CHAPTER FIVE

Consolidation of Financial Statements under Purchase Accounting

5.1.Basic Concepts of Consolidated Financial Statements
Consolidated financial statements are the combined financial statements of a parent company and its subsidiaries.
Because consolidated financial statements present an aggregated look at the financial position of a parent and its
subsidiaries. Consolidated Financial Statements is prepared by the Parent by combining separate financial statements
of the parent and the subsidiary as the Parent Company is the Reporting Entity
Nature of consolidated financial statements
They are similar to the combined financial statements for a Home Office and its branches. Assets, liabilities,
revenue, and expenses of the parent company and its subsidiaries are totaled; inter-company transactions and
balances are eliminated; and the final consolidated amounts are reported in the balance sheet, income statements,
statement of stockholders’ equity, and statement of cash flows. However, the separate legal entity status of the parent
and subsidiary corporations necessitates eliminations that are generally more complex.
The Meaning of Controlling Interest
Traditionally, an investor’s direct or indirect ownership of more than 50% of an investee’s outstanding common
stock has been required to evidence the controlling interest underlying a parent-subsidiary relationship. However,
even though such a common stock ownership exists, other circumstances may cancel out the parent company’s
actual control of the subsidiary.
For Example:
1. Subsidiary in liquidation or reorganization in court and supervised by bankruptcy proceedings is not controlled
by its parent.
2. A foreign subsidiary in a country having severe production, monetary or income tax restrictions may be subject
to the authority of the foreign country rather than the parent company.
3. If minority shareholders of a subsidiary have the right to participate effectively in the financial and operating
activities of the subsidiary in the ordinary course of business, the subsidiary’s financial statements should not be
consolidated with those of the parent company.
Example of Controlling Interest
 Direct Controlling Interest = Father – Son Relationship
ABC Company 80% Inv’t KLM Company

 Indirect Controlling Interest = Father – Son – Grandson Relationship

Father and Son together control Grandson
ABC Company Over 80% XYZ Company

40% Inv’t
40% Investment
KLM Company

Father controls Son; Son controls Grandson

ABC Company 90% KLM Company 80% XYZ Company
Steps for Consolidation
1. Update the balances of accounts affected by business combination transaction
2. Record the financial information for both Parent and Subsidiary on the worksheet
3. Remove the Investment in Subsidiary balance
4. Remove the Subsidiary’s equity account balances
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 5. Remove Intercompany transactions (e.g. payables and receivables)
6. Adjust the Subsidiary’s net assets to CFV
7. Allocate any excess of cost over CFV to identifiable intangible assets or goodwill
8. Combine all account balances
5.2.Consolidation of Wholly Owned Subsidiary on the Date of Business Combination under Purchase
Accounting
Example 5.2: There is no question of control of a wholly owned subsidiary. Thus, as an illustration assume that on
December 31, 2008, PALM Corporation issued 10,000 shares of its 10 par common stock (current fair value Br45
a share) to shareholder of STARR Company for all the outstanding Br 5 par common stock of Starr. There was no
contingent consideration. Out of pocket costs of the business combination paid by Palm Corp on December 31,
2008 consisted of the following;
Finder’s fees and legal fees of the combination Br 60,000
Costs of issuing common stock 35,000
Total costs Br 95,000
Assume also that the combination qualified for purchase accounting. Starr Company was to continue its corporate
existence as a wholly owned subsidiary of Palm Corporation. Both companies had a December 31 fiscal year and
use the same accounting policies. Income tax rate for both companies was 40%. Financial statements of the two
companies as of December 31, 2008 prior to combination are presented below follow
Palm Corporation Starr Company
Income statement
Net sales Br 990,000 Br 600,000
Interest revenue 10,000 - 0-
Total Revenues 1,000,000 600,000
Cost & expenses:
Cost of goods sold 635,000 410,000
Operating expense 158,333 73,333
Interest expense 50,000 30,000
Income tax Expense 62,667 34,667
Total Costs and expenses (906,000) (548,000)
Net income 94,000 52,000
Statement of RES
Retained Earnings beginning of year 65,000 100,000
Add: Net income 94,000 52,000
Less: dividends (25,000) (20,000)
Retained Earnings ending of year 134,000 132,000
Balance sheet
Assets:
Cash Br100, 000 Br40,000
Inventories 150,000 110,000
Other current assets 110,000 70,000
Receivable from Starr Co 25,000
Plant asset (net) 450,000 300,000
Patent (net) -0- 20,000
Total 835,000 540,000
Liability and SHE:
Payable to Palm Corp 25,000
Income taxes payable 26,000 10, 000
Other liabilities 325,000 115,000
Common stock Br 10 par 300,000
Common stock for Br 5 par 200,000
Additional Paid in capital 50,000 58,000

