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Minority Interest in the Consolidated Retained Earnings Statement.

Hugo Nurnberg is a Professor at Baruch College-CUNY.

SYNOPSIS: Consolidated financial statements purport to report income, financial position, and cash flows of a parent company and its subsidiaries as if the group were a single company with one or more branches or divisions. Under the parent company theory, the consolidated entity perspective assumed in the consolidated income statement, the consolidated balance sheet, and the consolidated retained earnings statement differs from the consolidated entity perspective assumed in the consolidated cash flow statement. Even under extant expositions of the entity theory, the consolidated entity perspective assumed in the consolidated income statement, the consolidated balance sheet, and the consolidated cash flow statement differs from the consolidated entity perspective assumed in the consolidated retained earnings statement.

This paper develops a consistent consolidated entity perspective for all four consolidated financial statements. It demonstrates that under the entity theory, consolidated retained earnings includes the separate equities of both the parent company stockholders and the minority interest. As such, both elements of retained earnings should be reported in the consolidated retained earnings statement to make it comparable to the consolidated retained earnings statement of companies without subsidiaries or with only wholly owned subsidiaries. The effect on certain financial ratios of public companies may be substantial. The paper also demonstrates that for purchased subsidiaries, minority interest in consolidated retained earnings includes unamortized write-ups of identifiable net assets and goodwill arising from purchase-type business combinations.

FASB Statement No. 94, Consolidation of All Majority-Owned Subsidiaries (SFAS No. 94, FASB 1987, para. 13) requires consolidation of all majority-owned subsidiaries unless control is likely to be temporary or does not rest with the owners of the majority voting interest. [1] Acceptable consolidation procedures represent a mixture of the parent company (or proprietary) theory and the entity (or economic unit) theory of consolidated financial statements. [2] Due to this mixture, the consolidated income statement, the consolidated balance sheet, and the consolidated retained earnings statement assume a parent company stockholder perspective, whereas the consolidated cash flow statement assumes a consolidated entity perspective. Even under extant expositions of the entity theory, the consolidated income statement, the consolidated balance sheet, and the consolidated cash flow statement assume a consolidated entity perspective, but the consolidated retained earnings statement assumes a parent company stockholder perspective. As a result, the consolidated retained earnings statement does not completely report all of the consolidated entity's retained earnings and changes therein, and is not comparable to the retained earnings statement of companies without subsidiaries or with only wholly owned subsidiaries. For public companies, the effect on the dividend payout ratio, the earnings retention ratio, and the retained earnings to total assets ratio may be substantial.

PURPOSE AND PLAN OF PAPER

This paper develops a consistent consolidated entity perspective to underlie all four consolidated financial statements. It demonstrates that under the entity theory, consolidated retained earnings include the separate equities of both the parent company (or controlling) stockholders and the minority interest (or controlling stockholders) of its subsidiaries. As such, the incomes, dividends, and beginning and ending retained earnings balances of both stockholder groups should be reported in the consolidated retained earnings statement.

Initially, the paper briefly examines the purpose of consolidated financial statements, as well as the consolidated balance sheet and consolidated income statement under the parent company and entity theories. The bulk of the paper examines the consolidated retained earnings statement under the parent company theory (and extant versions of the entity theory) vs. my proposed application of the entity theory. For ease of presentation, consideration of minority interest in a subsidiary established by the parent company (henceforth, newly established subsidiary) precedes consideration of minority interest in an existing company that becomes a subsidiary of the parent company in a purchase-type business combination (henceforth purchased subsidiary).

Because the focus of the paper is on reporting minority interest in the consolidated retained earnings statement, there are no subsequent intercompany transactions other than dividends. As a result, there is no need to consider unrealized intercompany profits under the parent company vs. entity theories. Additionally, there is no need to consider differences in net asset valuations under purchase vs. pooling of interests accounting. [3]

PURPOSE OF CONSOLIDATED FINANCIAL STATEMENTS

According to Accounting Research Bulletin No. 51, Consolidated Financial Statements (ARB No. 51, AICPA 1959, para. 1), the purpose of consolidated financial statements:

is to present, primarily for the benefit of the shareholders and creditors of the parent company, the results of operations and the financial position of a parent company and its subsidiaries essentially as if the group were a single company with one or more branches or divisions.

More recently, the FASB (1999a, para. 7) proposed to amend this section of ARB No. 51 and concluded that the purpose of consolidated financial statements:

is to report financial position, results of operations, and cash flows of a reporting entity that comprises a parent and its affiliates essentially as if all of their assets, liabilities, and activities were held, incurred, and conducted by a single entity with one or more branches or divisions.

Unfortunately, this conclusion mixes the purpose of consolidated financial statements (why consolidate) with consolidation policy (which subsidiaries to consolidate) and full vs. proportionate consolidation (include all vs. only the parent company's share of subsidiary assets, liabilities, revenues, and expenses). Because the focus of this paper is the consolidated retained earnings statement, further consideration of consolidation policy and full vs. proportionate consolidation issues is not necessary. [4] What remains germane to this paper is the central purpose of consolidated statements, to wit, to report financial position, results of operations, and cash flows of a parent company and its subsidiaries as if they were a single company with one or more branches or divisions.

PARENT COMPANY VS. ENTITY THEORIES OF CONSOLIDATED FINANCIAL STATEMENTS

Consistent with this general purpose, some accountants (e.g., Hatfield 1927, 448; Moonitz 1951, 76-80; Meigs et al. 1966, 257-258) argue that consolidated statements should be based on a consolidated entity perspective, consistent with the entity (or economic unit) theory of consolidated financial statements. But ARB No. 51 notes that consolidated statements are presented primarily for the benefit of parent company stockholders and creditors. Consistent with preparing consolidated statements primarily for parent company stockholders and creditors, some accountants (e.g., Sanders et al. 1938, 105-106; Smolinski 1963, 173-175) argue that consolidated statements should be based on a parent company stockholder perspective, consistent with the parent company (or proprietary) theory of consolidated financial statements. [5]

Current prevailing GAAP reflects various mixtures of both theories but leans more toward the parent company theory than toward the entity theory. The 1995 FASB ED proposed to shift the mixture more toward the entity theory and make it more uniform, but this aspect of the 1995 ED was deleted from the 1999 ED.

