ACCTG473:

PROFESSOR: OK. And in this lesson, we're going to talk about accounting for investment in common stock, especially we're going to compare between the fair value method and equity method. And secondly, this is the first-- it's actually the first consolidation practice. And the first situation is that when a parent company acquires another company stock 100% at the book value without differential.

So let's first talk about accounting for investment common stock. So this is kind of review from-- of the intermediate accounting tool. So in the intermediate accounting, you probably learned about the accounting for stock investments. So based on-- depending on the share ownership, we have three different accounting.

The firstly, the fair value method, is usually when the-- when a parent company acquires less than 20% of another company acquired-- the acquiring stock. If that is the case, we usually consider that. There is no significant influence, which is a lacking influence on investing. If that is the case, we use the fair value method.

And for this part, for this variable method, the acquiring company-- acquiring or investing company and this record based on share-- based on the dividend declared from the investee. And also, investing company record the revenue or loss based on the change in fair value of the stock price.

A second method is the equity method. Usually, this is the case when investing company acquires an investee's company stock, at least 20%. OK, at least 20%. And we usually consider that the investing company can influence significantly on investee. And if that is the case, we invest in company record the profit when investing-- the investor record income based and the share of income should be recorded as the investing company's income.

And dividend declared by the investee is considered the return of capital. And this, actually, is not the income for the investing company, but instead, that is considered the reduction of investment. So basically, again, this is kind of review of there in intermediate accounting.

You've got to clearly know that the journal entry and also how to present in the financial statement for each method. For example, the fair value method, we record the fair value as a balance sheet amount. And also, what's the income statement effect, the share of dividend, and the fair value change.

Is the income for the fair method? In the case of equity method, the balance sheet is based on the adjust code based on-- and depending on the change based-- depending on the share of earnings and share of dividend. For the income statement effect from the equity method, that's the share of income from the investing.

So there is-- and also, especially when investing company acquires more than 50%, then we consider that investing company can control the investing. If there is a case, investing company or parent company is required to prepare for consolidated financial statement.

And there is an example of there-- of the comparing the equity method and the fair value method. So you can please take a time to review this journal entry. OK, so you got to know that clearly understand this journal entries for each method. And also, you got to know that what is the balance sheet amount and what's the income statement effect?

So, for example, the first case is that-- the example says that the company acquires 20% of another company stock. And the first case, a case one, is that does not gain a significant influence over the XYZ. If that is the case, because there is no-- the influence is not achieved. So if there is a case, the investing company needs to use the fair value method instead of equity method.

And the journal entry is-- the first journal entry related to the purchase journal entry. Second one, the share of dividend. So dividend declared by the investee, XYZ Company, is $20,000 and the ownership is 20%. So therefore, $4,000 of dividend income should be recorded by the investing company.

And also, at the end of the year, the stock price is-- of the investee is $98,000 and it has actually decreased from $100,000, which is a $2,000 decrease. That should be recorded as a unrealized loss, which is income statement effect. And also, that decrease in investment.

As a result, at the end of the year, XYZ, the parent company or investing company, needs to record an investment as $98,000 in the balance sheet. And income statement effect is that dividend income $4,000 minus unrealized loss $2,000. The net effect is positive $2,000.

In the second case, what if the parent company or investing company exercise an influence? If that is the case, we use the equity method. Based on equity method, the purchase journal entry the same, but notice that, in the case of equity method, investing company or parent company record income when investing record earnings.

So that's the 20% of the invested income, which is $60,000. That is a $12,000. Notice the journal entry, the debit investment in subsidiary credit income from subsidiary $12,000. So this income from subsidiary increased the investment and increase the income from subsidiary. So that's the equity entry.

And thirdly, for the dividend is considered the reduction of the investment and return of capital. So $20,000 of the dividend declared by the investee, the 20% is $4,000. That is the reduction of investment, not the investment-- dividend income. So notice that-- what's the credit count? The credit account is investment in XYZ for $4,000. So $4,000 of investment decreases.

As a consequence, what's the balance sheet effect? The balance sheet based on equity method, the parent company or investing company ABC should record $1 or a $108,000. $100,000 plus $12,000 minus $4,000, which is $108,000.

For the income statement, that's the-- what's the effect of income? So income should be recorded when XYZ report earnings. So that's $12,000. So that's the-- it's very important and this is a very important concept. And basically, for the consolidation, we special-- you got to pay special-- pay attention to the equity method entry. So now, let's take a look at another example of the-- this accounting first that investment.

So this is another example. If you look at the information provided, so Small Company, S company, reported net income $40,000 and paid dividends at $15,000 during the year and company acquired 20% of S Company stock January 1st for $105,000. At the end of the year, December 31st, 20x7, M Company-- the fair value of the share-- fair value of the S company is $121,000. And M company, which is acquiring company reporting, operating income of $90,000.

So the first case, again, if M concludes the acquiring company is the M Company, Mock Corporation, is the-- is acquiring company or investing company-- so if M company can exercise their influence on S Company, if that's the case. So this is the keyword that, based on that, we can conclude that the M Company should use the-- apply the fair value method.

So again, what's the journal entry? So the firstly, the purchase. So investment in a debit, investment in subsidiary, credit cash, $105,000. And secondly, according to fair value method, the parent or acquiring

company record income based on the share of dividend declared by the subsidiary or a small company that's there.

