Chapter 2 – REPORTING INTERCORPORATE INTERESTS AND CONSOLIDATION OF WHOLLY
OWNED SUBSIDIARIES WITH NO DIFFERENTIAL
CHAPTER 2
REPORTING INTERCORPORATE INTERESTS AND CONSOLIDATION
OF WHOLLY OWNED SUBSIDIARIES WITH NO DIFFERENTIAL
IMPORTANT NOTE TO INSTRUCTORS
The 11th edition uses a building block approach to our coverage of consolidation in
chapters 2 through 5. Chapter 2 introduces our coverage of consolidation in the most basic
setting when the subsidiary is either created or purchased at an amount equal to the book value of
the subsidiary’s underlying net assets.
Chapter 3 explains how the basic consolidation process changes when the parent
company owns less than 100 percent of the subsidiary. Chapter 4 shows how the consolidation
process differs when the parent company acquires the subsidiary for an amount greater (or less)
than the book value of the subsidiary’s net assets. Finally, Chapter 5 presents the most complex
consolidation scenario (where the parent owns less than 100 percent of the subsidiary’s
outstanding voting stock and the acquisition price is not equal to the book value of the
subsidiary’s net assets). In order to facilitate this new approach, we emphasize that this edition
includes consolidation entries used in consolidation to facilitate the elimination of the investment
in a subsidiary in two steps: (1) first the book value portion of the investment and income from
the subsidiary are eliminated and (2) then the differential portion of the investment and income
from subsidiary are eliminated with separate entries. We believe that this approach is more
intuitive for students.
Chapter 02 – REPORTING INTERCORPORATE INTERESTS
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OVERVIEW OF CHAPTER 2
Chapter 2 provides detailed coverage of the accounting and reporting requirements for
investments in the common stock of another company. It presents the criteria used in
determining when equity method reporting must be applied, and it fully illustrates and compares
both the cost method and equity method. While coverage of this topic may seem to replicate
materials presented in the typical intermediate accounting sequence, many students do not have
an adequate understanding of the entries recorded on the parent company’s books and experience
problems with the consolidation entries needed in the consolidation process as a result.
The discussion of the cost method includes purchases and sales of additional shares
subsequent to the initial investment. The discussion of the equity method significantly extends
beyond the cost method coverage to include changes in the number of shares held and retroactive
application of the equity method when sufficient additional shares of the investee are acquired to
attain significant influence. Chapter 2 also illustrates the use of fair value option.
We introduce the most basic setting for learning consolidation—when the subsidiary is
created or 100% is purchased at book value. In this most simple scenario, there is no differential
and there is no need to account for a noncontrolling interest. It allows students to become
familiar with the consolidation process in the easiest possible scenario.
Appendix 2A covers many topics that may be more tangential, including how to
determine significant influence, unrealized intercompany profits, additional requirements under
ASC 323-10, Investors’ share of other comprehensive income, and alternative versions to the
equity method of accounting for investments in consolidated subsidiaries.
Appendix 2B repeats the consolidation example from the chapter when the parent
company uses the cost method instead of the equity method.
Chapter 02 – REPORTING INTERCORPORATE INTERESTS
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LEARNING OBJECTIVES
When students finish studying this chapter, they should be able to:
LO 2-1 Understand and explain how ownership and control can influence the accounting
for investments in common stock.
LO 2-2 Prepare journal entries using the cost method for accounting for investments.
LO 2-3 Prepare journal entries using the equity method for accounting for investments.
LO 2-4 Understand and explain differences between the cost and equity methods.
LO 2-5 Prepare journal entries using the fair value option.
LO 2-6 Make calculations and prepare basic consolidation entries for a simple
consolidation.
LO 2-7 Prepare a consolidation worksheet.
SYNOPSIS OF CHAPTER 2
Reporting Intercorporate Interests and
Consolidation of Wholly Owned Subsidiaries with no Differential
Berkshire Hathaway’s Many Investments
LO 2-1 Understand and explain how ownership and control can influence the accounting
for investments in common stock.
Accounting for Investments in Common Stock
LO 2-2 Prepare journal entries using the cost method for accounting for investments.
The Cost Method
Accounting Procedures under the Cost Method
Declaration of Dividends in Excess of Earnings since Acquisition
Acquisition at Interim Date
Changes in the Number of Shares Held
LO 2-3 Prepare journal entries using the equity method for accounting for investments.
The Equity Method
Use of the Equity Method
Investor’s Equity in the Investee
Recognition of Income
Recognition of Dividends
Differences in the Carrying Amount of the Investment and Investment Income
under the Cost and Equity Methods
Acquisition at Interim Date
Changes in the Number of Shares Held
Chapter 02 – REPORTING INTERCORPORATE INTERESTS
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LO 2-4 Understand and explain differences between the cost and equity methods.
Comparison of the Cost and Equity Methods
LO 2-5 Prepare journal entries using the fair value option.
The Fair Value Option
LO 2-6 Make calculations and prepare basic consolidation entries for a simple
consolidation.
