof of debit and credit postings.. 82,000 82,000 a b c Recall that the consolidated net income is $142,000 under the economic unit concept. Recall that the consolidated statement of retained earnings includes only amounts that accrue to the controlling interest. This amount is reported (1) outside stockholders equity under the parent company concept and (2) inside stockholders equity under the economic unit concept. Explanation of entries: 1 The basic elimination entry. 2 The intercompany dividend elimination entry. 3 The NCI display entry. Review Points for Illustration 3A-1. Note the following: 1. The $25,000 reported for NCI in Subbco s net assets at year-end can be proven by multiplying Subbco s total stockholders equity of $100,000 by the NCI ownership percentage ($100,000 25% = $25,000).

4 4 APPENDIX 3A THE COST METHOD 2. If Parrco were required to furnish a consolidated statement of changes in stockholders equity (a GAAP requirement for publicly owned entities), it would appear as follows: Consolidated Statement of Changes in Stockholders Equity Non- Controlling Interest Total controlling Common Add l Retained Stockholders Interest a + Stock + PIC + Earnings = Equity Balances, 1/1/ $20,000 $10,000 $190,000 $117,000 $337,000 + Net income , , ,000 Dividends (3,000) (85,000) (88,000) Balances, 12/31/ $25,000 $10,000 $190,000 $166,000 $391,000 a This column appears only under the economic unit concept. 3. The $3,000 of dividends paid to the NCI was eliminated in consolidation so that it would not be summed with dividends paid by the parent just as dividends paid by a subsidiary to its parent are also not reported as dividends in the consolidated statement of retained earnings (as illustrated in Chapter 2). (Note that this $3,000 of dividends is reported in the noncontrolling interest column in the statement in Review Point 2 not in the retained earnings column.) EXERCISES FOR APPENDIX 3A E 3A-1 Partially Owned Subsidiaries: Consolidation Entries Use the information in Exercise 3-2 but assume that the parent uses the cost method. Required Prepare the consolidation entries required at 12/31/06. E 3A-2 Partially Owned Subsidiaries: Working in Reverse A parent company of a 60%-owned subsidiary uses the cost method. At the end of 2006, the parent made the following consolidation entry, among others: The NCI display entry: Common Stock ,000 Additional Paid-in Capital ,000 Retained Earnings, 1/1/ ,000 NCI in Net Income ,000 Dividends Declared ,000 NCI in Net Assets ,000 The parent also declared and paid dividends of $800,000 in Required What is the amount for each of the following items? a. The subsidiary s retained earnings balance at 12/31/06. b. The subsidiary s total equity at 12/31/06. c. The parent s year-end investment balance under the cost method. d. Optional: The parent s year-end investment balance under the equity method. e. The dividends declared by the subsidiary in f. The amount reported for dividends declared in the 2006 consolidated statement of retained earnings.

5 APPENDIX 3A THE COST METHOD 5 PROBLEMS FOR APPENDIX 3A P 3A-1 Consolidation Worksheet: Cost Method Use the information in Problem 3-1, but assume that the parent uses the cost method. Required 1. Prepare all consolidation entries as of 12/31/ Prepare a consolidation worksheet at 12/31/06. P 3A-2 Consolidation Worksheet: Cost Method Use the information in Problem 3-2 but assume that the parent uses the cost method. Required 1. Prepare all consolidation entries as of 12/31/ Prepare a consolidation worksheet at 12/31/06.