So notice that the dividend declared by the Small Company was $15,000. But you got to be careful. These $15,000 is 100% dividend declared by the Small Company. Parent company, or acquiring company, should record income just share of this dividend, which is 20% of the $15,000. That is $3,000.

And what is the journal entry? And notice that, in this case, dividends actually is paid. So therefore, the debit account will be cash $3,000 and credit dividend income based on the fair value method.

And thirdly, another journal entry we got to do is that the fair value change. The fair value at the end of the year is turned out to be $121,000. And we got to compare this amount with the original cost, $105,000. The fair value has increased from $105,000 to $121,000. The increase is $16,000. That increase should be recorded as a gain, which is the income statement effect.

So what's the journal entry? Debit investment in S Company. So investment increased by $16,000. And unrealized gain on S Company is $16,000. So that's the journal entry for-- based on the fair value method. So additional question is that, what is the income reported by M Company? What is the income reported by the acquiring company?

Notice that the M Company, the parent company, has its own income, $90,000. And so this is the-- the income $90,000 is the acquiring company's own income. And we got at the income from a small company based on this entry. So income should be-- M Company's income will be eventually $90,000 is own income plus dividend income $3,000 and also unrealized gain, which is the $16,000. So that will be $109,000. That is the $109,000.

One other month should be reported as an investment in S Company in the balance sheet. So again, this is the fair value method. So that should be reported at the fair market price, which is $121,000.

So now, let's look at the equity methods. Again, the keyword here is exercise significant influence, so that is the indication that the company, M Company, should use the equity method for this investment.

So equity method-- according to the equity method, basically, the acquiring company, M Company, should report-- should record income when acquired company acquiring or invest in a small company report income-- by the share of income.

The income reported by the Small was the $40,000. So therefore, 20% of the $40,000. That's the $8,000. By that amount, the M Company should report income. So what's the journal entry? So we got increased investment in Small, which is $8,000, and credit income from Small, $8,000. That's the entry.

And dividend is considered the reduction of the investment. So dividend amount is, again, $15,000, 20% of the $15,000, that's $3,000. So again, because dividend is paid, debit account is cash $3,000. Notice that what's the credit account, that's the investment. That's the reduction of investment, not the dividend revenue. So $3,000.

So how much the income reported by the M Company based on this equity method? So again, we got to start with their-- the m company's own income, $90,000 plus an income from S Company based on share of income, which is $98,000. So that's the total income reported by M based on-- based on equity method. How much should be reported as an investment is Small in the balance sheet? So that is the-- that is basically-- that is called adjusted cost.

So what adjusted cost means then, we start from cost, but we adjust based on the share of income and share of dividend. So basically, we start from $105,000 and in share of income by the investee is the increased our investment. But share of dividend decreases our investment. So that's the $110,000. So that should be reported in the balance sheet.

And it's very-- and as you may-- as you probably learn from the intermediate accounting, it's-- I think it's very important for you to know that the-- how to show in the in the account, especially investment. According to the key account, that's the investment in subsidiary. So there's the starting from acquisition price And the share of income increase the investment. Investment decreases because of the share of subsidiary dividend.

So this is the thing that we talk about in this lesson. So if we plug in the number, so that's the actual price, $105,000. Share of income, which is 20% of $40,000, that's $8,000. Share of dividend, 20% of $15,000, that's $3000. As a reserve, the investment ending balance is then-- is $111,000.

In the later, we are going to see that the situation where there is another thing that affect the investment, that's the additional amortization. So there is a share of amortization expense. So this will be discussed later in the lesson four, especially when there is a differential. So we will discuss then this part in the chapter in the lesson four.

PROFESSOR: Now, let's talk about the consolidation. And this is the first part, first step of the consolidation. So personally, let's try to understand the situation. The situation is that the parent company acquires 100% of the ownership of the subsidiary at book value-- at book value. So 100%.

So this is the stock acquisition. Personally, this is the stock acquisition. And 100% means that there is no noncontrolling interest. And this book value means that there is no fair value, book value, no differential. OK? So this is no differential. And no good deal-- no good deal.

So this is a really simple case. OK? No NCI, no Noncontrolling Interest, no differential, no goodwill. In the future, in the later lessons, especially lesson 5, we're going to see that when acquiring company, parent company acquires less than 100% at greater than the book value.

And if that is the case, there should be noncontrolling interest. We've got to consider noncontrolling interest. And also, we've got to consider the fact from the differential. And also, we've got to calculate the goodwill that should be reported as well.

For this consolidation, there are some timing issues. The first one is what would it be the consolidation at the time of acquisition-- at the time of acquisition-- whether it be the consolidation. And also, as time goes by, usually, year 1, at the end of the year, what would the consolidation look like?

And what about the consolidated financial statement at the end of the year? What about the following year-- the second year of after the acquisition? So we've got to make sure that the timing of the consolidation-- the thing is, then, so this is the stock acquisition, as you learned, as you know.

In this case, the parent in the case of stock acquisition-- both companies survive, OK? So at the stock acquisition, both companies remain independently. OK? So they have their own financial statement.

But as you know, in the case that acquisition parent company is required to prepare consolidated financial statement as if this is one entity-- so therefore, although the parent subsidiary independence survives and each company has their own financial statement, still, the parent company needs to prepare for consolidated financial statement as if this is one merged entity.

So therefore there should be consolidation and entry-- consolidation entry. This should be made on worksheet, not the real financial statement of the each company. So their individual financial statement will not be affected from this consolidation. Only on the worksheet, we do the consolidation entry. And we combine.