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 Retained Earnings 134,000 132,000
Total liabilities and SHE 835,000 540,000
On Dec, 31, 2008 current fair values of Starr Company’s identifiable assets and liabilities were the same as their
carrying amount, except for the following 3 assets:
Fair Values:
Inventories Br 135,000
Plant assets (net) Br 365,000
Patent (net) Br 25,000
Because Starr was to continue as a separate corporation and generally accepted principles do not sanction write-ups
of assets of a going concern, Starr didn’t prepare journal entries for the combination. Palm Corporation recorded
the combination as a purchase on December 31, 2008 with the following journal entries.
1. Issuance of 10,000 common stocks to stockholders of Starr Company
Investment in Starr Company 450,000
Common Stock 100,000
Additional PIC – Common Stock 350, 000
2. Out of pocket costs
Investment in Starr Company 60,000
Additional PIC - CS 35,000
Cash 95,000
The above entries are the same as the entries for a statutory merger accounted for using Purchase Method but they
do not include any debit or credit, to record individual assets and liabilities of Starr Company in the records of Palm
Corporation. This is because the investee was not liquidated as in a merger; it remains a separate legal entity.
Preparation of Consolidated Balance Sheet;- Purchase accounting for the business combination of Palm
Corporation and Starr Company requires a fresh start for the consolidated entity. This reflects the theory that a
business combination that meets the requirement of purchase accounting is an acquisition of the combines’ net assets
(assets less liabilities) by the combinor.
1. The operating results of the two companies prior to combination are those of two separate economic- as well as
legal – entities. Accordingly, a consolidated balance sheet is the only consolidated financial statement issued by
the investor (Palm Corporation) on the date of the business combination. This can be done with the use of a
working paper.
2. The parent company’s investment account and the subsidiary’s stockholder’s equity accounts do not appear in
the consolidated Balance sheet because they are reciprocal or intercompany accounts.
3. Under purchase accounting theory, the parent company (combinor) assets and liabilities are reflected at carrying
amount and that of the subsidiary (the combinee’s) at current fair values except intercompany accounts, in the
consolidated balance sheet.
4. Goodwill is recognized to the extent the cost of the parent company’s investment in 100% of the subsidiary’s
outstanding common stock exceeds the current fair value of the subsidiary’s identifiable net assets.
Based on the foregoing data, the following consolidated Balance sheet is prepared
Palm Corporation and Subsidiary
Consolidated Balance Sheet
December 31, 2008
Assets:
Cash (5,000 + 40,000) 45,000
Inventories (150,000 + 135,000) 285,000
Others (110,000 + 70,000) 180,000
Plant assets (net) (450,000 + 365,000) 815,000
Patent (net) (0+25,000) 25,000
Good will 25,000
Total assets 1,375,000
Liabilities and Shareholders’ Equity:
Liabilities:
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 Income taxes payable (26,000 + 10,000) 36,000
Others (325,000 + 115,000) 440,000
Stock holder’s equity:
Common stock, Br 10 par 400,000
Additional Paid in capital 365,000
Retained Earnings 134,000
Total liabilities & shareholder’s equity 1,375,000

Goodwill = Investment in Starr Company - Values of Starr Company’s net assets at CFV
Goodwill = 510,000 – (Br 635,000 – 150,000) = Br510,000 – 485,000 = 25,000
Working Paper for Consolidated Balance Sheet
 Preparation of consolidated balance sheet on the date of purchase type business combination usually requires the
use of a working paper for consolidated balance sheet, even for a parent company and a wholly owned
subsidiary.
 A consolidated balance sheet is prepared using a working paper for Palm Corporation a shown below.
 The working paper for consolidated balance sheet on the date of purchase-type business combination has the
following features:
1. The elimination is not entered in either the parent company’s or the subsidiary’s accounting records; it is only a
part of the working paper for preparation of the consolidated balance sheet.
2. The elimination is used to reflect differences between current fair values and carrying amounts of the
subsidiary’s identifiable net assets because the subsidiary did not write up its assets to current fair values on the
date of the business combination.
3. The Elimination column in the working paper for consolidated balance sheet reflects increases and decreases,
rather than debits and credits. Debits and credits are not appropriate in a working paper dealing with financial
statements.
4. Intercompany receivables and payables are placed on the same line of the working paper for consolidated
balance sheet and are combined to produce a consolidated amount of zero.
5. The respective corporations are identified in the working paper elimination. The reason for precise identification
is to deal with the eliminations of intercompany profits (or gains).
6. The consolidated paid-in capital amounts are those of the parent company only. Subsidiary’s Paid-in capital
amounts always are eliminated in the process of consolidation.
7. Consolidated retained earnings on the date of purchase-type business combination include only the retained
earnings of the parent company. This treatment is consistent with the theory that purchase accounting reflects a
fresh start in an acquisition of net assets (assets less liabilities), not a combining of existing stockholder interest.
8. The amounts in the consolidated column of the working paper for consolidated balance sheet reflects the
financial position of a single economic entity comprising two legal entities, with all intercompany balances of
the two entities eliminated
Palm Corporation and Subsidiary
Working Paper for Consolidated Balance Sheet
December 31, 2008
Palm Corporation Starr Company Elimination Consolidated
Assets: ↑ (↓)
Cash 5,000 40,000 45,000
Inventories 150,000 110,000 25,000 285,000
Other current assets 110,000 70,000 180,000
Intercompany receivables 25,000 (25,000)
(payables)
Investment in Starr Co...................................................................
500,000 (500,000)
.

