Chapter 9, Problem 9.10Q

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 is found mostly in the treasury stock method. Under the treasury stock method, the acquisition of the parent’s stock by the subsidiary is treated as treasury stock, similar to that as if the parent holds its own stock in the treasury after it repurchased its own stock. This investment by a subsidiary in parent stock is recognized using the cost method because of the size of the investment is usually very small and not capable of influencing parental ownership significantly.

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.