The reason of using the worksheet is just to prepare a consolidated financial statement. OK? So you've got to make sure that this concept-- although it is a very challenging concept, just be aware, then, because each company survives independently. So therefore, the journal entry, which is the consolidated entry, should be made only on the worksheet, not affecting each company's financial statement.

OK, so let's talk more specifically about the time of acquisition. At the time of acquisition, you'll remember that previously, we talked about the combined balance sheet. When a parent company acquires a subsidiary, 100% net asset, at the time, the parent company book value is combined with the fair value of the subsidiary. This is the same.

So we just add these two numbers together, OK? Together, the parent book, parent number, and the subsidiary number, we just add together. And one thing we've got to be careful of is that at the time, we just combine their asset and liability, but not their equity. So therefore, their equity should be eliminated. Their equity should be eliminated. OK?

And also, what happens is then the parent record investment-- the parent record investment-- in its balance sheet. So we've got, basically, the consolidated entry is canceling out each other. They are active with our investment. That's because we are going to add their asset and liability 100%.

So investment is a double counting. So we just eliminate their equity with our investment. OK? So that's the main entry-- consolidate entry, which is the basic consolidation entry. So notice that journal entry-- debit their equity, credit our investment.

And also, at the time of acquisition, the only available financial statement is consolidated balance sheet. So that's the only available financial statement. There is no income statement because there is no operation started yet affecting the parent's book. So therefore, only consolidated financial-- the balance sheet is available at the time of acquisition.

So you can see some examples here. So for example, parent acquires subsidiary's stock for $300,000. It's actually the same as the book value. OK? That's the same as the book value of the subsidiary's equity-- $300,000. And that's the same as subsidiary's equity, which is a net asset of the book-- net asset of the subsidiary.

So therefore, because the consideration, $300,000, is the same as the book value, there is no differential. And there is no noncontrolled interest. So the parent's journal entry-- because this is that action-- they record investment in subsidiary and credit cash-- $300. That's the parent entry.

At the time of acquisition, the thing is the consolidated balance sheet-- we combine their asset and liability, 100%. So therefore, we've got to eliminate our investment. So these investments should be eliminated by crediting investment. And we've got to eliminate the subsidiary's equity.

We cancel each other. And we just combine their asset and liability. If you do that-- and also, one thing that you've got to be aware of is that we've got to eliminate the pre-acquisition accumulative position from subsidiary. So if you look at this balance sheet, before acquisition, if you see the subsidiaries, building and equipment is $600,000, and accumulated depreciation, $300,000.

And the book value there is $300,000, which is the difference between these two numbers. For consolidation, we usually consider, then, the depreciable asset is acquired as a new asset. So instead of combining 600 and accumulate 300, we just combine just the $300,000 of the net amount as if this is acquired as a new asset from the subsidiary.

So in order to achieve that objective, what we need to do is that we do this entry. We credit accumulated depreciation-- $300,000. At the same time, we decrease the building and equipment-- $300,000. Notice that is the accumulated percent before acquisition-- before acquisition.

This should be eliminated. OK? Again, these entries-- these are the consolidated entries. This only happens in the worksheet. So this concept is really important. So worksheet means that no effect on each company's financial statement.

So that means we've got to repeat. So there should be a repeat process. We do the same thing in the following period as well. So if we do that, we can prepare this. If you reflect this consolidation entry in the worksheet, so this is the parent's balance sheet. And this is the subsidiary's balance sheet.

And what do you need to consolidate is basically that parent plus S. So that's the basic step. And then we do something. We need something, adjustment. That is basically this adjustment. So eliminating equity and eliminating investment and eliminate pre-acquisition accumulated depreciation and corresponding building and equipment.

So as you can see, based on that investment, that is credited to making the balance 0. So we eliminate the investment, basically. And also, building equipment is decreased by 300. And accumulated depreciation-- pre-acquisition accumulated $300,000-- decreases.

In the credit, in the liability and equity, we just eliminate their equity. So we debit their equity-- 200, 100. And the remaining balance is just for the parent's equity. Common stock, 500, 300. And finally, we can make sure of the accuracy by comparing these numbers-- $1,300,000.

OK. Now, let's take a look at another example through the Excel worksheet. OK? So let's take a look at another example together. So this is the consolidation at acquisition. So let's take a look at an example together. OK? So let's try to understand the situation.

So a company acquired 100% of the F company. B company acquired 100% of F company's stock. So this is the acquisition for $150,000. OK? 150,000. So that's the consideration. And F company-- so who is the acquiring company? That's the B company.

And subsidiary or acquiring is based-- F company. The $150,000-- that is actually the same as their equity, the 90, 60, their common stock retained. The sum of these two numbers is exactly same as 150. So this is the case-- 100% acquisition. And the consideration, $150,000, is just the same as the book value of net asset of subsidiary. So there is no differential.

And as you can see, this also confirms the fact that the book value of F net asset liability is the same as the fair value. OK? So there is no differential. And also, there's an additional information. F company, which is the subsidiary-- accumulated depreciation on the action date was $30,000. OK?

So from here, $150,000 of this-- the number of building equipment, $150,000-- that includes the $30,000 of accumulated. But that should be eliminated. That should be eliminated. So let's try to do some entries. Let's try to do an entry and try to prepare this consolidated balance sheet.

Again, at the time of acquisition, only consolidated balance sheet is available. So the first entry that the parent company needs to do is that purchase. OK? The purchase investment in F company-- $150,000, cash, $150,000. Secondly, now, we've got to consolidate, which is basically elimination entry.