Almost all of the differences in these two theories arise only when there is a minority interest in a partially owned subsidiary. [6] The existing literature extensively addresses consolidated balance sheet and consolidated income statement reporting differences, but virtually ignores consolidated retained earnings statement reporting differences under these two theories. [7]

The reporting of minority interest under the parent company and entity theories is discussed and illustrated below. Initially, I examine and illustrate balance sheet and income statement display issues. Thereafter, I more extensively examine and illustrate retained earnings statement display issues, using the same numerical example, and relate them to the consolidated cash flow statement. Because reporting minority interest in the consolidated retained earnings statement is principally a display issue, it is illustrated initially with a single newly established subsidiary. Thereafter, the same display issues, as well as additional net asset valuation issues, are illustrated for a purchased subsidiary. [8]

EXAMPLE

Assume a parent company and its 60 percent-owned subsidiary, subsequently referred to as Company P and Company S, respectively. Company P established Company S three years ago by investing $1,800 in exchange for 60 percent of the no-par common stock of Company S. Exhibit 1 summarizes the terms of the transaction and the dividend policy of Company S.

For internal purposes, Company P could use either the cost method or the equity method in its accounts and separate financial statements to account for its investment in the stock of Company S. The same consolidated financial statements result under either the parent company or entity theory. (The working paper adjusting and eliminating entries differ, however, depending on whether the cost or equity method is used in the accounts and separate financial statements of Company P.) Most companies use the cost method for internal purposes, [9] but the equity method is held to facilitate the preparation of the consolidation statements. [10] The separate financial statements of Company P under both methods, as well as the separate financial statements of Company S, are found in Exhibit 2.

Under either the cost or equity method, Company P records its investment in the stock of Company S at its $1,800 cost when it establishes Company S on 1 January 20x6. As indicated in Panel A of Exhibit 2, if Company P uses the cost method, its 20x8 separate company income statement would report $1,200 of dividend income, equal to 60 percent of Company S's $2,000 dividend declared in 20x8. Additionally, its 31 December 20x8 separate company balance sheet would report the investment in the stock of Company S at the $1,800 original cost, and $3,100 of retained earnings, the dividend basis retained earnings of Company P. [11]

As indicated in Panel B of Exhibit 2, if Company P uses the equity method, its 20x8 separate company income statement would report $1,500 of equity in earnings of Company S, equal to 60 percent of Company S's $2,500 net income for 20x8. Additionally, its 31 December 20x8 separate company balance sheet would report a $2,340 investment in the stock of Company S, equal to the $1,800 original cost plus $540 or 60 percent of Company S's $900 retained earnings accumulated since acquisition. Similarly, its 31 December 20x8 separate company balance sheet would report a $3,640 retained earnings balance, equal to the $3,100 dividend basis retained earnings of Company P plus $540 or 60 percent of Company S's $900 retained earnings accumulated since acquisition. [12]

CONSOLIDATED BALANCE SKEET AND INCOME STATEMENT

The consolidated statements are found in Exhibits 3 through 6. For ease of exposition, I consider the consolidated balance sheet and consolidated income statement before considering the consolidated retained earnings statement, and each is considered initially under parent company theory and then under entity theory. The consolidated balance sheets and consolidated income statements are found in Exhibits 3 and 4.

Parent Company Theory

Under the parent company theory, the consolidated financial statements are prepared from the perspective of the parent company stockholders' interest in the parent company itself plus its undivided interest in the net assets of the subsidiary. Thus, the consolidated balance sheet is essentially an expansion of the parent company's balance sheet, with subsidiary assets, liabilities, and minority interest substituted for the parent company's investment in the subsidiary. The $1,560 minority interest is reported either as a liability or, as illustrated in Panel A of Exhibit 3, as a separate balance sheet element between liabilities and stockholders' equity. [13] Accordingly, the $7,540 consolidated stockholders' equity is not the stockholders' equity of the two companies as if they were one economic unit. Rather, it is the portion on the stockholders' equity of the two companies attributable to the parent company stockholders.

Similarly, under the parent company theory, the consolidated income statement is essentially an expansion of the parent company's income statement, with subsidiary revenues, expenses, and minority interest deduction substituted for the parent company's equity in subsidiary income. [14] The $1,000 minority interest deduction is reported either as an expense or, as illustrated in Panel A of Exhibit 4, as a separate deduction to derive the $2,600 consolidated net income. As such, the $2,600 consolidated net income is not the net income of the two companies as if they were one economic unit. Rather, it is the portion on the net income of the two companies attributable to the parent company stockholders.

Entity Theory

Under the entity theory, the consolidated financial statements reflect a group of legally separate companies as a single consolidated entity. Accordingly, the consolidated balance sheet reports the assets and liabilities of the constituent companies as the assets and liabilities of the consolidated entity. Total stockholders' equity of $9,100 has two components--a $7,540 controlling interest and a $1,560 noncontrolling interest, as illustrated in Panel B of Exhibit 3. The $7,540 controlling interest represents the stock-holder ownership interest in the parent company. It typically represents more than 50 percent of the voting common stock of the subsidiary. The noncontrolling interest represents the stockholder ownership interest in the subsidiary held by parties other than the parent company. These parties typically own less than 50 percent of the voting common shares of the subsidiary, hence are commonly referred to as minority interest. Importantly, the $1,560 minority interest is a noncontrolling stockho lder ownership interest in the subsidiary, as illustrated in Panel B of Exhibit 3; it is not a liability or separate element between liabilities and stockholders' equity.

Similarly, the consolidated income statement reports the revenues and expenses of the constituent companies as the revenues and expenses of the consolidated entity, netting to a $3,600 consolidated net income. The $1,000 minority interest deduction is an allocation of a portion of that $3,600 consolidated net income to the noncontrolling stockholder ownership interest in

the partially owned subsidiary, as illustrated in Panel B of Exhibit 4. Importantly, the $1,000 minority interest deduction is neither an expense nor a separate deduction to derive the $3,600 consolidated net income. [15]

Evaluation of Balance Sheet and Income Statement Display under Parent Company and Entity Theories

Reporting minority interest as a liability or as a separate element between liabilities and owners' equity under the parent company theory conflicts with the definition of liabilities and the prescription to report just assets, liabilities, and owners' equity in the balance sheet in FASB Concepts Statement No. 6, Elements of Financial Statements (FASB, 1985, paras. 35, 254). [16] Similarly, classifying the minority interest deduction as an expense or separate deduction to derive consolidated net income under the parent company theory conflicts with the SFAC No. 6 (1985, para. 35) definition of expense and the prescription to report just revenues, expenses, gains, and losses in the income statement. [17]

These classifications lead to alternative financial statement presentations, thereby reducing comparability across companies, particularly with financial statements of companies without subsidiaries or with only wholly owned subsidiaries. The reduced comparability is especially pronounced with respect to liability and equity subtotals in balance sheets and various expense subtotals in the income statement.