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 Plan asset (net) 450,000 300,000 65,000 815,000
Patent (net) -0- 20,000 5,000 25,000
Goodwill (net) -0- __-0- 25,000 25,000
Total asset 1,250,000 515,000 (390,000) 1,375,000
Liabilities & SHE:
Income taxes Payables 26,000 10,000 – 36,000
Other Liabilities 325,000 115,000 – 440,000
Common stock Br 10 par 400,000 – – 400,000
Common stock Br 5 par – 200,000 (200,000) –
Additional Paid in capital 365,000 58,000 ( 58,000 ) 365,000
Retained Earnings 134,000 132,000 (132,000) 134,000
Total Liab. & SHE 1,250,000 515,000 (390,000) 1,375,000

Working Paper Elimination Journal Entries shown below:

Debit Credit
Common stocks Br 5 par-Starr................................. 200,000
Additional paid in capital-Starr................................ 58,000 Reciprocal Ledger Accounts (390,000)
Retained Earnings-Starr............................................ 132,000
Inventories (135,000-110,000)................................. 25,000
Plant assets (net) (365,000-300,000)........................ 65,000 Increase in Assets (95,000)
Patent (net) (25,000-20,000)..................................... 5,000
Goodwill (net) (500,000-485,000)........................... 25,000 Excess Cost
Investment in Starr Company......................... 510,000
Br 390,000 represents the carrying amounts of the net assets of Star Company. Br 110,000 (500,000 – 390,000) is
attributable to the excess of current fair values over carrying amounts of certain identifiable assets of Starr and
Goodwill.
5.3.Consolidation of Partially Owned Subsidiary on the Data of Business Combination Under Purchase
Accounting
Consolidation of a parent company and its partially owned subsidiary differs from the consolidation of a wholly
owned subsidiary in one major respect - the recognition of minority interest (non-controlling interest).
 Minority interest or no controlling interest is a term applied to the claims of stockholders other than the parent
company (controlling interest) to the net income or losses and net assets of the subsidiary. The minority interest in
the subsidiary’s net income or losses is displayed in the consolidated income statement, and the minority interest in
the subsidiary’s net assets is displayed in the consolidated balance sheet.
Example 5.3: To illustrate the consolidation techniques for a purchase type business combination involving a
partially owned subsidiary, assume the following facts:
On December 31,2009 Post Corporation issued 57,000 shares of its Br 1 par common stock (Current fair value Br
20 a share ) to stockholders of Sage Company in exchange for 38,000 of the 40,000 outstanding shares of Sage’s Br
10 par common stock Thus Post acquired 95% of the interest in Sage (38/40). There was no contingent
consideration. Out-of-pocket costs of the combination paid in cash by Post on December 31, 2009 were as follows:
 Finder’s and legal fees of Combination...................................................Br 52, 250
 Cost of issuing shares.............................................................................. 72,750
 Total......................................................................................................... 125,000
Financial statements of the two companies before the combination are as follows:
Income statement Post Corporation Sage Company
Net sales Br 5,500,000 Br 1,000,000
Costs & Expenses:
Cost of goods sold 3,850,000 650,000
Operating expense 925,000 170,000

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 Interest expense 75,000 40,000
Income tax Expense 260,000 56,000
Total Costs and expenses (5,110,000) (916,000)
Net income 390,000 84,000
Statement of RES
Retained Earnings, beginning of year 810,000 290,000
Add: Net income 390,000 84,000
Sub-totals 1,200,000 374,000
Less: Dividends (150,000) (40,000)
Retained Earnings End of the year 1,050,000 334,000
Balance Sheet
Balance sheet Post Corporation Sage Company
Assets:
Cash Br 200,000 Br 100,000
Inventories 800,000 500,000
Other current assets 550,000 215,000
Plant asset, (net) 3,500,000 1,100,000
Goodwill (net)..................................................... 100,000 __-0-
Total 5,150, 000 1,915,000
Liability and SHE:
Income taxes payable 100,000 16,000
Other liabilities 2,450,000 930,000
Common stock Br 1 par 1,000,000
Common stock for Br 10 par 400,000
Additional Paid in capital 550,000 235,000
Retained Earnings 1,050,000 334,000
Total liabilities and SHE 5,150, 000 1,915,000
On Dec, 31, 2009 current fair values of Sage company’s identifiable assets and liabilities were the same as their
carrying amount, except for the following assets:
Market Values
Inventories Br 526,000
Plant assets (net) Br1,290,000
Leasehold Br30,000
Post Corporation records the combination with Sage Company as a purchase and thus, the following journal
entries are made:
1. Issuance of 57,000 shares to Sage company
Investment in Sage Company (57,000 shares @ Br 20) 1,140,000
Common Stock 57, 000
Paid in capital 1,083,000
2. To record out-of-pocket cost
Investment in Sage Company 52,250
Paid in capital 72,750
Cash l 125,000
Investment in Subsidiary Account
Investment in Sage Company
1,140,000
52,250
1,192,250