Overview of the Consolidation Process
Consolidation Procedures for Wholly-Owned Subsidiaries that are Created or Purchased
at Book Value
LO 2-7 Prepare a consolidation worksheet.
Consolidation Worksheets
Worksheet Format
Nature of Consolidation Entries
Consolidated Balance Sheet with Wholly-Owned Subsidiary
100 Percent Ownership Acquired at Book Value
Consolidation Subsequent to Acquisition
Consolidated Net Income
Consolidated Retained Earnings
Consolidated Financial Statements—100 Percent Ownership, Created or Acquired at
Book Value
Initial Year of Ownership
Second and Subsequent Years of Ownership
Consolidated Net Income and Retained Earnings
Appendix 2A—Additional Considerations Relating to the Equity Method
Determination of Significant Influence
Unrealized Intercompany Profits
Additional Requirements of ASC 323-10
Investor’s Share of Other Comprehensive Income
Alternative Versions of the Equity Method of Accounting for Investments in
Subsidiaries
Appendix 2B—Consolidation and the Cost Method
Consolidation—Year of Combination
Consolidation—Second Year of Ownership
Chapter 02 – REPORTING INTERCORPORATE INTERESTS
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NOTES ON POWERPOINT SLIDES
We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since
instructors often have different styles and preferences, we have attempted to include slides that
will accommodate different approaches and that can be adapted to classes with different levels of
preparation. For example, some instructors prefer to introduce the material before students have
read the chapter. We have tried to facilitate these types of introductory discussions by including
slides that replicate key points from the chapter. Other instructors expect students to have read
the chapter and attempted homework problems before coming to class. As a result, they may not
find it useful to review all of the topics in the chapter or to include slides that simply review
many of the details they expect students to study before class. However, instructors following
this approach often like to use sample exercises and problems built into the slides that allow
them to have extended discussions or to facilitate group interaction in class.
If instructors elect to spend two class periods on the same subject, they might find a combination
of both styles to be useful by first introducing foundational material before students have read
the chapter and studied the topic, followed by an extended discussion the next class period after
students have read the chapter and attempted homework problems.
We have tried to develop slides that can facilitate a flexible approach to allow instructors to
select the slides that best match their objectives and style for class discussions. This is the reason
we are including over 100 slides for some chapters in the text. We do not expect all instructors
to use all slides, but the slide files should help support different teaching approaches and allow
instructors to select the subset of slides that best matches their specific discussion objectives.
The slides are organized by learning objective. We have included a slide at the beginning of
each learning objective to show where the new material begins. Instructors may or may not want
to use these learning objective slides in class. We provide them primarily as a way of organizing
the material. We also include short multiple choice questions at the end of most learning
objectives. Some instructors find it useful to pause periodically during class to assess students’
level of understanding. For this reason, we include several “practice quiz questions” that can be
used throughout class discussions to engage students, help them focus on key points, or to
facilitate group interaction. Finally, we provide longer exercises and problems that many
instructors find useful in assessing understanding and encouraging group learning.
LO 2-1 Understand and explain how ownership and control can influence the accounting for
investments in common stock.
• Slides 3-7 summarize basic concepts related to LO 2-1. While slide 4 repeats the
diagram from the chapter, slide 5 provides a more interactive view of the same
concept.
• Instructors should choose slides from this LO that they deem most important to
emphasize to their students
LO 2-2 Prepare journal entries using the cost method for accounting for investments.
Chapter 02 – REPORTING INTERCORPORATE INTERESTS
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• Slides 11-19 summarize basic concepts related to LO 2-2 related to the cost method.
The simple example in slide 16 allows students to practice cost method journal
entries.
• Instructors should choose slides from this LO that they deem most important to
emphasize to their students
LO 2-3 Prepare journal entries using the equity method for accounting for investments.
• Slides 22-37 summarize basic concepts related to LO 2-3 related to the equity
method. The simple example in slides 29-30 allows students to practice equity
method journal entries.
• Instructors should choose slides from this LO that they deem most important to
emphasize to their students
LO 2-4 Understand and explain differences between the cost and equity methods.
• Slides 39-45 summarize basic concepts related to LO 2-4 comparing the cost and
equity methods. The example in slides 42–44 allows students to practice making
journal entries under both methods and to easily compare them.
• Instructors should choose slides from this LO that they deem most important to
emphasize to their students
LO 2-5 Prepare journal entries using the fair value option.
• Slides 49-50 summarizes the fair value option and slide 50 provides an example to
allow students to practice the fair value option.
LO 2-6 Make calculations and prepare basic consolidation entries for a simple consolidation.
• Slides 52-53 provide a summary of the consolidation process.
LO 2-7 Prepare a consolidation worksheet.
• Slides 55-110 show students how to set up the worksheet.
• Slide 56 allows the instructor to explain how the worksheet is used to calculate the
numbers used in consolidated financial statements.
• Slides 57-59 introduce the concept of consolidation entries.
• Slide 60 introduces a comprehensive example to be used to illustrate the
consolidation process under the equity method.