So make sure that we got it cancelled. We've got to eliminate their equity and cancel with our investment. So our investment-- $150,000. And also, we've got to cancel. We've got to cancel with their equity. And make sure that-- this book value calculation table actually helps you understand how our investment can be matched with and cancelled with their equity.

So their common stock at this time is that $60,000 and $90,000 retained earnings. OK? So that's $60,000 and $90,000. The sum of these two numbers is exactly the same as $150,000 of our investment. And based on that, base cost of entry is-- basically, we cancel that with our investment.

The common, we debit. We eliminate their equity common stock. We eliminate their retained earnings. And the sum is 150. That is actually the same as our investment-- $150,000. Again, why do we eliminate our investment? Because we're going to-- the parent company-- consolidate 100% asset and liability.

And the net amount is just the same as $150,000. So therefore, we've got to eliminate the investment to avoid the double counting. And also, this is the basic consolidation entry. In addition to that, we've got to eliminate the pre-acquisition accumulated depreciation-- $30,000.

The way to eliminate that one is that we eliminate accumulated depreciation-- $30,000. And at the same time, we eliminate building and equipment-- $30,000-- as if this is a new asset from the subsidiary at the time of acquisition. So based on that, if we do that, now, we can just prepare the consolidation balance sheet.

Basically, we got through the-- so this is each company's balance sheet. And we have a column for consolidated balance sheet. So it's basically parent, the subsidy, and some adjustment. OK?

So everything-- we just add them together. That's good enough. But we've got to be careful about something. For example, the building equipment is this part-- we've got to eliminate as $30,000 and $30,000 at the same time, which is to eliminate the pre-acquisition accumulated depreciation.

And investment is based on the $150,000. Should be, as you can see-- we eliminate. We credit. So we credit $150,000 in the worksheet, making sure that investment becomes 0 eventually. And also, what have we got to eliminate? We've got to eliminate their equity-- their equity.

So from here we eliminate their common stock, their retained earnings. So because this credit balance-- we debit to eliminate those accounts. So $60,000 should be eliminated. And $90,000 of the subsidiary retained earnings should be eliminated. OK?

If we do that, this is the only one. This is common stock retained earnings. It's just the same as the parent with common stock retainers because we eliminated subsidiaries in equity through the consolidation entry. And as a result, we can verify this equality-- the $747,000. And that completes that consolidated balance sheet at the time of acquisition.

PROFESSOR: OK, now, let's talk about the consolidation after the acquisition, especially the first year and the second year after the acquisition. Let's start with discussing the first year of the acquisition by looking at this example. So in this particular example, I can see that, again, the situation is that the parent acquires 100% of the stock, common stocks of the acquiring subsidiary, at book value.

So there is no differential. There is no non-controlling interest. So, now, the action happened January 1st, 20X1. Now, the time is December 31st, this 20X1. So over the year, subsidiary recorded income of $50,000 and paid dividend, $30,000, OK? So because the subsidiary now starts to contribute to the parents through the act method and the consolidation, so the consolidation should include not only the balance sheet, also.

But the financial statement includes consolidated income statement and consolidated balance sheet, the retained earnings statement, et cetera. And so, those are the main financial statements of the consolidation, the income statement, retained earnings, and the balance sheet. OK, so, now, the parent needs to, and we assume, that the parent uses the equity method to account for the investment in the subsidiary.

So what's the journal entry for the parents? The parents record the purchase initially, firstly, the purchase of this subsidiary stock, which is $300,000 debit and cash $300,000. And based on equity method, the parent company needs to report investment income, income from subsidiary, based on the share of income. But in this case, because the share ownership is 100%, the entire income is recorded as income from subsidiary and debit account. And also, debit account is the increasing investment-- so debit investment, $50,000, and credit income from subsidiary.

And third, the dividend paid by the subsidiary decreases investment. So the journal entry, again, because their share ownership is 100%, the entire $30,000 is actually decreased the investment. And the journal entry is the debit cash, $30,000, credit investment, $30,000. As a result, the investment amount at the end of the year will be-- how much is the investment?

The investment amount, initially, the purchase, $300,000, and the share of income at $50,000 increase investment. And dividend paid by the investee, subsidiary, or decreased investment as a reserve, the ending balance of the investment at the end of the year will be $320,000. And also, how about income from subsidiary? Income from special subsidiary, so that is the what? That is the $50,000, OK? That is the $50,000.

So this equity method is actually trying to approximate the effect of consolidation, the effect from the subsidiary, by using these two counts, the investment in special, investment in subsidiary, and income from subsidiary. So the purpose of consolidation is basically, as we discussed earlier, the basic consolidation, basically, we have to cancel our investment amount with the equity, OK? So that's the starting point.

Our investment at the end of the year is the $320,000. And we will cancel this investment amount with the subsidiary's equity amount at the end of the year. And also, income from the subsidiary, $50,000, will be also eliminated because, through the consolidation, the parents will combine the subsidiary's revenues and expenses entirely, as reserve income from subsidiary will be eliminated.

So, basic consolidation entry, so we have to do some basic consolidation entries. So to make it easy, this basic consolidation entry, this book value calculation is very useful. On the right-hand side, we record the equity, the subsidiary's equity, common the retained earnings. The first line is the beginning value of the equity. And the second line is the net income, that increased retained earnings. And third line is the dividend from the subsidiary.