Working Paper for Consolidated Balance Sheet

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As minority interest in net assets of a partially owned subsidiary& measurement of goodwill acquired in the
combination complicates the process, it is advisable to use a working paper.
Developing the Elimination
 Common stock –Sage Company 400,000
 Additional paid in capital- Sage Company 235,000
 RES, Sage Company 334,000
 Intercompany accounts (net assets = A – L) 969,000
The footing of Br 969,000 of the debit items of the partial elimination above represents the carrying amounts of the
net assets of Sage Company and is Br 223,250 less than the investment in Sage Company of Br 1,192,250. Part of
this Br 223,250 difference is the excess of the total cost of Post Corporation’s investment in Sage Company plus
the minority interest in Sage Company’s net assets over the carrying amounts of Sage’s identifiable net assets.
Difference between current fair vales and carrying amount of combinee’s identifiable assets are presented below:
 Inventories (526,000 – 500,000) 26,000
 Plant assets (net) (1,290,000 – 1,100,000) 190,000
 Leasehold 30,000
 Total 246,000
Working Paper Elimination Journal Entry:
Common Stock – Sage Company 400,000
Additional paid in capital – Sage Company 235,000
RES – Sage Company 334,000
Inventories (526,000 – 500,000) 26,000
Plant assets, net (1,290,000 – 1,100,000) 190,000
Leasehold 30,000
Goodwill 38,000
Investment in Sage Company 1,192,250
Minority Interest in Net Assets of Subsidiary 60,750
Computation of Goodwill and Minority Interest:
The revised footing of Br 1,215,000 (969,000 + 246,000) of the debit items of the above partial elimination
represents the current fair values of Sage Company’s identifiable net assets on December 31, 2009. Two items must
be recorded to complete the elimination for Post Corporation and Subsidiary. Thus, Minority Interest and Goodwill
should be computed. First, computations of Minority interest in combinee’s identifiable net assets
Minority interest:
CFV of net assets............................................................................... 1,215,000
Minority interest (100% – 95%) ...................................................... 5%
Minority interest (5% @ 1,215,000) ................................................ 60,750 – This is recorded by crediting Minority Interest
Account like liability
Alternative way of Calculating Net Assets at CFV:
Cash 100,000
Inventories 526,000
Other Current Assets 15,000
Plant (net) 1,290,000
Leasehold 30,000
Total Assets at CFV 2,161,000
Less: Liabilities at CFV (16,000 + 930,000) 946,000)
Net Assets at CFV 1,215,000
Goodwill: Second, the Goodwill acquired by Post Corporation in the business combination with Sage Company is
computed as follows and recorded:
Investment for 95% interest in Sage Company............................................................ 1,192,250
Less: CFV of 95% of Investment in net assets (1,215,000 @ 0.95)........................... 1,154,250
Goodwill acquired by Post Corporation ...................................................................... 38,000

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 The working paper for consolidated balance sheet is presented below:
Post Corporation and Subsidiary
Working Paper for Consolidated Balance Sheet
December 31, 2009
Post Sage
Elimination Consolidated
Corporation Company
Assets: ↑ (↓)
Cash 75,000 100,000 175,000
Inventories 800,000 500,000 26,000 1,326,000
Other current assets 550,000 215,000 765,000
Investment in Sage Co 1,192,250 (1,192,250)
Plan asset (net) 3,500,000 1,100,000 190,000 4,790,000
Leasehold Assets (net) -0- -0- 30,000 30,000
Goodwill (net) 100,000 38,000 138,000
Total asset 6,217,250 1,915,000 (908,250 7,224,000
Liabilities & SHE:
Income taxes Payables 100,000 16,000 – 116,000
Other Liabilities 2,450,000 930,000 – 3,380,000
Minority Interest in NAs Sub 60,750 60,750
Common stock Br 1 par 1,057,000 – 1,057,000
Common stock Br 10 par – 400,000 (400,000) –
Additional Paid in capital 1,560,250 235,000 ( 235,000) 1,560,250
Retained Earnings 1,050,000 334,000 (334,000) 1,050,000
Total Liability & SHE 6,217,250 1,915,000 (908,250) 7,224,000

Consolidated Balance sheet of the parent company and partially owned subsidiary
Post Corporation and Subsidiary
Consolidated Balance Sheet
December 31, 2009
Assets:
Cash Br 175, 000
Inventories 1,326,000
Other Current assets 765,000
Total current assets 2, 266,000
Plant assets, net 4,790,000
Leasehold 30,000
Goodwill 138,000
Total assets 7,224,000
Liabilities and SHE:
Liabilities:
Income tax payable 116,000
Other 3,380,000
Minority Interest in net assets of subs 60,750
Total liabilities 3,556,750
Stockholders’ Equity:
Common stock Br 1par 1,057,000
Additional PIC 1,560,250
Retained Earnings 1, 050,000
Total Shareholders’ Equity 3,667,250
Total Liability and SHE 7,224,000
5.4.Consolidated Financial Statements: Subsequent to Date of Business Combination under Purchase
Accounting
Subsequent to date of a business combination the parent company accounts for operating results of subsidiary.
That is it accounts for:

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  Net income or net loss, and
 Dividends declared paid by subsidiary
In addition, a number of intercompany transactions and event that frequently occur in a Parent-Subsidiary
relationship shall be recorded. All the three basic financial statements must be consolidated for accounting periods
subsequent to the date of purchase type business combination. The items that must be included in the elimination
are:
1. The Subsidiary’s beginning-of-year stockholder’s Equity and its dividends,
2. The parent’s investment, and the parent’s investment income accounts;
3. Unamortized Current Fair Value excesses of the subsidiary’s net assets; and
4. Certain operating expenses of the subsidiary
A parent company may choose the Equity Method or the Cost Method to account for the operating results of
consolidated purchased subsidiaries.
1. Equity Method
 The Parent company records its share of subsidiary’s net income or net loss, adjusted for depreciation and
amortization of differences between current fair values and carrying amounts of a purchased subsidiary’s net
asset on the date of business combination, as well as its share of dividends declared by subsidiary.
 Proponents of the equity method of accounting maintain that the method is consistent with accrual accounting,
because it recognizes increases or decreases in the carrying amounts of parent company’s investment in the
subsidiary when they are realized by the subsidiary as net income or net loss, not when they are paid by the
subsidiary as dividends.
 Proponents claim that it stresses the economic substance of the parent-subsidiary relationship because the two
companies constitute a single economic entity for financial accounting.
 They also claim that dividends declared by subsidiary are not revenues to the parent (as claimed by cost methods):
instead, they are liquidations (reduction) of investment in subsidiary.
2. Cost Method
 Parent Company accounts for the operations of a subsidiary only to the extent that dividends are decrared by
subsidisry.
 Dividends declared by the subsidiry subsequent to the business combination are revenue to parent company
 Dividends declared by the subsidiary in excess of postcombination net income are reduction in carrying amount
of the investrment in subsidiary. (Liquidating Dividend).
 Net income or net loss of subsidiary is not recorded by parent company when the cost method of accounting is
used.
 Supporters argue that the cost method appropriatly recoginizes legal form of the parent company – subsidiary
relationship.
 Parent company and subsidiry are sparate legal entities; accounting for a subsidiary’s operations should
recognize the separatness, according to proponents of cost method.
Choosing Between the Two Metheds
 Consolidated financial statement amounts are the same regadless of the mehods used. But the working paper
eliminations are different
 The equity method is appropriate for pooled subsidaries as well purchased subsidiaries.
5.4.1. Accounting for Operating Results of Wholly Owned Purchased Subsidiaries: Subsequent to Date of
Business Combination
Illustration of eqiuity method for wholly owned purchased subsidiary for first year after business Combination.
Example 5.4.1.( A Continuation of Example 5.2)