Because these classifications are display differences, users could readily transform consolidated statements from a parent company theory display to an entity theory display and vice versa, assuming full disclosure of minority interest. For this reason, some might argue that such display differences are unimportant (see Bernard and Schipper 1994). As the FASB (1995b, para. 62) notes in another context, however, disclosure is not an adequate substitute for recognition of assets, liabilities, revenues, and expenses in financial statements. Presumably, disclosure is not an adequate substitute for minority interest classification either (see Hopkins 1996, 45-47). [18] Moreover, full disclosure of minority interest may not be universal, and users may not be able to readily transform displays to a comparable basis. Additionally, these subtotals may be included as reported in several computer databases without adjustment, thereby reducing the comparability of these subtotals across companies. [19]

Rather than relying on users to transform displays, a simpler and more effective way to improve the comparability and usefulness of consolidated financial statements is for all companies to use the entity theory display. By adopting the entity theory display, the consolidated balance sheet subtotals more closely reflect the debt vs. equity capital financing of consolidated assets, the consolidated income statement subtotals more closely reflect the interrelationship of expenses with revenues, and the comparability of reported liability, equity, and expense subtotals in published reports and computer databases is enhanced.

CONSOLIDATED RETAINED EARNINGS STATEMENT

Under current GAAP, consolidated retained earnings equals the retained earnings of the parent company plus its share of the retained earnings of a purchased subsidiary since acquisition. Thus, consolidated retained earnings is defined under current GAAP as the retained earnings attributable to the controlling interest alone and to the exclusion of the retained earnings attributable to the minority interest. This is a manifestation of the parent company theory, where the consolidated financial statements are prepared from the perspective of the parent company stockholders, not the consolidated entity itself.

The minority interest is the noncontrolling stockholder ownership interest in the subsidiary. Accordingly, it represents the noncontrolling stockholder equity in the common stock, additional paid-in capital, and retained earnings of the subsidiary. This notwithstanding, most authors (e.g., Baker et al. 1999, 186; Beams et al. 2000, 422; Boatsman et al. 1994, 52; Hoyle et al. 1998, 169; Huefner et al. 2000, p. 3-34; Pahler and Mori 2000, 78-79), even those (e.g., Engler et al. 1995, 111; Fischer et al. 1999, p. 2-22; Haried et al. 1994, 63-64) who discuss the entity theory, show the minority interest as a single line item in the consolidated balance sheet, consistent with current GAAP. Few authors (e.g., Sanders et al. 1938, 105), favor distinguishing between paid-in capital and retained earnings attributable to the minority interest. As a result, the consolidated balance sheet de-emphasizes classification of consolidated stockholders' equity by source. More specifically, the consolidated balance sheet de-emp hasizes the two principal sources of minority interest, contributed capital (capital stock and additional paid-in capital) and earned capital (retained earnings). This de-emphasis on classifying minority interest by source carries over to the consolidated retained earnings statement.

The consolidated retained earnings statement is considered initially under parent company theory and then under entity theory. The consolidated retained earnings statements under each theory are found in Exhibit 5.

Parent Company Theory

Under the parent company theory, minority interest in subsidiary retained earnings is not reported in the consolidated retained earnings statement. Rather, the consolidated retained earnings statement reports only the retained earnings attributable to the parent company stockholders. As illustrated in Panel A of Exhibit 5, the $2,600 increase in consolidated retained earnings equals the $2,600 consolidated net income after deducting the $1,000 minority interest in subsidiary net income. Similarly, the total $700 decrease in consolidated retained earnings equals the $700 dividend declared by Company P and excludes the minority interest's $800 or 40 percent share of the $2,000 dividend declared by Company S, consistent with current GAAP. [20]

This presentation assumes the same consolidated entity perspective assumed in the consolidated balance sheet and consolidated income statement under the parent company theory--the perspective of the parent company shareholders, rather than the consolidated entity itself. But it assumes a different consolidated entity perspective from that assumed in the consolidated cash flow statement under the parent company theory, as illustrated in Panel A of Exhibit 6.

Under the parent company theory, the consolidated retained earnings statement reports just the $700 dividend declared to Company P shareholders. In contrast, the consolidated cash flow statement reports all $1,500 of dividend outflows to Company P and Company S shareholders after eliminating the $1,200 intercompany dividend. [21] Similarly, the $3,200 consolidated net cash flow from operating activities reflects all the net cash flow from operating activities of the consolidated entity, not just the amount allocable to the controlling interest. [22]

It makes no sense to report consolidated entity cash flows allocable to just the controlling entity. [23] Only a consolidated entity perspective makes sense in the consolidated cash flow statement. Under the parent company theory, however, a narrower parent company stockholder perspective is assumed in the other consolidated financial statements.

Entity Theory

Under the entity theory, the minority interest deduction in the income statement is an allocation of consolidated net income to the noncontrolling stockholders, not an expense.

Similarly, the minority interest in the consolidated balance sheet is a noncontrolling stockholder ownership interest in the capital stock, additional paid-in capital, and retained earnings of the subsidiary, not a liability or ambiguous element between liabilities and owners' equity. Accordingly, consolidated retained earnings has two components:

(1) minority (or noncontrolling) ownership interest in the retained earnings of the subsidiary; and

(2) parent company (or controlling) ownership interest in the retained earnings of the parent and subsidiary companies.

Under a consistent application of the entity theory, the consolidated retained earnings statement should report changes in each of these two components of consolidated retained earnings as well as beginning and ending balances, as illustrated in Panel B of Exhibit 5. [24] The $3,600 total increase in consolidated retained earnings has two components--the $1,000 minority interest and the $2,600 controlling interest in consolidated net income. Similarly, the $1,500 total decrease in consolidated retained earnings has two components--the $800 minority interest in the $2,000 dividends declared by Company S, and the $700 dividends declared by Company P. Of course, the $1,500 consolidated dividends declared excludes $1,200 or 60 percent of Company S's $2,000 dividends declared, as these dividends are payable to Company P, hence are intercompany and eliminated in the consolidation process.