As a result, the last line is actually the ending balance. The common stock of the subsidiary is just $200,000. And ending balance, retained earnings, is $120,000. On the left-hand side is actually our investment. The investment at the end of the year is $320,000, OK? So, therefore, this $320,000 is exactly the same as the ending balance of the subsidiary's equity. And the thing is, then, through the consolidation and through the elimination, we will cancel these two amount, OK? We will cancel the equity. And we will cancel our investment at the end of the year.

So, please be aware of this. Be familiar with this consolidation entry. So our purpose is that there are equity. So we will cancel their equity with our investment at the end of the year. So we buy debiting equity and crediting investment. So you can see, the debit common stock. And this is the beginning balance, OK? The common stock, $200,000, the subsidiary's common retained earnings, $100,000 with debit. And also, we debit income from subsidiary, which is $50,000-- $50,000.

We credit dividends declared. So this is from the subsidiary, dividend from subsidiary. And through the consolidation, that should be eliminated. So dividends paid from the subsidiaries should be eliminated. And if you do the calculation, the net amount is the same as $320,000. Essentially, this is the same as the ending balance of the subsidiary's equity amount. And we cancel with our investment at the end of the year, which is $320,000.

So that's the basic consolidation entry to eliminate their investment. And secondly, we got to eliminate the pre-acquisition accumulated depreciation. That was $300,000, OK? Before acquisition, the subsidiary had the accumulated amount of the $300,000. So we eliminate the amount by debiting accumulated depreciation, $300,000, and crediting building and equipment, $300,000.

If you do that, then we are now ready to prepare for consolidated financial statement, OK? So the first starting point is income statement. So, basically, we combine the parent and subsidiary's income statement. So, again, the consolidation is nothing but the addition of the parent number and subsidy number and some adjustment. So that's the consolidated number. So we can see that, in the income statement, everything is actually-- it's just good enough to just add the parent number and subsidiary number.

But notice that there is income from subsidiary, $50,000. And where does it come from? Because the parent uses ACT method. So parent has, in their book, they have income from subsidiary through this active method entry. And through the consolidation entry, this income from the subsidiary should be eliminated. So how to eliminate the number is that, in the worksheet, we debit $50,000. And as a result, the ending balance becomes zero.

And why? Again, why we eliminate this amount is because we combine their subsidiary's revenue, sales, and expenses, 100% So, therefore, we got to eliminate our income from subsidiary because that's a double counting. So we eliminate this amount, this income from subsidiary, to avoid the double counting and making the balance zero. As a reserve, the consolidated income is $190,000. Notice that this $190,000 of consolidated income is the same as the parent's income, $190,000.

And this is not a coincidence. But why is the case? Because parent uses equity method. The parent uses equity method. The purpose of equity method is to approximate the effect of a consolidation. And we call

that equity method as one-line consolidation, one-line consolidation, because this approximate effect of consolidation. And why this is the same? Because, through this income from subsidiary, the parent already includes this income, $50,000.

That's exactly the same as the subsidiary's income, $50,000. So, basically, we eliminate the $50,000 through this entry. But we add their net income, $50,000. The same amount is eliminated. But we add the same amount through the consolidation process. As a result, these two number should be the same. Consolidated income and parent income should be the same, as long as the parent uses the equity method.

Then, secondly, we got to prepare for the statement, retained earnings. And starting from the beginning balance, so 300 100, we have to eliminate the beginning balance of the subsidiary. We do this by debiting. So as a result, the beginning balance in the consolidated retained earnings is the same as the parent retained earnings. And net income, this is actually, just copy and paste down from this net income, this line. And just copy and paste to this part.

And as a result, $190,000 should be added to the consolidated retained earnings. And, finally, dividend declared, the subsidiary dividend should be eliminated. And this is $60,000. As a result, consolidated retained earnings is $430,000. Again, this is the same as the parent's retained earnings. And the reason is because the parent uses equity method. So that completes the statement retained earnings.

Now, we got to prepare for consolidated balance sheet. So, again, most of the time, it's good enough just by adding the parent number and subsidiary number. But there are some things that we got to make adjustments, especially investment in subsidiary, which is ending balance between $20,000, based on equity method entry that should be eliminated.

So we credit $320,000, making the balance zero in the consolidated number. And the buildings and equipment and accumulated depreciation, why we do that? Because this is the pre-acquisition of accumulated depreciation. The reason is because we want to show the building and equipment as a new asset after this acquisition.

So, therefore, the accumulated depreciation before acquisition should be eliminated. So if we do that, we obtain the total consolidated asset as $1,430,000. And, lastly, in the equity part, we got to eliminate the common stock, which is the subsidiary's common should be eliminated. And this retained earnings line, you just copy and paste from the statement of retained earnings. Statement of retained earnings, the ending balance should be copied and pasted down.

And then, if you do that, the total consolidated liability and equity should be the same as this total asset. And that verifies the accuracy of this consolidation process. So, now, let's take a look at another example of the initial year consolidation by looking at the Excel worksheet. So this is the initial year example.

We have trial balances from a parent company and a subsidiary company. And this is after one year after the acquisition. At the beginning of the year, the parent company acquires a subsidiary stock 100%, $300,000 consolidation, which is the same as the book value-- so, book value. So, therefore, there is no differential. There is no non-controlling interest. And the parent uses the equity method to account for the investment. And this is the timeline.

