[Marissa]

Can someone tell me why these two questions differ? In the first one, they are adding the net income’s of the parent and sub. In the second one, they are only including net income of the parent. Why? I’m confused if consolidated net income includes both parent and sub or just parent.

Question 1: Davis acquired 100% of Sector on January 3, 20X3, when Davis had retained earnings of $6,000 and Sector had retained earnings of $2,300. The acquisition price was $4,500 when Sector’s net assets had a carrying value of $3,900. At that time, Sector had land with a fair value that exceeded its book value by $100 and equipment with a 4 year remaining useful life with a fair value that exceeded its carrying value by $200. Any remaining difference was attributable to goodwill. Davis reported net income of $1,250 in 20X3, before taking into account any of Sector’s results. Sector reported net income of $500. Neither entity distributed dividends. What amount will be reported as retained earnings on Davis’s December 31, 20X3 consolidated balance sheet?

Question 1 Answer: On its December 31, 20X3 consolidated balance sheet, Davis will report retained earnings that will consist of its January 3 balance of $6,000, its income of $1,250, and Sector’s income of $500 after adjusting for depreciation on the $200 fair value adjustment related to equipment. Since the equipment had a remaining useful life of 4 years, there would be additional depreciation of $50 reducing Sector’s income to $450. As a result, consolidated retained earnings will be $6,000 + $1,250 + $500 – $50 = $7,700. Sector’s retained earnings at January 3 is eliminated.

Question 2:The separate condensed balance sheets and income statements of Purl Corp. and its wholly owned subsidiary, Scott Corp., are as follows:

INCOME STATEMENTS

For the Year Ended December 31, 20X0

Purl Scott
Sales $2,000,000 $750,000
Cost of goods sold $1,540,000 $500,000
Gross margin $460,000 $250,000
Operating expense $260,000 $150,000
Operating income $200,000 $100,000
Equity in earnings of Scott $60,000 —
Income before income taxes $260,000 $100,000
Provision for income taxes $60,000 $30,000
Net income $200,000 $70,000
Additional information:

On January 1, 20X0, Purl purchased for $360,000 all of Scott’s $10 par, voting common stock. On January 1, 20X0, the fair value of Scott’s assets and liabilities equaled their carrying amount of $410,000 and $160,000, respectively, except that the fair values of certain items identifiable in Scott’s inventory were $10,000 more than their carrying amounts. These items were still on hand at December 31, 20X0. Purl’s policy is to amortize intangible assets over a 10-year period, unless a definite life is ascertainable.
During 20X0, Purl and Scott paid cash dividends of $100,000 and $30,000, respectively. For tax purposes, Purl receives the 100% exclusion for dividends received from Scott.
There were no intercompany transactions, except for Purl’s receipt of dividends from Scott and Purl’s recording of its share of Scott’s earnings.
Both Purl and Scott paid income taxes at the rate of 30%.
In the December 31, 20X0, consolidated financial statements of Purl and its subsidiary:

Net income should be

Question 2 answer: When consolidated financial statements are prepared, stockholders’ equity and net income will be the same as when the parent prepares separate financial statements applying the equity method. Since Purl’s separate financial statements, on which the equity method was applied, shows net income of $200,000, that will also be the amount of consolidated net income.

[water]

Net income on Consolidated F/S should include just the parent's income. However with the equity method, the parent will book the income of its sub in the following way:

Investment xx
Equity in earnings xx

The Equity in earnings is an I/S account and it represents the sub's income times parent's ownership %. It will be added to parent's net income. Therefore you shouldn't include the sub's net income nor retained earnings in the statements, because it was already booked to the parent in the form of Equity in Earnings.

#1 = Davis RE + Davis income (“before taking into account sub's income”) + Equity in earnings of sub
= $6,000 + 1,250 + 450 = $7,700

#2 = They give you Purl's income AFTER including Scott's income from the equity method (problem states that it includes “Purl's recording of its share of Scott's earnings.”) so you would just use that.

[Author]

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