The same consolidated entity perspective is assumed in the consolidated cash flow statement under the entity theory, as illustrated in Panel B of Exhibit 6. The consolidated cash flow statement reports all $1,500 of dividends paid to parent company and minority interest stockholders and all $3,200 of net cash flow from operating activities. Given that dividends declared equal dividends paid, the $1,500 consolidated dividends paid excludes $1,200 or 60 percent of Company S's $2,000 dividends paid to Company P.

MEASUREMENT ISSUES OF PURCHASED SUBSIDIARIES

For newly established subsidiaries, differences between the parent company and entity theories relate principally to matters of display, which in turn reflect differences in the nature of the consolidated entity assumed. For purchased subsidiaries, additional differences between the parent company and entity theories relate to the measurement of inventories, plant assets, and goodwill in the consolidated balance sheet, and cost of goods sold, depreciation expense, goodwill amortization expense, and the minority interest deduction in the consolidated income statement. The theory underlying these asset and liability measurement differences are discussed in most advanced financial accounting textbooks (see, e.g., Baker et al. 1999, 140-144; Beams et al. 2000, 412-417; Engler et al. 1995, 26-28, 120-123; Fischer et al. 1999, app. SA1; Haried et al. 1994, 424-433; Hoyle et al. 1998, 152-155; Huefner et al. 2000, A2-A7; Larsen 2000, 249-252; Pahler and Mori 2000, 79-81, 219-220). Because this paper is concerned pr incipally with display issues, the theory underlying these measurement differences will not be repeated here. Rather, this section illustrates how these measurement differences affect the presentation of minority interest in the consolidated retained earnings statement, using a slight revision of the original example.

More specifically, the revised example assumes all the information in the separate company financial statements of Company P under the cost method and Company S as found in Panels A and C, respectively, of Exhibit 2, except as follows:

(1) Company P acquires 60 percent of the outstanding no-par capital stock of Company S on 1 January 20x6 for $2,700, when Company S is an established company with $3,000 of capital stock, $0 of additional paid-in capital, and $300 of retained earnings, and when fair value exceeds book value of its plant assets by $200.

(2) Company P has $4,800 of no-par capital stock outstanding.

Accordingly, at acquisition, Company P reports its investment in Company S at $2,700 under the cost (or equity) method in its separate financial statements for internal purposes, and also reports $4,800 of capital stock--each $900 more than in the original illustration. [25] Company S is now a purchased subsidiary with appreciated plant assets and positive goodwill, not a newly established subsidiary without appreciated plant assets or goodwill. At acquisition, subsidiary plant assets and goodwill have remaining useful lives of 10 years and 20 years, respectively, and are amortized straight-line to zero. The terms of the transaction and the calculation of the $720 excess of the $2,700 cost over $1,920 book value of the investment in the stock of Company S is found in the first section of Panel A of Exhibit 7.

Parent Company Theory

Under the parent company theory, the $720 excess is allocated $120 to plant assets, and the $600 residual is allocated to goodwill, as indicated in the first section of Panel A of Exhibit 7, where the $120 equals 60 percent of the $200 excess of total fair value over total book value of subsidiary plant assets at acquisition. Because subsidiary plant assets and goodwill have remaining useful lives at acquisition of 10 years and 20 years, respectively, additional depreciation expense of one-tenth of $120 or $12, and goodwill amortization of one-twentieth of $600 or $30, are recognized each year under the parent company theory, as indicated in the second and third sections of Panel A of Exhibit 7, together with the accumulated depreciation/amortization and undepreciated/unamortized balances at 31 December 20x8, three years after acquisition.

Under the parent company theory, minority interest deduction in the 20x8 consolidated income statement is $1,000, consolidated net income is $2,558, consolidated operating net cash flow is $3,200, and minority interest in the 31 December 20x8 consolidated balance sheet is $1,560, as indicated in the first, second, third, and fourth sections of Panel A of Exhibit 8.

Entity Theory

Under the entity theory, the $2,700 cost for a 60 percent-owned subsidiary implies a $2,700(100/60) or $4,500 implied fair value for the entire subsidiary and, similarly, the $720 excess of cost over book value implies a $720(100/60) or $1,200 excess of total fair value over total book value of subsidiary net assets at acquisition, as indicated in the first section of Panel B of Exhibit 7. The $1,200 total excess implied is allocated $200 to plant assets, and the $1,000 residual to goodwill. [26] Consistently, additional depreciation expense of one-tenth of $200 or $20, and goodwill amortization of one-twentieth of $1,000 or $50, are recognized each year under the entity theory, as indicated in the second and third sections of Panel B of Exhibit 7, together with the accumulated amounts for three years and the unamortized amounts at 31 December 20x8. The extra $8 of additional depreciation expense and extra $20 of goodwill amortization expense are attributable to the 40 percent minority interest.

As a result of the additional depreciation and goodwill amortization expense, the minority interest deduction in the consolidated income statement is $972 under the entity theory, or $28 less than under the parent company theory, as indicated in the first section of Panel B of Exhibit 8. On the other hand, consolidated net income under the parent company theory and controlling interest in consolidated net income under the entity theory are the same $2,558, as indicated in the second section of Exhibit 8. Similarly, net cash flow from operating activities is the same $3,200 under both the parent company and entity theories, although the reconciliations differ, as indicated in the third section of Exhibit 8.

Assuming positive goodwill, purchased subsidiary identifiable net assets are reported at fair value and subsidiary goodwill is reported at implied fair value in the consolidated balance sheet at acquisition under the entity theory. As a result, minority interest stockholders' equity is also reported at implied fair value in the consolidated balance sheet at acquisition--that is, at its share of the implied fair value of subsidiary net assets (including goodwill). Reporting minority interest stockholders' equity at implied fair value at acquisition is equivalent to reporting minority interest stockholders' equity at book value--that is, at its share of subsidiary capital stock, additional paid-in capital, and retained earnings--plus its share of write-ups from book value to fair value of purchased subsidiary net assets at acquisition. Subsequently, minority interest stockholders' equity is reported in the consolidated balance sheet at book value, plus its share of the write-ups, less its share of the accumula ted amortization on these write-ups. Equivalently, minority interest stockholders' equity is reported at book value plus its share of the unamortized write-ups. Thus, minority interest at 31 December 20x8 is $1,956 under the entity theory, which is 40 percent of $990 or $396 more than under the parent company theory, as indicated in the fourth section of Exhibit 8.

