Chapter 10, Problem 10.14Q

To determine

Introduction:

Reciprocal ownership: A reciprocal relationship is when two companies hold stock in each other. It is rare in practice. The method of dealing with reciprocal relationships found mostly in the treasury stock method. Under the treasury stock method, when a parent’s stock is purchased by a subsidiary they are treated as treasury stock in the same way when the parent had repurchased its own stock. The accounting for same is done using the cost method because these are normally small investments and does not significantly influence parent.

To explain: The overstating of its income by parent company if no adjustment is made in case of a reciprocal ownership arrangement between two subsidiaries.