So you've got to make sure, what's the timeline? The timeline here is the December 31st, 20X8, which is one year after the acquisition. Now, the parent company needs to prepare for consolidated financial statement. And if you see that, if you look close, a little closer about this trial balance number in the parent number, so there is an income from subsidiary, which is $75,000-- $75,000.

And the subsidiary, during the year, they'll pay the dividend of $20,000. And if you see that, there's the sales from the subsidiary. And there is income. And there's expenses reported by the subsidiary. So there's cost of goods sold, depreciation expense, and asset expense. So if we subtract those numbers, those three numbers from the sales, that is the same as the $75,000.

So $250,000 minus expenses, cost of goods sold, depreciation expense, and asset expense, the difference is just the same as $75,000. Why is this the same? That's obvious. It's kind of obvious because the parent uses equity method. So, the subsidiary income is $75,000. And the dividend is the $20,000. So what's the journal entry? What's the journal entry?

So, journal entry, so, again, the parent uses the equity method, so the purchase, $300,000, investment and cash. And what happens is that, according to equity method, the parent company needs to record the income from subsidiary. So the subsidiary reports income as $75,000, based on the sales and expenses. The difference is the income of the $75,000.

So, for that number, the parent company increases the investment, $75,000, and credit income from subsidiaries, $75,000-- $75,000. And the dividend is $20,000. Dividend is $20,000. That is considered the reduction of the investment, according to equity method. So that's $20,000 cash and credit investment.

OK, if you do that, you will find out the balance. Ending balance of the investment is-- and acquisition, net income, and dividend, that's $355,000. And income from subsidiary is $75,000, OK? So for consolidation, as we discussed, we got to eliminate our investment and income from subsidiary to avoid the double counting, because we will combine subsidiary's revenue expenses and their asset entirely. So we got to eliminate those numbers from parent's to for the consolidation to avoid double counting.

OK, so, now, let's try to do some consolidation entries. So, again, it's very convenient to compare, by using this table, by comparing subsidiary's equity and our investment account. So the first line is, again, that's the initial balance. The beginning balance, common stock is 200,000. Retain the 100. So that is related to our investment, $300,000. And the subsidiary reporting income, $75,000, that increases our investment. And dividend paid at $20,000, that decreases our investment.

So, therefore, our investment is the same as 355, which is the same as the ending balance of the subsidiary's equity. And they will cancel each other. So by using this information, we can easily complete this basic consolidation entry. So, basically, we got to eliminate the initial balance, the beginning balance, common stock, $200,000. And the beginning balance of retained earnings of subsidiary, $100,000, should be eliminated. And income from subsidiary should be eliminated, which is the $75,000.

So that completes the debit part. In the credit, we got to eliminate dividend declared, $20,000, from subsidiary. But basically, we cannot pay the dividend for the same company, OK? Consolidation, the idea is that we assume that this is the one entity. As a result, subsidiary dividend cannot be paid to the parents. That should be eliminated. And, again, this net amount should be the same as our investment. So, therefore, we eliminate our investment amount. So that is the consolidation worksheet. So that is the basic consolidation entry.

In addition to that, we got to eliminate the acquisition's accumulated depreciation. So if you see here, so this is actually continuation from the previous example. But this is one year after. So what happens is that the accumulated depreciation, at the end of the year, that is the actual number is $20,000. But if you see, the depreciation expense is $10,000, OK?

So one year after, accumulated depreciation is $20,000. And annual depreciation expense is $10,000. So what it means, then, the difference is the $10,000. That should be the acquisition of accumulated

depreciation. And that should be eliminated through the consolidation process. So that is the $10,000, accumulated depreciation, 10,000. And building and equipment is $10,000.

And now, after doing that, we are ready to prepare for consolidated financial statements, starting from the income statement. So everything, which is good enough, just combine the parent number and subsidiary number, just pure addition. But we got to eliminate income from subsidiary, $75,000, which is reported by the parent. It should be eliminated to avoid the double counting.

In the worksheet, we debit $75,000, making sure the balance should be zero in the consolidated number. If you do that, you will find out, the consolidated income is $400,000. That is the same as the parent's income, $400,000. And why is this the case? Because the parent uses equity method. So that's the reason why this is identical.

And secondly, after doing that, now, we are ready to prepare for retained earnings. Again, this $100,000 of the subsidiary's retained earnings should be eliminated by debiting in the worksheet. And then, the net income is copy and pasted from this net income from the consolidated income statement. So that's just leaving it as they are. And the dividends declared, the subsidiary's dividend should be eliminated by crediting $20,000 in the worksheet.

If you do that, you can verify this equality. The consolidated retained earnings, $25,000, should be the same as the parent's retained earnings. And again, the reason is just because the parent uses equity method. Now, let's go to the balance sheet. So, starting from the asset, most of them is actually just pure addition. So there are some accounts that we have to make adjustment, especially this investment, $355,000. Through the consolidated entry, this number should be eliminated by crediting in the worksheet, $355,000.

And as a result, the consolidated number is zero. And what else? We've got to eliminate the pre-acquisition accumulated depreciation for this building and equipment from the subsidiary. By reducing building and equipment by $10,000, which is pre-acquisition accumulated depreciation, at the same time, we got to eliminate and reduce the accumulated depreciation of the $10,000 from the subsidiary. If you do that, we have this consolidated asset, $1,445,000.