Minority Interest in Consolidated Retained Earnings

Under the parent company theory, the minority interest in consolidated retained earnings is its share of unadjusted subsidiary retained earnings. But it is buried in a $1,560 single line item for minority interest reported among liabilities or between liabilities and stockholders' equity. Moreover, as indicated in the last section of Panel A of Exhibit 8, no mention is made of the minority interest in the consolidated retained earnings statement under the parent company theory.

Under the entity theory, $1,956 minority interest stockholders' equity equals the $1,560 book value plus its $396 share of the unamortized write-ups (or write-downs) from book value to fair value of purchased subsidiary net assets, as noted earlier. The $756 minority interest in consolidated retained earnings includes two components, (1) $360 or 40 percent of the $900 unadjusted subsidiary retained earnings, and (2) $396 or 40 percent of the $990 of unamortized write-ups of subsidiary plant assets and goodwill.

Conceptually, the unamortized write-ups of $396 are, alternatively, minority interest in unrealized subsidiary retained earnings or minority interest in subsidiary appraisal capital. Conceivably, they might be reported as a separate fourth category of minority interest stockholders' equity under the entity theory. But minority interest in consolidated net income is its share of subsidiary net income after adjusting for amortization of these write-ups of subsidiary plant assets and goodwill, as noted earlier. By reporting a fourth category, minority interest in consolidated net income less minority interest in subsidiary dividends does not equal the periodic change in minority interest retained earnings under the entity theory.

For this reason, the minority interest in unamortized write-ups of subsidiary plant assets and goodwill should be included in minority interest retained earnings under the entity theory. By including minority interest in unamortized write-ups in minority interest retained earnings, minority interest in consolidated net income less minority interest in subsidiary dividends equals the change in minority interest retained earnings for the period under the entity theory. This is illustrated succinctly in the 20x8 consolidated retained earnings statement in the last section of Panel B of Exhibit 8, and analyzed more fully as follows:
1 January 20x8 minority interest in retained earnings:
  40% of $400 unadjusted subsidiary retained earnings            $  160
  40% of $1,060 unamortized excess                                  424
    Total
Add: Minority interest in consolidated net income:
  Minority interest in unadjusted subsidiary net income          $1,000
  Minority interest in annual amortization of excess
    attributable to plant assets [40% of 1/10 of $200]              (8)
  Minority interest in annual amortization of excess               (20)
    attributable to goodwill [40% of 1/20 of $1,0001]
  Minority interest in consolidated net income:
Less: Minority interest in subsidiary dividends [40% of $2,000]
31 December 20x8 minority interest in retained earnings:
  40% of $900 unadjusted subsidiary retained earnings            $  360
  40% of $990 unamortized excess                                    396
    Total
1 January 20x8 minority interest in retained earnings:
  40% of $400 unadjusted subsidiary retained earnings
  40% of $1,060 unamortized excess
    Total                                                        $584
Add: Minority interest in consolidated net income:
  Minority interest in unadjusted subsidiary net income
  Minority interest in annual amortization of excess
    attributable to plant assets [40% of 1/10 of $200]
  Minority interest in annual amortization of excess
    attributable to goodwill [40% of 1/20 of $1,0001]
  Minority interest in consolidated net income:                   972
Less: Minority interest in subsidiary dividends [40% of $2,000]  (800)
31 December 20x8 minority interest in retained earnings:
  40% of $900 unadjusted subsidiary retained earnings
  40% of $990 unamortized excess
    Total                                                        $756


Using the three-way classification, the $584 minority interest in subsidiary retained earnings at 1 January 20x8 includes its 40 percent share of the $160 unamortized subsidiary plant asset write-up plus its 40 percent share of the $900 unamortized goodwill at 1 January 20x8. [27] Similarly, the $756 minority interest in subsidiary retained earnings at 31 December 20x8 includes its 40 percent share of the $140 unamortized subsidiary plant asset write-up plus its 40 percent share of the $850 unamortized goodwill at 31 December 20x8. Calculated this way, the $172 increase for 20x8 in minority interest in subsidiary retained earnings equals the excess of the $972 minority interest consolidated net income over the $800 minority interest in subsidiary dividends.

USEFULNESS OF RETAINED EARNINGS STATEMENT DISPLAY UNDER PARENT COMPANY AND ENTITY THEORIES

In its 1999 Exposure Draft, the FASB (1999a, para. 180) concludes that the usefulness of consolidated financial statements is significantly impaired if they omit relevant information. FASB Concepts Statement No.2 (FASB 1980, glossary, p. xv) defines completeness as "the inclusion in reported information of everything material that is necessary for faithful representation of the relevant phenomena," and explains (FASB 1980, para. 79-80) that completeness is a significant aspect of both relevance and reliability of information:

Freedom from bias...implies that nothing material is left out of the information that may be necessary to insure that it validly represents the underlying events and conditions. Reliability implies completeness of information, at least within the bounds of what is material and feasible, considering the cost....

Completeness of information also affects its relevance. Relevance of information is adversely affected if a relevant piece of information is omitted, even if the omission does not falsify what is shown.

The consolidated retained earnings statement purports to reflect the earnings, dividends, and beginning and ending retained earnings balances of the consolidated entity. To be complete, it should report all the earnings, all the dividends, and all the beginning and ending retained earnings balances of the consolidated entity. Thus, it should report all the earnings, all the dividends, and all the beginning and ending retained earnings balances attributable to both the parent company and minority interest stockholders under the entity theory, not just the portions attributable to the parent company stockholders alone under the parent company theory.

It is more complete and therefore more reliable and relevant to present the consolidated retained earnings statement under the entity theory, as illustrated in Panel B of Exhibit 5, than under the parent company theory, as illustrated in Panel A of Exhibit 5. By reporting all the earnings, all the dividends, and all the retained earnings beginning and ending balances of both stockholder groups under the entity theory, the resulting information is more comparable to similar entities without subsidiaries or with only wholly owned subsidiaries. Comparability is reduced by reporting just the portions attributable to the parent company stockholders under the parent company theory.

IMPACT OF DIFFERENT RETAINED EARNINGS STATEMENT DISPLAYS ON FINANCIAL RATIOS

How income, dividends, and opening and closing balances are reported in the consolidated retained earnings statement may significantly impact dividend payout ratios, dividend coverage ratios, earnings retention ratios, and retained earnings to total assets ratios.