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1. Assume that Starr Company had net income of Br 60,000 for the year ended December 31, 2009, and dividends
of Br 24,000 are declared on December 20, 2009.
December 20, 2009:
Dividends Declared 24,000
Intercompany Dividends Payable 24,000
Intercompany dividends payable will be eliminated when preparing consolidated statement.
Palm corporation will record the follwing entry:
December 20, 2009:
Intercompany Dividend Receivable 24,000
Inv’t in Starr Company Common Stock 24,000
December 31, 2003:
Investment in Starr Company Common Stock 60,000
Intercompany Investment Income 60,000
2. Adjustment of purchased subsidiary’s net income:
Palm must prepare a third equity method journal entry on December 31,2009 to adjust Starr’s net income for
depreciation and amortization attributable to the difference between CFV and carrying values of Starr’s Company
net assets on December 31,2008, the date of combination. Because such differences were not considered by the
subsidiary, the subsidiary’s 2003 net income is overstated from the point of view of the consolidated entity. Assume
that on December 31, 2008 (date of combination), differences between CFV& carrying values of Starr company’s
net assets were as follow:
December 31, 2008 December 31, 2009
Inventories (FIFO) Br 25,000 ─
Plant Assets, net:
Land 15,000 15,000
Building (10 Years) 30,000 27,000
Machinery (10 Years) 20,000 18,000
Patent (5 Years) 5,000 4,000
Goodwill (No Impairment) 25,000 25,000
Total 120,000 89,000
 Plant Assets, net (December 31, 2002) = 15,000 + 30,000 + 20,000 = Br65,000
 Plant Assets, net (December 31, 2003) = 15,000 + 27,000 = Br60,000
Palm Corporation prepares the following additional equity method journal entry to reflect the effects of depreciation
and amortization of the differences between the CFV and carrying amounts of Starr Company’s net assets on Starr's
net income for the year ended Dec.31.2009.
The amount of amortization, which the difference between CFVs and carrying amounts of Starr Company’s
net assets on December 31, 2009 is determined as follows:
Inventories sold and included in the COGS Br25,000
Building - depreciation (30,000 /10) 3,000
Machinery – depreciation (20,000/ 15) 2,000
Patent-amortization (5,000/ 5) 1,000
Total 31,000
December 31, 2009:
Intercompany Investment Income 31,000
Investment in Starr Company 31,000
Note: Intercompany Investment Income = 60,000 - 31,000 = 29,000
The working paper elimination subsequent to combination must include accounts that appear in the constituent
companies’ income statement, Retained Earnings statement and balance sheet because all the three statement are to
be consolidated. A consolidated statement of cash flows is prepared from the three basic consolidated financial
statements and their information.
Developing the Elimination Journal Entries:
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The working paper eliminations are as follows:
A. Removing Subsidiary’ Equity Account and Increase in Assets
Common stock–Starr Company 200,000
Add paid in capital–Starr Company 58,000
Retained Earnings–Starr Company 132,000
Inter-company Investment Income 29,000
Plant asset, net–Starr Company 60,000
Patent (net)–Starr Company 4,000
Goodwill (net)–Starr Company 25,000
COGS–Starr Company 25,000
Operating Expenses–Starr Company 6,000
Investment in Starr Company 515,000
Dividends–Starr Company 24,000
The above working paper elimination journal entry is to eliminate intercompany investment and equity accounts of
subsidiary at beginning of year, and subsidiary dividend.
B. For year 2009 depreciation and amortization on differences between fair values and carrying amounts of Starr's
net assets based on the following assumptions:
COGS Expenses
Inventories sold Br 25,000
Building depreciation 3,000
Machinery depreciation 2,000
Patent amortization ______ 1,000
Total 25,000 6,000