Now, let's move on to the liability and the equity. So liability is just good enough just pure addition. Common stock, and again, we got to eliminate subsidiary's common stock, $200,000, by debiting the worksheet. And the retained earnings, just copy and paste from the statement retained earnings. So therefore, as a consequence, we can verify the equality of the parents. This asset, consolidated asset, is the same as consolidated liabilities and equity.

PROFESSOR: OK, now let's talk about the consolidation in the second year. Again, the situation is that 100% acquisition at book value. So there is no differential, no non-controlling interest. So in the second year, we will continue to use the same example as we did earlier previously.

So in the second year, subsidiary reports income $75,000 and also paid a dividend $40,000. As we did in the first year, the subsidiary, the Peerless will record the income, the same income $75,000 through their equity master entry and $40,000 dividend will decrease the investment $40,000. So equity master entry is just a $75,000 and $40,000. $75,000 investment in subsidiary income from $75,000. And the dividend is a cash 40 and investment decrease $40,000.

As a result, the investment, and I think it's very useful and important for you to practice what will be the ending balance, what will be the ending balance, especially this investment amount? The beginning balance, from the previous year, the beginning balance from the previous year was $320,000. So that's a $320,000 from the previous year.

For this year, in the second year, $75,000 income increased the investment, and $40,000 dividend decrease the investment in subsidiary. As a reserve, the ending balance in the second year will be $395,000 minus $40,000 gives you the 355,000 OK, so that's the $355,000. And income from subsidiary in the second year, this again, is just the income, which is $75,000. So those two numbers should be eliminated through the consolidation process.

So again, now, let's quickly look at the consolidation entries. To facilitate the consolidation process it's very useful to prepare this book value calculation. In the right-hand side, the summarize the equity of the subsidiary, the starting from beginning balance and income and dividend. And you can see the ending balance is $200,000 and retained earnings $155,000.

And our investment is, actually, through the equity method, is just matches the beginning balance $320,000 of the investment. Their net income increase our investment, and their dividend decrease the investment, ending balance, $355,000. So essentially we need to eliminate $355,000 of our investment with their equity.

So what's the basic construct entry? So the commerce that we debit, we limit their beginning balance common stock $200,000. And their beginning balance retained earnings, $120,000 should be eliminated and income from sum should be eliminated at $75,000. So that's the debit part.

In the credit, dividend declared by the subsidiary needs to be eliminated by crediting $40,000, and the net amount is the same at $355,000. So we eliminate, finally, our investment in subsidiary. And also, we do the same elimination of the pre-acquisition accumulated depreciation.

Again, we repeat this process because these consolidation entries are made in the in the worksheet, not affecting the individual financial statement of each company. So therefore, we got to repeat this process. The same accumulated depreciation should be eliminated every year. So once we do that, now we are ready to prepare for consolidated financial statement.

So we combine the processes. Again, we combine the parent and subsidiary and do some adjustment. So for this part, starting from the income statement, so we add the parent and subsidiary number is, especially income from subsidiary $75,000, which is the based on activation number should be eliminated to avoid the double counting and making sure the balance is zero.

And as a result, the consolidated income number is $235,000. And that is, again, that's the same as the parent number. The reason is, again, because the parent uses active method, they already include the $75,000 income in their income statement. And we eliminate the $75,000, but we add the same $75,000 through the consolidation process.

So therefore, the post numbers should be identical. In the statement and now, we got to do statement retained earnings. But personally, we got to eliminate the beginning balance of the retained earnings and also net income is just copy and paste from the consolidated income statement, so that's just the same.

And we got to subtract dividend declared, especially we got to eliminate the dividend from the subsidiary. And again, if we do that, the ending balance of retained earnings of consolidated retained earnings should be the same as the parent's retained earnings. Again, the reason is simply because the parent uses equity method.

Now let's go to the balance sheet. So especially we got to focus on the one account we got to eliminate investment in subsidiary, $355,000 which is should be eliminated and making the balance posted number is zero, and the building and equipment accumulated depreciation, we do the same elimination of the pre-acquisition accumulated depreciation $300,000, resulting in the ending balance of a consolidated asset. Total asset is $1,605,000.

For the liability and the equity, for a liability just we just add together a common stock subsidiary. $200,000 should be eliminated by debiting. And retained earnings, it's just a copy and paste from the statement retained earnings ending balance.

As a result, we can verify this equality. Total asset is the same as total liability and equity. And as a result, we can verify the accuracy of the consolidation. And also, our focus is basically equity method. OK, so the test and the exam will be based on equity method, but it's good to know the parent can use the sum. The parent company or parent company may use the cost method, instead of equity method.

So cost method is similar to the fair value method. So according to cost method, parents record income based on the dividend. Dividend declared by the subsidiary. So they record dividend income. And their subsidiary income does not affect in the case cost method.

Unlike the fair value method, cost method does not record income for the fair value change. So the journal entry is just this kind of journal entry, the purchase and dividend income. And based on that, we do the this consolidation entry. So basically, we beginning balance of our investment with canceled with their equity, and dividend income and dividend declared should be eliminated.

And we do the eliminate the pre-acquisition of community position with the same as the previous example. So you can just read the textbook for more detail. But I'd like to point out the fact that the parent's income is then not the $50,000, just the $30,000 base, just the dividend income. And basically what you need to do, we got to eliminate this dividend income and add their substrate income, revenue expense, 100%.

As a result, our cost income $190,000, whereas, our parent income, $170,000. So you can see that in the case of cost method, these numbers are not the same. That's kind of obvious because unlike the-- different from the equity method, parents just record $30,000 income instead of the total $50,000. So that makes the difference of $20,000.