Conventionally, the dividend payout ratio is defined (see, e.g. White et al. 1998, 180) as the percentage of earnings paid out as dividends, that is:

Dividend Payout Ratio = Dividends/Net Income

The reciprocal of the dividend payout ratio is the dividend coverage ratio. The retention ratio is unity less the dividend payout ratio and reflects the extent to which income is reinvested in the entity. Finally, the retained earnings to total assets ratio is defined (see, e.g., Stickney 1993, 398) as the percentage of assets financed with reinvested earnings, that is:

Retained Earnings to Total Assets Ratio = Retained Earnings/Total Assets

Multiple Ratios of Single Corporation

When a single legal corporation has preferred and common stock outstanding, three sets of dividend payout, dividend retention, and earnings retention ratios may be computed for different purposes. For example, the three dividend payout ratios are computed as follows:

Preferred Stock Dividend Payout Ratio = Dividends on Preferred Stock/Net Income

Common Stock Dividend Payout Ratio = Dividends on Common Stock/Net Income-Dividends on Preferred Stock

Total Dividend Payout Ratio = Total Dividends/Net Income

For each of the three payout ratios, there is a counterpart dividend coverage ratio and an earnings retention ratio.

The preferred stock dividend payout ratio reflects the extent to which income available to preferred stockholders is distributed to them. The common stock dividend payout ratio reflects the extent to which income available to common stockholders is distributed to them. The total dividend payout ratio reflects the extent to which total income is distributed to both stockholder groups. Unity less the total dividend payout ratio reflects the extent to which income is reinvested in the entity rather than distributed as dividends to either stockholder group. Finally, the retained earnings to total assets ratio reflects accumulated profitability and relative firm age, assuming no stock dividends or other transfers from paid-in capital to earned capital.

Multiple Ratios of Consolidated Entity

Analogously, when there are controlling common stockholders and minority common stockholders in a consolidated entity, three sets of dividend payout, dividend retention, and earnings retention ratios may be computed for different purposes. For example, the three dividend payout ratios are computed as follows:

Minority Stockholders Dividend Payout Ratio = Dividends to Minority Stockholders/Net Income to Minority Stockholders

Controlling Stockholders' Dividend Payout Ratio = Dividends to Controlling Stockholders/Net Income to Controlling Stockholders

Total Dividend Payout Ratio = Total Consolidated Dividends Consolidated Net Income

Again, for each of the three payout ratios, there is a counterpart dividend coverage ratio and an earnings retention ratio.

The minority and controlling stockholders' dividend payout ratios reflect the extent to which income attributable to each stockholder group is distributed to that group. The total dividend payout ratio reflects the extent to which consolidated income is distributed to both stockholder groups. Unity less the minority stockholders' dividend payout ratio, or the minority stockholders' retention ratio, reflects the extent to which income attributable to minority stockholders is reinvested in the partially owned subsidiary. Similarly, the controlling stockholders' retention ratio reflects the extent to which income attributable to the controlling stockholders is reinvested in the parent company, and the total retention ratio reflects the extent to which consolidated income is reinvested in the consolidated entity.

Only the controlling stockholders' set of ratios is readily calculated from the consolidated retained earnings statement under the parent company theory. All three sets of ratios are readily calculated from the consolidated retained earnings statement under the entity theory. Accordingly, users will have a different perspective on the extent to which income is distributed as dividends rather than reinvested, depending on whether the consolidated retained earnings statement is prepared under the parent company theory or the entity theory.

Similarly, when there are controlling common stockholders and minority common stockholders in a consolidated entity, two retained earnings to total assets ratios may be computed:

Controlling Stockholders' Retained Earnings to Total Assets Ratio = Controlling Stockholders' Retained Earnings/Total Assets

Total Retained Earnings to Total Assets Ratio = Total Retained Earnings/Total Assets

Ostensibly, the controlling stockholders' retained earnings to total assets ratio reflects the accumulated profitability and relative age of the consolidated entity, but its numerator excludes retained earnings attributable to minority stockholders. [28] Because the total retained earnings to total assets ratio includes retained earnings attributable to the minority stockholders, it more accurately reflects accumulated profitability and relative age of the consolidated entity.

Only the controlling stockholders' retained earnings to total assets ratio is readily calculated from the consolidated financial statements under the parent company theory. Both ratios are readily calculated from the consolidated financial statements under the entity theory. Accordingly, users may have a different perspective on the accumulated profitability and relative age of the consolidated entity, depending on whether the consolidated retained earnings is reported under the parent company theory or the entity theory.

Ratios from Published Statements

The difference in these financial ratios calculated using consolidated retained earnings under the parent company and entity theories, and the resulting difference in user perspective, may be substantial. For example, in its fiscal 1999 consolidated income statement, Magellan Petroleum Corporation reports a $945,212 consolidated net income after a $1,677,797 deduction for minority interest in partially owned Magellan Petroleum Australia Ltd., consistent with the parent company theory. In its fiscal 1999 consolidated statement of changes in stockholders' equity, Magellan Petroleum Corporation reports no dividends declared on common stock. Accordingly, under the parent company theory, the dividend payout ratio is zero, as indicated in Panel A of Exhibit 9, and the earnings retention ratio is 100 percent. It appears that all of Magellan's earnings is being reinvested in the business. But as disclosed in note 4 to the consolidated financial statements, dividends of $686,567 are declared to minority stockholders of Magellan Petroleum Australia Ltd. Under the entity theory, Magellan Petroleum Corporation would have reported consolidated net income to common stockholders and minority interest of $2,623,009 and consolidated dividends declared to these groups of $686,567, resulting in a dividend payout ratio of 26.17 percent, as indicated in Panel B of Exhibit 9, and an earnings retention ratio of 73.83 percent, compared to a dividend payout ratio of zero and an earnings retention ratio of 100 percent under the parent company theory. Thus, Magellan Petroleum Corporation is not reinvesting all of its earnings. Rather, a substantial 26.17 percent of earnings is being distributed as dividends. Additionally, the retained earnings to total asset ratio of Magellan Petroleum Corporation is negative 41.61 percent under the parent company theory but only negative 33.96 percent under the entity theory, as indicated in Panels A and B of Exhibit 9, another substantial difference.

