Chapter 3, Problem 56P

a.

To determine

Explain how the parent company's pre-consolidation Investment Income for the

 year ended December 312019 is assessed.

Explanation of Solution

Equity income is money generated from stock dividends that investors can access by buying dividend-declared stocks or by buying funds that invest in dividend-declared stocks.

Investment income is revenue derived from interest payments, dividends, capital gains collected when a security or other resources are sold, and any other profits made through any kind of investment fund. Individuals usually earn most of their total net income annually through regular wage income. Under the cost method, parent’s company reported investment income for the year ended December 312019 is equal to the dividends of the subsidiary under the cost method. Hence, the parent company's reported Investment Income for the year ended December 31, 2019 is $\$50,000$

b.

To determine

Explain how the parent company's reported Equity Investment balance as of December 31 2019 is assessed.

Explanation of Solution

An investment in equity is money which is invested in a company by buying that company's shares in the stock market. Typically, those shares are traded in a stock exchange. Under the cost method, that is the subsidiary's original purchase price. Hence, the parent company's reported Equity Investment balance as of December 312019 is $\$1,760,000$

c.

To determine

Assess the retained earnings balance of the subsidiary as of the date of acquisition.

Explanation of Solution

Retained earnings (RE) is the part of the profit left over to the business after its shareholders have paid out dividends.

The computations to yield the retained earnings balance of the subsidiary as of the date of acquisition are as follows:

Particulars	Amount ($)
Investment balance (cost)	$\$1,760,000$
Less: AAP on acquisition date	$\$1,005,000$
Less: Common stock (S) on acquisition date	$\$110,000$
Less: APIC (S) on acquisition date	$\$140,000$
Retained earnings (S) on acquisition date	$\$505,000$

Table (1)

Working notes:

Equity Investment on the date of acquisition is $\$1,760,000$

AAP on the acquisition date is $\$1,005,000$

Common stock of subsidiary on the date of acquisition is $\$110,000$.

APIC of subsidiary on the date of acquisition is $\$140,000$.

Hence, the retained earnings balance of the subsidiary as of the date of acquisition is $\$505,000$

d.

To determine

Compute the Equity Investment balance at December 312019.

Explanation of Solution

An investment in equity is money which is invested in a company by buying that company's shares in the stock market. Typically, those shares are traded in a stock exchange.

Using the equity method, Equity Investment would be equivalent to the book value of the shareholders' equity of the subsidiary plus the unamortized AAP balance:

Particulars	Amount ($)
EOY Book value of subsidiary’s Stockholders’ Equity	$\$1,250,000$
EOY Unamortized balance of the AAP	$\$845,000$
EOY Equity Investment (Equity method)	$\$2,095,000$

Table (1)

Working notes:

Common stock of the subsidiary is $\$110,000$

APIC of the subsidiary is $\$140,000$

Retained Earnings of the subsidiary is $\$1,000,000$

AAP amortization on PPE (net) and patent is $\$40,000(\$15,000+\$25,000)$

EOY Unamortized balance of the AAP is $(\$1,005,000)-(\$40,000\times 3)=\$885,000$

Hence, EOY Equity Investment (Equity method) is $\$2,095,000$

e.

To determine

Prepare the [ADJ] entry necessary to bring Equity Investment from its current balance (using cost method) to the required balance on January 1, 2019 (using equity method).

Explanation of Solution

An investment in equity is money which is invested in a company by buying that company's shares in the stock market. Typically, those shares are traded in a stock exchange.

The consolidation journal entry [ADJ] increases the retained earnings of the parent's BOY to the balance which would have been reported if the parent used the equity method. The adjustment amount is equal to the change in the retained earnings of the subsidiary from the date of acquisition until the beginning of the consolidation year, adjusted for the cumulative AAP amortization that would have been recognized through the BOY.

Calculate the amount of adjustment:

[ADJ] is $(\$850,000-\$505,000)-(3\times \$40,000)=\$225,000$

The [ADJ] entry necessary to bring Equity Investment from its current balance (using cost method) to the required balance on January 1, 2019 (using equity method) is as follows:

Date	Accounting Explanation	Amount ($)	Amount ($)
	Equity Investment	$\$225,000$
	Retained Earnings (P)		$\$225,000$
	(to adjust the parent’s Retained Earnings to its proper balance under equity method)

Table (1)

f.

To determine

Prepare the consolidation entries for the year ended December 312019.