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C. Allocate unamortized differences between the combination date CFVs and carrying amounts of Starr’s net asset.
Working Paper Eliminations for Equity Method
 Three components of the subsidiary’s stockholders’ equity are reciprocal to the parent company’s Investment
Ledger Account.
 The subsidiary’s beginning-of-year retained earnings amount is eliminated.
 Subsidiary’s dividends are an offset to the subsidiary’s retained earnings.
 The balance of the parent company’s Investment Ledger Account is net of the dividends received from the
subsidiary.
 The elimination of the subsidiary’s beginning-of-year retained earnings makes beginning-of-year consolidated
retained earnings identical to the end-of-previous-year consolidated retained earnings.
 The debits to the subsidiary’s plant assets, patent, and goodwill bring into the consolidated balance sheet the
un-amortized differences between current fair values and carrying amounts of the subsidiary’s assets on the
date of the business combination.
 The amount of the parent company’s inter-company investment income is an element of the balance of the
parent’s Investment Ledger Account.
Palm Corporation and Subsidiary
Working Paper For Consolidated Financial Statements
For Year Ended Dec.31,2009
Palm Starr Conso-
Elimination
Types of financial statements: Corporation Company lidated
Income statement
Revenue:
Net Sales 1,100,000 680,000 1,780,000
Intercompany Investment Income 29,000 a (29,000)
Total Revenue 1,129,000 680,000 (29,000) 1,780,000
Cost of goods sold 700,000 450,000 a 25,000 1,175,000
Operating expenses 217,667 130,000 a 6,000 353,667
Interest expense 49,000 49,000
Income tax expenses 53,333 40,000 93,333
Total Costs and Expenses 1,020,000 620,000 *31,000 1,671,000
Net income 109,000 60,000 (60,000) 109,000
Statement of Retained Earnings
Retained Earnings Jan.1, 2003 134,000 132,000 a (132,000) 134,000
Net income for the year 109,000 60,000 (60,000) 109,000
Subtotal 243,000 192,000 (192,000) 243,000
Dividend Declared 30,000 24,000 **a (24,000) 30,000
Retained Earnings end of year 213,000 168,000 (168,000) 213,000
Balance Sheet
Cash 5,900 72,100 78,000
Intercompany Receivables (Payables) 24,000 (24,000)  –
Inventories 136,000 115,000 251,000
Other current assets 88,000 131,000 219,000
Investment in Starr Company 515,000 – a (515,000)   –
Plant asset, net 440,000 340,000 a 60,000 840,000
Patent, net – 16,000 a 4,000 20,000 *Br
Goodwill, net –   – a 25,000 25,000 31,000 is
Total Asset 1,208,900 650,100 (426,000) 1,433,000 an
Liability and SHE increase
Income tax payable 40,000 20,000 60,000 in total
Other liabilities 190,900 204,100 395,000 costs and
Common stock Br 10 par 400,000 12
  – 400,000
Common stock Br 5 par – 200,000 a (200,000)   –
Additional paid-in capital 365,000 58,000 a (58,000) 365,000
Retained Earnings 213,000 168,000 a (168,000) 213,000
Total Liability & SHE 1,208,900 650,100 (426,000) 1,433,000
 expenses and a decrease in net income; **Br 24,000 is a decrease in dividends and an increase in retained
earnings.
Note: Use the working paper and prepare consolidated financial statements (Consolidated income statement,
statement of retained Earning and balance sheet)
 Income Statement
PALM CORPORATION AND SUBSIDIARY
Consolidated Income Statement
For Year Ended December 31, 2009
Net sales Br1,780,000
Cost and expenses:
Cost of goods sold 1,175,000
Operating expenses 353,667
Interest Expense 49,000
Income Taxes Expense 93,333
Total costs and expenses (1,671,000)
Net Income Br109,000
Basic earnings per share (40,000 shares outstanding) Br2.74
 Statement of Retained Earnings
PALM CORPORATION AND SUBSIDIARY
Consolidated Statement of Retained Earnings
For year ended December 31, 2009
Retained earnings, beginning of year Br134,000
Add: Net Income 109,000
Subtotal Br243,000
Less: Dividends (Br 0.75 a share) 30,000
Retained earnings, end of year Br213,000
 Balance Sheet
PALM CORPORATION AND SUBSIDIARY
Consolidated Balance Sheet
December 31, 2009
Assets:
Cash 78,000
Inventories 251,000
Other Assets 219,000
Plant Assets, net 841,000
Patent, net 20,000
Goodwill 25,000
Total Assets 1,433,000
Liabilities and Stockholders’ Equity:
Liabilities:
Income taxes payable 60,000
Other liabilities 395,000
Stockholders’ Equity:
Common stock, Br10 par 400,000
Additional paid-in capital 365,000
Retained earnings 213,500
Total liabilities and stockholders’ equity 1,433,000
The following point are noticeable in the consolidated financial statements and the working paper:
 In effect, the elimination of the inter-company investment income comprises a reclassification of the inter-
company investment income to the adjusted components of the subsidiary’s net income in the consolidated
income statement.