So that's the basic idea. So that's the basic idea. So because the reason the retained earnings, as well, is different. Consolidated retained earnings and the parent retained are different in the case of the cost method. But make sure this consolidated fund is the same. It's the same.

This last column is the same regardless of which method company uses either active method, cost method, it's just the same. Consolidated number are the same, but the equality between the parents and cost number are different. Equity method the same, whereas, cost method is different.

OK, now, let's take a look at the second-year example, another example, through the Excel worksheet. So now it is a second-year example. So this is a kind of continuation from the previous example.

So again, so activation happened two years ago, January 1, 20X8. The action price is $300,000, which was equal to the book value of the subsidiaries at the time. Now, the timeline, to make sure the timeline is the second year, which is December 31, 20X9. So this is the second year, two year after the acquisition.

So again, we got to make sure that, again, the parent uses active method to account for the investment. So their investment amount will reflect the effect of the consolidation. So there you can make sure that you see these trial balances. The parent report, the income from subsidiary $80,000, and their investment amount, their investment is $405,000 So that's how those are based on active method entries.

And if you look at the subsidiary's numbers, so they pay the dividend during the year, $30,000 and also income, their income is sales minus this cost of goods sold depreciation and selling and is a expense. If you do the calculation, $300,000, and if you subtract all the expenses, that should be the same as that is the same as $80,000.

That is kind of obvious because, again, that's because the parent uses active method and 100% ownership. So therefore, the income from subsidiary should be the same as the net income reported by the subsidiary, which is sales minus expenses, $80,000. And also accumulated depreciation is $30,000 in the second year.

So after the acquisition, $30,000 over-- so $30,000 and annual depreciation expense, $10,000 based on the idea what we can find out the pre-acquisition accumulated depreciation. Over two years, $30,000, after two years, $30,000 and annual depreciation expense, $10,000.

After two years after acquisition, the company should have reported total $20,000 of accumulated depreciation after the acquisition. So therefore, the difference of $10,000 should have been the pre-acquisition accumulated depreciation that needs to be eliminated through the consolidation process.

So now let's take a look at the journal entry, which is the active method. So active method investment amount, so the income from subsidiary is-- the subsidiary reporting income $80,000 that increase our investment and also that increases our income from subsidiary.

And dividend paid and declared by the subsidiary, that was the $30,000 that decreases our investment, that decreases our investment in subsidiary, $30,000 cash, and investment decreased by $30,000.

So if you see that the investment amount of $355,000, that is actually from carryover from the previous year. If you do reflect this information, the ending balance is that $405,000 of investment. Income from subsidiary is $80,000. Again, those are based on accumlated And those two number should be eliminated in the consolidated worksheet. Consolidation process in the worksheet will eliminate those amount and cancel with the subsidiary's equity.

So again, it's really useful to prepare this table to compare a subsidiary's equity with our investment. So this is the beginning balance of the equity, $200,000 $155,000. Again, that is the-- you can see that the number is that this is the beginning balance. Beginning balance equity $200,000, $155,000.

During the year, subsidiary report $80,000 income and declare dividend $30,000. As a result, the ending balance common stock at $200,000 and ending balance of retained earnings $205,000. That should be the same as our investment of $405,000.

So once we prepare this table, then we are ready to do some consolidated entry. Essentially, the thing is that we eliminate the equity of subsidiary, and we eliminate our investment. Common stock, the beginning balance is $200,000. And retained on its beginning balance $155,000, and income from subsidiary $80,000, and dividend declared $30,000 credit. We eliminate, we cancel with our investment ending balance, $405,000.

And in addition to that, because the consolidation is a journal entry is done on the worksheet, we got to the same elimination of the preaction accumulated depreciation. Again, that was the $10,000. So debit accumulated depreciation $10,000 and credit building and equipment $10,000.

So and once you do that, we are ready to complete this consolidated financial statement. So again, income from this subsidiary, in the second year, needs to be eliminated to avoid double counting because we add there, a subsidiary add sales and expenses entirely. So to avoid double count, we eliminate that one. And the consolidated number, that's a zero.

And after doing that, we can verify the quality of consolidated income $380,000. It's the same as the parent's income, $380,000. Again, the reason is because parent uses equity method.

So let's move on to our retained earnings statement. So firstly, we got to eliminate the beginning balance of retained earnings of subsidiary by debiting $155,000. And this net income is just same as-- this net income just copy and paste. The dividend declared, substituted dividend, needs to be eliminated by crediting in the worksheet $30,000.

As a result, you can verify this equality again. Consolidated retained $680,000 should be the same as $680,000 of the parent's retained earnings. In the balance sheet, we got to eliminate the investment, the ending balance investment, $405,000. In the worksheet we credit $405,000. And achieves the zero balance in the consolidated number.

And the building equipment and accumulated depreciation, again, we eliminate pre-accretion accumulated depreciation as if the asset is a new asset after the acquisition, $10,000 and $10,000. So that mixing making the total, the consolidated asset $1,525.000

Now, let's move on to the liability and equity. The liability is just the same. We just add together. Then the common stock, their common stock should be eliminated by debiting the worksheet $200,000. And then you can verify and earnings, again, just to copy and paste from this ending balance of retained earnings.

And as a result, you can verify this equality of the total asset, total liabilities, and equity. And so that completes. You can verify this accuracy by comparing these two numbers.