Explanation of Solution

Consolidated financial statements are a group of entities financial statements that are presented as those of a single economic entity. They are the financial statements of a group in which the parent company and its subsidiaries introduce their assets, liabilities, equity, revenue, expenses and cash flows as those of a single business organization.

Consolidated accounting is used to club a parent company's financial information and one or more subsidiaries. The parent prepares consolidated financial statements through adjustment of entries and elimination of transactions between companies.

The required consolidation journal entries are as follows:

Date	Account title and Explanation	Post Ref	Debit ($)	Credit ($)
	[C] Investment Income (P)		$\$50,000$
	Dividends (S)			$\$50,000$
	(To eliminate all changes in the Equity Investment account, leaving only beginning balance in the account. Note: no equity income since the parent uses the cost method.)
	[E]  BOY Common Stock (S)		$\$110,000$
	BOY APIC (S)		$\$140,000$
	BOY Retained Earnings (S)		$\$850,000$
	Equity Investment			$\$1,100,000$
	(To eliminate the portion of the investment account related to the book value of the subsidiary's stockholders' equity @ BOY)
	[A]  PPE, net (S) @ BOY		$\$135,000$
	Patent (S) @ BOY		$\$300,000$
	Goodwill (S) @ BOY		$\$450,000$
	Equity Investment (P) @ BOY			$\$885,000$
	(To assign the remaining Equity Investment account (i.e., unamortized BOY AAP) to appropriate asset & liability accounts)
	[D] Operating expenses		$\$40,000$
	PPE, net (S)			$\$15,000$
	Patent (S)			$\$25,000$
	(To record depreciation and amortization expense for the [A] assets)
	[I] No intercompany transactions

Table (1)

g.

To determine

Prepare the consolidation spreadsheet for the year ended December 31, 2019.

Explanation of Solution

Consolidated financial statements are a group of entities financial statements that are presented as those of a single economic entity. They are the financial statements of a group in which the parent company and its subsidiaries introduce their assets, liabilities, equity, revenue, expenses and cash flows as those of a single business organization.

A consolidated balance sheet provides a parent company's assets and liabilities and all of its subsidiaries in a legal document, without any differentiation on which items pertain to which companies.

Consolidation worksheet is an instrument used to prepare a parent's consolidated financial statements and their subsidiaries. It demonstrates the individual book values of companies, the adjustments and eliminations necessary, and the consolidated final values.

The consolidated spreadsheet for the year ended December 31, 2019 is shown below:

						Elimination entries
Income Statement		Parent		Subsidiary		Dr		Cr		Consolidated
Sales		7,500,000		1,600,000						9,100,000
Cost of goods sold		(5,400,000)		(950,000)						(6,350,000)
Gross Profit		2,100,000		650,000						2,750,000
Investment Income		50,000			[C]	50,000				0
Operating Expenses		(1,450,000)		(450,000)	[D]	40,000				(1,940,000)
Net Income		700,000		200,000						810,000
Statement of Retained Earnings
Beginning Retained Earnings		2,230,000		850,000	[E]	850,000	[ADJ]	225,000		2,455,000
Net Income		700,000		200,000						810,000
Dividends		(230,000)		(50,000)			[C]	50,000		(230,000)
Ending retained Earnings		2,700,000		1,000,000						3,035,000
Balance Sheet
Assets
Cash		$740,000		$420,000						$1,160,000
Accounts receivable		1,200,000		380,000						1,580,000
Inventory		1,900,000		490,000						2,390,000
Equity investment		1,760,000			[ADJ]	225,000	[E]	1,100,000		0
							[A]	885,000
PPE, net		4,000,000		910,000	[A]	135,000	[D]	15,000		5,030,000
Patent					[A]	300,000	[D]	25,000		275,000
Goodwill					[A]	450,000				450,000
		$9,600,000		$2,200,000						$10,885,000
Liabilities and Stockholder's Equity
Accounts payable		900,000		$140,000						1,040,000
Accrued liabilities		500,000		260,000						760,000
Long-term Liabilities		2,600,000		550,000						3,150,000
Common stock		700,000		110,000	[E]	110,000				700,000
APIC		2,200,000		140,000	[E]	140,000				2,200,000
Retained earnings		2,700,000		1,000,000						3,035,000
		$9,600,000		$2,200,000		$2,300,000		$2,300,000		$10,885,000