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 The increases in the subsidiary’s cost of goods sold and operating expenses, in effect, reclassify the comparable
decrease in the parent company’s Investment ledger account under the equity method of accounting.
 The inter-company receivable and payable, placed in adjacent columns on the same line, are offset without a
formal elimination.
 The elimination cancels all inter-company transactions and balances not dealt with by the offset described above.
 The elimination cancels the subsidiary’s retained earnings balance at the beginning-of-year, so that each of the
three basic financial statements may be consolidated in turn.
 The first-in, first-out method is used by subsidiary to account for inventories; thus the difference attributable to
subsidiary’s beginning inventories is allocated to cost of goods sold for the year ended.
 Income tax effects of the elimination’s increase in subsidiary’s expenses are not included in the elimination.
 One of the effects of the elimination is to reduce the differences between the current fair values and the carrying
amounts of the subsidiary’s net assets, except land and goodwill, on the business combination date.
 The parent company’s use of the equity method of accounting results in the equalities described below:
 Parent Company Net Income = Consolidated Net Income
 Parent Company Retained Earnings = Consolidated Retained Earnings
 Despite the equalities, consolidated financial statements are superior to parent company financial
statements for the presentation of financial position and operating results of parent and subsidiary companies.
CLOSING ENTRIES:
After consolidated financial statements have been completed, both the parent company and its subsidiaries prepare
closing entries and post to ledger accounts, to complete the accounting cycle for the year. The subsidiary’s closing
entries are prepared in the usual fashion. However, the parent company’s use of equity method of accounting
necessitates specialized closing entries. The equity method of accounting disregards legal form in favor of economic
substance. However, state corporation laws generally require separate accounting for retained earnings available for
dividends to stockholders.
For the Parent Company (Palm Corporation), the December 31, 2003 closing entries under the Equity method of
accounting for purchased subsidiary are as follows:
To close revenue accounts:
Net Sales 1,100,000
Investment Income from subsidairy 29,000
Income Summary 1,129,000
To close expense accounts:
Income Summary 1,020,000
Cost of Goods Sold 700,000
Operating Expenses 217,667
Interest Expense 49,000
Income Tax Expense 53,333
To close income summary accounts; to transfer net income legally available for dividends to retained earnings; and
to segregate 100% share of adjusted net income of subsidiary not distributed as dividends by the subsidiary:
Income Summary 109,000
Retained Earnings of Subsidiary (29,000 – 24,000) 5,000
Retained Earnings (109,000- 5,000) 104,000
To close dividends declared accounts:
Retained Earnings 30,000
Dividend 30,000
5.4.2. Accounting for Operating Results of partially Owned purchased Subsidiaries Subsequent to Date of
Business Combination
This requires computation of the minority interest in net income or net loss of the subsidiary. Under the parent
concept of the consolidated financial statements, the consolidated income statement of a parent company and its
14
partially owned subsidiary includes an expense: minority interest in net income (loss) of subsidiary. In the
consolidated balance sheet, the minority interest in net assets of subsidiary is displayed among liabilities.
Illustration of Equity method for partially owned purchases subsidiary for first year after Business
Combination (Continuing with Post-Sage company relationship)
Example 5.4.2: Assume that on December 5, 2004 Sage Company declared dividend of Br 1 per Share Payable on
December 19, 2010 and net income of Sage for the year was Br 90,000.
Sage records the following journal entries.
December 5, 2010: To record declaration of dividend payable
Dividends Declared (40,000 @ 1) 40,000
Dividends Payable (Br 40,000 @ 0.05) 2,000
Intercompany Dividends Payable (40,000 @ 0, 95) 38,000
December 19, 2010: To record payment of dividend declared
Dividends Payable 2,000
Intercompany Dividends Payable 38,000
Cash 40,000
Post Corporation record the following journal entries for 2004, under the equity method in relation with subsidiary
1. December 5, 2010: to record dividend declared by Sage Company for proportionate Share of Dividend
Intercompany Dividend Receivable 38,000
Investment in Sage Company 38,000
2. December 19, 2010: To record receipt of dividend from Sage Company
Cash 38,000
Intercompany Dividend Receivable. 38,000
(Proportionate Share of Dividend)
3. December 31, 2010:
Investment in Sage Company 85,500
Intercompany Investment Income (95% @ 90,000 =85,500) 85,500
To record 95% of net income of sage company for the year ended dec.31, 2010 Adjustment of purchased
Subsidiary’s net income. Assume the following CFV and carrying values:
Excess Cost Expense Dec.31, Balance
Inventories (FIFO) 26,000 (26,000) ─
Plant Assets, net:
Land 60,000 ─ 60,000
Building (20 Years) 80,000 (4,000) 76,000
Machinery (5 Years) 50,000 (10,000) 40,000
Leasehold (6Years) 30,000 (5,000) 25,000
Total 246,000 (45,000) 201,000
Plant Assets, net (December 31, 2009) = 60,000 + 80,000 + 50,000 = 190,000
Plant Assets, net (December 31, 2010) = 60,000 + 76,000 + 40,000 = 176,000
4. Post Corporation prepares the following additional entry to record the amortization of excess cost:
Intercompany Investment Income (95% @ 45,000) 42,750
Investment in Sage Company Common Stock 42,750
The Investment in Sage Company
Investment in Sage Company
1,192,250 38,000 Dividend
85,500 42,750 Amortization of Excess Cost