Similarly, in its 1998 consolidated income statement, Cedar Income Fund, Ltd. reports $179,948 consolidated net income after an $89,950 deduction for minority interest. In its 1998 consolidated statement of changes in stockholders' equity, Cedar Income Fund, Ltd. reports $557,504 of dividends declared on common stock ($179,948 from retained earnings and $377,556 from additional paid-in capital). Accordingly, under the parent company theory, the dividend payout ratio is 309.81 percent, as indicated in Panel A of Exhibit 9. Under the entity theory, however, Cedar Income Fund, Ltd. would have reported consolidated net income to common stockholders and (minority interest) limited partners of $269,898 and consolidated dividends declared to these groups of $898,164, resulting in a dividend payout ratio of 332.78 percent under the entity theory, as indicated in Panel B of Exhibit 9, or 107.41 percent of the 309.81 percent dividend payout ratio under the parent company theory. As a real estate investment trust, howe ver, the retained earnings to total asset ratio of Cedar Income Fund, Ltd. is zero under the parent company and entity theories, as indicated in Panels A and B of Exhibit 9.

Finally, consider Good Times Restaurants Inc., a restaurant franchiser with several restaurants jointly owned with two separate co-development partners. In its 1998 consolidated income statement, Good Times Restaurants reports negative $226,000 consolidated net income after a $266,000 deduction for minority interest. In its 1998 consolidated statement of changes in stockholders' equity, Good Times Restaurants reports no dividends declared on common stock. Accordingly, under the parent company theory, the dividend payout ratio is zero, as indicated in Panel A of Exhibit 9. Under the entity theory, however, Good Times Restaurants would have reported consolidated net income to common stockholders and minority interest of $40,000 and consolidated dividends declared to both groups of $440,000, resulting in a dividend payout ratio of 1,100.00 percent under the entity theory, as indicated in Panel B of Exhibit 9, compared to a zero dividend payout ratio under the parent company theory. On the other hand, the retain ed earnings to total asset ratio of Good Times Restaurants is negative 139.42 percent under both the parent company and entity theories, as indicated in Panels A and B of Exhibit 9, because distributions exceed earnings of the partially owned restaurants.

CONCLUSION

Under the parent company theory and current GAAP, the consolidated balance sheet, consolidated income statement, and consolidated retained earnings statement assume a consolidated entity from the perspective of the parent company stockholders. As a result, whenever there are partially-owned subsidiaries, the consolidated balance sheet, consolidated income statement, and consolidated retained earnings statement incompletely report financial position, net income, and changes in retained earnings of the consolidated entity. Even under extant expositions of the entity theory, the consolidated retained earnings statement assumes a consolidated entity from the perspective of the parent company stockholders, and hence incompletely reports the consolidated entity's retained earnings and changes therein. As a result, the consolidated retained earnings statement is not comparable to the retained earnings statement of companies without subsidiaries or with only wholly owned subsidiaries.

Using a consistent consolidated entity perspective for all four consolidated financial statements under the entity theory, this paper demonstrates that consolidated retained earnings includes the separate equities of both the parent company and minority interest stockholders. As such, both elements of retained earnings and changes therein should be reported in the consolidated retained earnings statement to make it comparable to the consolidated retained earnings statement of companies without subsidiaries or with only wholly owned subsidiaries. This paper also demonstrates that for purchased subsidiaries, minority interest in consolidated retained earnings includes unamortized write-ups of identifiable net assets and goodwill arising from purchase-type business combinations, and that the effect on certain financial ratios may be substantial depending on how consolidated retained earnings is reported.

More generally, all four consolidated statements should consistently assume the same consolidated entity from the perspective of the entity itself, consistent with the entity theory as proposed in this paper. In this way, the consolidated balance sheet, consolidated income statement, consolidated retained earnings statement, and consolidated cash flow statement will completely report financial position, net income, changes in retained earnings, and cash flows of the consolidated entity, respectively. Because they are more complete, the consolidated financial statements under the entity theory will be more relevant, more reliable, more comparable, and more useful than consolidated financial statements under the parent company theory. Importantly, the consolidated retained earnings statement under this consistent application of the entity theory is comparable to the retained earnings statement of companies without subsidiaries or companies with only wholly owned subsidiaries.

(1.) To clarify the meaning of control and temporary control and to make consolidation policy more uniform across companies, the FASB (1995a, 1997, 1999a) has recently proposed to require consolidation of all subsidiaries over which the parent company has effective control by means other than majority ownership.

(2.) The entity theory of consolidated financial statements should be distinguished from (1) the entity concept and (2) the entity theory of income. The entity concept is concerned with the delineation of an area of economic interest of particular individuals, groups, or institutions, in order to identify, accumulate, and report financial information (see AAA 1965, 359-361). The entity theory of income is concerned with the treatment of interest and income taxes in financial statements; under the entity theory of income, interest on debt and income taxes are distributions of income, not determinants of income (see Paton 1922, 181,267). Finally, the entity theory of consolidated financial statements is concerned with the display and measurement of assets, liabilities, stockholders' equity, revenues, and expenses in consolidated financial statements (see Moonitz 1951).

(3.) In September 1999, the FASB (1999b, para. 13) proposed to prohibit pooling of interests accounting, but this prohibition would only apply prospectively.

(4.) Under proportionate consolidation, the consolidated balance sheet reports parent company assets and liabilities and the parent company's share of subsidiary assets and liabilities. Similarly, the consolidated income statement reports parent company revenues and expenses and the parent company's share of subsidiary revenues and expenses. Neither financial statement reports minority interest (see Pacter 1991, 23-31).

(5.) Advocates of the entity theory also argue that the measurement of a partially owned subsidiary's net assets in consolidated financial statements at acquisition should not be affected by the size of a minority interest in that subsidiary. Advocates of the parent company theory also argue that the measurement of a partially owned subsidiary's net assets in consolidated financial statements at acquisition is properly affected by the size of a minority interest in that subsidiary. Such measurement issues do not arise for newly established subsidiaries or for subsidiaries resulting from pooling-of-interests-type combinations.

(6.) For ease of exposition, henceforth I discuss a single minority interest in a single partially owned subsidiary. For parent companies with several partially owned subsidiaries, of course, there are several minority interests.

(7.) There are no significant consolidated cash flow statement reporting differences under these two theories. See Exhibit 6, Panels A and B.