• Slides 61-71 show how to make basic book value calculations used in the basic
consolidation entry. This series of slides provides the foundation for helping students
begin to learn how to prepare consolidated financial statements. Instructors should
spend enough time here to ensure that students understand these basic concepts.
• Slides 72-74 show students how to set up the worksheet. In slide 72 instructors should
explain that the first step in preparing a consolidation worksheet is to enter the
numbers from trail balances of the parent and subsidiary into the first two columns of
the worksheet. In slide 73, we emphasize that the same line items that are subtotaled
in the actual financial statements of the companies need to subtotaled in the
consolidation entry columns. This is a critical point. In slide 74 we ask students to
introduce the numbers from the basic consolidation entry for the Pea Soup example
from the previous section into the worksheet. We emphasize that debits and credits in
Chapter 02 – REPORTING INTERCORPORATE INTERESTS
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each sub-section need to be sub-totaled. However, it is critical to help students
understand that the articulation in the financial statements also applies to the
adjustment columns. Since net income carries down to the statement of retained
earnings, the sub totals in the consolidation entry adjustment columns must be carried
down with the net income number. Likewise, since the ending balance in retained
earnings carries down from the statement of retained earnings to the balance sheet,
the sub totals in the consolidation entry columns must be carried down with the
retained earnings ending balances. We spend a few minutes emphasizing the
“mechanics” of the worksheet because students who try to work too quickly and skip
these important details will inevitably make mistakes in their consolidation column.
Emphasize that taking time to pay attention to these details will save students a
significant amount of time (and headaches) in the long run.
• Slides 75-80 walk students through the consolidation worksheet one line item at a
time. We only do this once in chapter 2. Once students have practiced adding across
each row, we assume they can do it on future worksheets. While this may seem like a
tedious exercise (and even though this is an advanced financial accounting text), we
have found from our experience that students often forget the normal balance in
different types of accounts and have trouble remembering whether a debit or credit
entry increases or decreases different types of accounts. We find that walking
through this exercise one time helps students to remember these basic concepts.
• Slide 81 emphasizes that when the parent uses the fully adjusted equity method, the
parent’s net income and retained earnings ending balance will always be equal to the
corresponding consolidated numbers.
• Slide 82 provides a detailed comprehensive consolidation example. We have students
work this exercise in small groups in class. Advanced preparation includes either
providing students a spreadsheet file or a hard copy similar to slide 73 so that they
can work this exercise in class. In slide 83, we ask students to work together to
perform the book value calculations. In slide 84, we review the book value
calculations and explain which numbers are used in the basic consolidation entry. We
then ask students to attempt the basic consolidation entry in their groups. In slide 85,
we show them the answer.
• Slides 86-87 allow the instructor to explain the optional accumulated depreciation
consolidation entry. The idea is that if the company had purchased property, plant,
and equipment assets “used” from another company, the acquiring company would
have recorded the assets at their purchase price with zero accumulated depreciation.
The acquiring company would not have been concerned with the former owner’s cost
basis or accumulated depreciation. In purchasing another company, it is also useful to
ensure that the fixed assets of the acquired company appear in the consolidated
financial statements as if the acquiring company had acquired those assets on the date
of acquisition. This consolidation entry nets the accumulated depreciation on the date
of acquisition against the cost basis, so that they appear as if they were newly
acquired (at their net book values) on the acquisition date. This entry essentially
allows these assets to start with a “clean slate” on the date of acquisition with no
accumulated depreciation.
• Slide 88 allows the instructor to ask students to enter the basic consolidation entry
into the adjustment columns, calculate their sub-totals, and carry down the net income
Chapter 02 – REPORTING INTERCORPORATE INTERESTS
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and retained earnings ending balance adjustments to ensure proper “mechanics” for
their consolidation. After having students go through this process with their groups,
we show them slide 88 BEFORE having them complete the worksheet. Slide 89
provides the solution.
• Slides 102-110 walk through the consolidation process in the second and following
years of ownership.
Appendix 2B
• Slide 113 summarizes the difference between the cost and equity method.
• Slides 114-116 repeat the same consolidation example using the cost method. Some
instructors like to show students how to perform a consolidation under the cost
method.
• Slides 117-118 compare the equity method and cost method results of the example.
• Slides 120-122 can be used to give students practice with the cost method.
• Slides 123-124 present some final thoughts on the equity method and cost method
comparisons.
TEACHING IDEAS
1. Students could be asked to write a brief memo discussing why companies would be
encouraged to invest in the stock of other companies. A question could be raised as to the
trade-off of investing in stock of another company or increasing the capital expenditures
of the company for additional fixed assets. What are the economic benefits of investing in
another company?
2. Students could be assigned a recent article on investments on the Internet and asked to
prepare an executive summary of the article, highlighting its major points for a business
executive (e.g., a corporate controller or a partner in a CPA firm) who has not read the
article.
3. Students could be asked to review the financial statements of a large public company and
write a report on their investments. Students should list the different type of investments,
percentage ownership, and method of accounting for the investments.