1,197,000

15
Note: Goodwill in a business combination involving a partially owned subsidiary is attributable to the parent
company in a partially owned subsidiary rather than the subsidiary. Consequently, amortization of goodwill is
debited to the amortization Expense ledger account of the parent company.
Developing the Elimination Entries
 Post Corporation uses the equity method of accounting for its investment in Sage Company results in balance
the Investment ledger account that is a mixture of three components.
i. The carrying amount of Sage's identifiable net assets
ii. the "current fair value excess or Excess Cost over CFV: which is attributable to Sage's identifiable
assets: and
iii. the goodwill acquired by post in the business combination with Sage
A. The Eliminations column of the working paper is presented below:
Common Stock –Sage Company 400,000
Add paid in capital – Sage Company 235,000
Retained Earning – Sage Company 334,000
Investment Income from the Subsidiary 42,750
Plant Assets (net) – Sage Company 176,000
Leasehold – Sage Company 25,000
Goodwill – Sage Company 38,000
CGS – Sage Company 26,000
Operating Expenses- Sage Company 19,000
Investment in Sage Company 1,197,000
Dividends – Sage Company 40,000
Minority Interest in Net Asset of the sub 58,750
* Minority interest in dividend declared by the subsidiary Br 40,000 @ 0.05 = Br 2000. Thus the Minority Interest in
Net Assets of the Subsidiary would be 60,750 – 2000 = Br58, 750.
**For year 2010 depreciation and amortization on differences between CFVs and carrying amounts of Sage’s net
assets are as follows:
COGS Operating Expenses
Inventories Sold 26,000
B. Minority
Building Depreciation 4,000
Machinery Depreciation 10,000 Interest in
Net Leasehold Amortization 5,000 Income
and Total 26,000 19,000 Net Assets
Minority Interest in Net Income of Subsidiary 2,250
Minority Interest in Net Assets of Subsidiary 2,250
Minority interest in subsidiary's adjusted net income for year 2009 is computed as follows:
Net Income of Subsidiary ............................................................................Br 90,000
Net reduction of elimination (A) (43,000 + 2000)....................................... (45,000)
Adjusted Net Income of subsidiary.............................................................. 45,000
Minority Interest in Adjusted Income (45,000 x 0.05)................................. (2,250)
Post Corporation and Subsidiary
Working paper for consolidated Financial statements
For year Ended Dec.31,2010
Post Sage
Elimination Consolidated
Corporation Company
Income Statement
Revenue:
Net Sales 5,611,000 1,089,000 6,700,000
Intercompany Investment Income 42,750 a (42,750)
Total Revenue 5,653,750 1,089,000 (42,750) 6,700,000
Cost of goods sold 3,925,000 700,000 a 26,000 4,651,000
Operating expenses 556,000 129,000 a 19,000 704,000
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 Interest and income tax expense 710,000 170,000 880,000
Minority Interest in the net income of Sub b 2,250 2,250
Total costs and Expenses 5,191,000 999,000 *47,250 6,237,250
Net income 462,750 90,000 (90,000) 462,750
Statement of Retained Earrings
Retained Earnings Jan.1.2010 1,050,000 334,000 a (334,000) 1,050,000
Net income for the year 462,750 90,000 (90,000) 462,750
Subtotal 1,512,750 424,000 (424,000) 1,512,750
Dividend Declared 158,550 40,000 **a ( 40,000) 158,550
Retained Earnings end of year 1,354,200 384,000 (384,000) 1,354,200
Balance Sheet
Assets:
Inventories 861,000 439,000 1,300,000
Other Current Assets 639,000 371,000 1,010,000
Investment in Sage Company CS 1,197,000 a (1,197,000)
Plant asset( net) 3,600,000 1,150,000 a 176,000 4,926,000
Leasehold(net) a 25,000 25,000
Goodwill ( net) 95,000 a 38,000 133,000
Total Asset 6,392,000 1,960,000 (958,000) 7,394,000
Liability and SHE:
Liabilities 2,420,550 941,000 3,361,550
a 58,750
Minority Interest in the Net Asset Subsidiary b 2,250 61,000
Common stock Br 1 par 1,057,000 1,057,000
Common stock Br 10 par 400,000 a (400,000)
Additional paid-in capital 1,560,250 235,000 a (235,000) 1,560,250
Retained Earnings 1,354,200 384,000 (384,000) 1,354,200
Total Liability & SHE 6,392,000 1,960,000 (958,000) 7,394,000
* An increase in total costs and expenses and a decrease in net income ** A decrease in dividends and an
increase in retained earnings
Consolidated Financial statements
The consolidated income statement, statement of retained earnings and balance sheet of Post Corporation and
subsidiary for the year ended Dec.31, 2010 are shown below:
 Income Statement
Post Corporation and Subsidiary Sage Company
Consolidated Income statement
For the year ended December 31, 2010
Net Sales Br6,700,000
Costs and Expenses:
Cost of Goods Sold 4,651,000
Operating Expense 704,000
Interest and Income Tax Expense 880,000
Minority Interest in Net Income of The Subsidiary 2,25
0
Total Costs and Expenses (6,237,250)
Net Income Br462,750
Earning per share of common stock (462,750 / 1,057,000 shares) Br 0.44
 Retained Earning Statement
Post Corporation and Subsidiary Sage Company
Consolidated Retained Earning Statement
For year ended Dec.31 2010
Retained earnings, beginning of the year Br 1,050,000
17
 Add: Net income 462,750
Subtotal 1,512,750
Less: Dividends (Br 0.15 a share) (158,550)
Retained Earnings, Ending of the Year 1,354,200
 Balance Sheet
Post Corporation and Subsidiary Sage Company
Consolidated Balance Sheet
For year ended Dec.31, 2010
Assets:
Inventories 1,300,000
Other Assets 1,010,000
Plant Assets, net 4,926,000
Leasehold, net 25,000
Goodwill, net 133,000
Total assets 7,394,000
Liabilities and Stockholders' Equity:
Liabilities:
Liabilities Other Than Minority Interest 3,361,550
Minority interest in net assets of subsidiary 61,000
Stockholders' Equity:
Common stock, Br 1par 1,057,000
Additional Paid In Capital 1,560,250
Retained Earnings 1,3504,200
Total liabilities and stockholders' equity 7,394,000

Closing entries:
Parent's Dec.31 2010 closing entries under the Equity method of accounting for purchased subsidiary are as
follows:
To close revenue accounts
Net Sales 5,611,000
Intercompany investment income 42,750
Income summary 5,653,750
To close expense accounts:
Income Summary 5,191,000
Cost of Goods Sold 3,925,000
Operating Expenses 556,000
Interest and Income tax expense 710,000
To close income summary accounts; to transfer net income legally available for dividends to retained
earnings; and to segregate 95% share of adjusted net income of subsidiary not distributed as dividends:
Income Summary 462,750
Retained Earnings of Subsidiary (42,750 – 38,000) 4,750
Retained Earnings (462,750 – 4,750) 458,000
To close dividends declared accounts:
Retained Earnings 158,550
Dividend Declared 158,550

18