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Chapter 02 - Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with no Differential
CHAPTER 2
Q2-1 (a) An investment in the voting common stock of another company is reported on an
equity-method basis when the investor is able to significantly influence the operating and
Q2-2A Significant influence occurs when the investor has the ability to influence the operating
and financial policies of the investee. Representation on the board of directors of the investee is
Q2-3A Equity-method reporting should not be used when (a) the investee has initiated
litigation or complaints challenging the investor's ability to exercise significant influence, (b) the
Q2-4 The balances will be the same at the date of acquisition and in the periods that follow
Q2-5 When a company has used the cost method and purchases additional shares which
cause it to gain significant influence, a retroactive adjustment is recorded to move from a cost
Q2-6 An investor considers a dividend to be a liquidating dividend when the cumulative
dividends received from the investee exceed a proportionate share of the cumulative earnings
Q2-7 Liquidating dividends decrease the investment account in both cases. All dividends are
as well.
Q2-8 A dividend is treated as a reduction of the investment account under equity-method
method.
Q2-9 Dividends received by the investor are recorded as dividend income under both the cost
and fair value methods. The change in the fair value of the shares held by the investor is
Q2-10A When the modified equity method is used, a proportionate share of subsidiary net
income and dividends is recorded on the parent's books and an appropriate amount of any
Q2-11 A one-line consolidation implies that under equity-method reporting the investor's net
Q2-12A The term modified equity method generally is used when the investor records its
portion of the reported net income and dividends of the investee and amortizes an appropriate
Q2-13A The investor reports a proportionate share of an investee's extraordinary item as an
Q2-14 An adjusting entry is recorded on the company's books and causes the balances
reported by the parent or subsidiary company to change. Consolidation entries, on the other
Q2-15 Each of the stockholders' equity accounts of the subsidiary is eliminated in the
consolidation process. Thus, none of the balances is included in the stockholders' equity
Q2-16 Additional entries are needed to eliminate all income statement and retained earnings
Q2-17 Separate parts of the consolidation worksheet are used to develop the consolidated
income statement, retained earnings statement, and balance sheet. All consolidation entries
Q2-18 None of the dividends declared by the subsidiary are included in the consolidated
Q2-19 Consolidated net income includes 100 percent of the revenues and expenses of the
Q2-20 Consolidated retained earnings is that portion of the undistributed earnings of the
Q2-21 Consolidated retained earnings at the end of the period is equal to the beginning
Q2-22 The retained earnings statement shows the increase or decrease in retained earnings
during the period. Thus, income for the period is added to the beginning balance and dividends
Copyright © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized
for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted
on a website in whole or part.
C2-1A Choice of Accounting Method
a. The equity method is to be used when an investor has significant influence over an investee.
1. Is the investee under the control of the courts or other parties as a result of filing for
2. Does the investor have representation on the board of directors, or has it attempted to
3. Has the investee initiated litigation or complaints challenging the investor's ability to
4. Has the investor signed an agreement surrendering its ability to exercise significant
5. Is majority ownership concentrated in a small group that operates the company without
6. Is the investor able to acquire the information needed to use equity-method reporting?
b. When subsidiary net income is greater than dividends paid, equity-method reporting is likely
to show a larger reported contribution to the earnings of Slanted Building Supplies. If 20X4
earnings are negative or less than dividends distributed in 20X4, the cost basis is likely to result
C2-2 Intercorporate Ownership
MEMO
To: Chief Accountant
Most Company
From: , CPA
Re: Equity Method Reporting for Investment in Adams Company
ASC 323-10-15-6 through 15-8
C2-3A Application of the Equity Method
MEMO
To: Controller
Forth Company
From: , CPA
Re: Equity Method Reporting for Investment in Brown Company
considered as well. [ASC 323-10-15-6 through 15-8]
Although Forth currently holds only 15 percent of Brown’s common stock, the other factors
associated with its ownership indicate that Forth does exercise significant influence over Brown.
Forth has two members on Brown’s board of directors, it purchases a substantial portion of
Brown’s output, and Forth appears to be the largest single shareholder by virtue of its sale of
C2-4 Need for Consolidation Process
After the financial statements of each of the individual companies are prepared in accordance
with generally accepted accounting principles, consolidated financial statements must be
prepared for the economic entity as a whole. The individual companies generally record
C2-5 Account Presentation
MEMO
To: Chief Accountant
Prime Company
From: , Accounting Staff
Re: Combining Broadly Diversified Balance Sheet Accounts
consolidated balance sheet. The actual number of assets and liabilities presented in the
consolidated balance sheet must be carefully considered, but is the decision of Prime’s
management.
It is important to recognize that the notes to the consolidated financial statements are regarded
as an integral part of the financial statements and Prime Company is required to include in its
be combined with the parent, the equity account balances should not; (c) negative account
balances in cash or accounts receivable should be reclassified as liabilities rather than being
added to the positive balances of other affiliates if there is no right of offset in the underlying
bank accounts, and (d) assets pledged for a specific purpose and not available for other use by
the consolidated entity generally should be separately reported.
ASC 280-10
ASC 810-10-65-1
C2-6 Consolidating an Unprofitable Subsidiary
MEMO
TO: Chief Accountant
Amazing Chemical Corporation
FROM: , Accounting Staff
280-10-50]. While the operating losses of the boatyard may not be evident in analyzing the
consolidated income statement, a review of the notes to the consolidated statements should
provide adequate disclosure of its operations as a reportable segment. The financial statements
ASC 810-10-10-1
ASC 810
ASC 280-10-50
ASC 810-10-65-1
Copyright © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized
for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted
on a website in whole or part.
E2-1 Multiple-Choice Questions on Use of Cost and Equity Methods
1. a – Cash dividends received will never cause an increase in the investment account under
either method.
2. a – Because the ownership in Amal Corporation is less than 20%, the cost method should be
applied. Accordingly, the $1,500 dividend received from Amal is recorded as dividend
revenue.
3. a – Under the equity method, net income increases the investment account while dividends
decrease it. Because net income was greater than the dividends declared, this results in
a net increase in the investment account. Under the cost method, the investment would
4. b – Under the equity method the company records a share of the affiliate net income as
income for the company. This increases the net income of the company which increases
earnings per share.