(8.) For a newly established subsidiary, book values equal fair values of subsidiary net assets at acquisition. As a result, measurements of subsidiary net assets and minority interest in the consolidated balance sheet and revenues, expenses, and minority interest deduction in the consolidated income statement do not differ depending on whether the parent company or entity theory is used. For a newly established subsidiary, use of parent company theory or entity theory affects only the display of minority interest in the consolidated statements, which in turn reflects differences in the assumed consolidated entity perspective under each theory.

For a purchased subsidiary, book values rarely equal fair values of subsidiary net assets at acquisition. As a result, measurements of (1) subsidiary net assets and minority interest in the consolidated balance sheet, (2) revenues, expenses, and minority interest deduction in the consolidated income statement, and (3) minority interest and changes therein in the consolidated retained earnings statement differ depending on whether the parent company or entity theory is used. See section "Measurement Issues of Purchased Subsidiaries."

(9.) According to Haried et al. (1994, p. x, emphasis in original), "the cost method is the method most widely used [by parent companies] to record on their books investments in consolidated subsidiaries. This was supported by the results of a survey of corporate controllers of Fortune 500 companies....More than 71 percent...use the cost method." Kieso and Weygandt (1998, 920, emphasis in original) report that "whether or not consolidated financial statements are prepared, the investment in the subsidiary is generally accounted for on the parent's books using the equity method," but provided no supporting evidence. Accordingly, the weight of evidence suggests that the cost method is more widely used than the equity method.

(10.) See, e.g., Huefner et al. (2000, p. 4-10).

(11.) By definition, the dividend basis retained earnings balance of the parent company under the cost method is the starting point for deriving parent company retained earnings under the equity method and consolidated retained earnings under the parent company theory. The information presented in the separate parent company financial statements under the cost method presents another perspective on the parent company that is useful for some purposes, such as short-term credit analysis.

(12.) The same $2,600 net income and the same $3,640 retained earnings are reported in Company P's separate financial statements using the equity method and in the consolidated financial statements under the parent company theory. See Panel A of Exhibits 3, 4, and 5. For this reason, the equity method is sometimes referred to as a "one-line" consolidation.

(13.) Displaying minority interest as a liability is a widespread practice in published consolidated balance sheets. An AICPA (1998, Table 2-29, p. 262) survey reports that 148 of 600 companies include minority interest among noncurrent liabilities. Presumably, most companies include minority interest between liabilities and stockholders' equity. Those (e.g., Kohler 1963, 321; Cooper and Ijiri 1983, 331) that favor reporting minority interest as a liability note that although it is not a legal obligation, the minority interest possesses some of the attributes of obligations in that minority stockholders' interests do not parallel the interests of the controlling stockholders. A rationale (e.g., Pacter 1991, paras. 69-70) for reporting the minority interest between liabilities and stockholders' equity under the parent company theory is that minority interest is neither a liability nor an ownership interest in the subsidiary's parent. "The traditional solution has been...to describe the...item as a quasi liabil ity...below liabilities but above stockholders' equity."

(14.) In an AICPA survey of 600 companies, 42 companies report the minority interest deduction among expenses or losses (AICPA 1998, Table 3-7, p. 308), whereas 87 companies report it as a charge or credit after the income tax caption (AICPA 1998, Table 3-16, p. 396). According to Pacter (1991, Exhibit 7.1, fn. 1, p. 162), parent company theory advocates vary as to whether they favor reporting minority interest deduction as an expense or as a separate income statement deduction apart from expenses and losses to derive consolidated net income attributable to parent company stockholders.

(15.) The 1995 Exposure Draft (1995a, paras. 22-23, 101-108) favored the entity theory display of minority interest and minority interest deduction. Because this position was controversial, it was not included in the 1999 Exposure Draft. In separate 1999 deliberations on display, however, the FASB (1999c, 4) concluded again in favor of the entity theory display of minority interest and minority interest deduction in the consolidated statements.

(16.) SFAC No. 6 (1985. paras. 35, 254) defines liabilities as "probable future sacrifices of economic benefits arising from present obligations.. .to transfer assets or provide services...as a result of past transactions or events," and notes explicitly that minority interest is not a present obligation to convey assets. Additionally, SFAC No. 6 defines no separate balance sheet element between liabilities and stockholders' equity. The 1995 Exposure Draft (1995a, paras. 105-106) notes explicitly that minority interest is not a liability and suggests that there is no justification for creating a new balance sheet element.

(17.) SFAC No. 6 (1985, para. 35) defines expenses as "outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entities' ongoing major or central operations." Additionally, SFAC No. 6 defines no basic income statement element other than revenues, gains, expenses, and losses.

(18.) Hopkins (1996) found that security analysts' assessments of a hybrid security as either debt or equity are affected by whether the security is reported as debt, equity, or between debt and equity, even with information about the security's attributes. Hopkins' (1996) results suggest that full disclosure may not suffice for reporting the economic substance of hybrid securities and that classification may be important even in an efficient market. The same may be true of minority interest, which may also be reported as debt, equity, or between debt and equity.

(19.) For example, Compustat annual data item No. 38 (and quarterly data item No. 53) for minority interest excludes minority interest reported among current liabilities.

(20.) These amounts, as well as beginning and ending balances, are identical to those reported in the separate company retained earnings statement of Company P under the equity method, as illustrated in Panel B of Exhibit 2. See footnote 14.

(21.) To avoid extraneous issues, assume that dividends declared equal dividends paid for the period. In this context, the $1,500 consolidated dividend outflow excludes $1,200 or 60 percent of Company S's $2,000 dividend outflow, as the $1,200 is paid to Company P. In practice, the dividend outflow would increase (decrease) for the decrease (increase) in consolidated dividends payable for the period, and is often reported as a single line item for $1,500, not as two line items as shown in Exhibit 6.

(22.) Because there are no plant asset purchases and sales, the complete extinguishment of $1,000 of bonded debt is assumed. Otherwise, the increase in cash for 20x8 would be $1,700 (rather than $700) and would exceed the 31 December 20x8 cash balance.

(23.) Indeed, any such allocation is questionable conceptually unless proportional consolidation underlies the other consolidated financial statements.

(24.) Surprisingly, even advocates of the entity theory (e.g., Moonitz 1951, 80-81) for the consolidated balance sheet and income statement favor a consolidated retained earnings statement under the parent company theory, as illustrated in Panel A of Exhibit 5. Thus, advocates of both the parent company theory and the entity theory propose basically the same consolidated retained earnings statement despite the somewhat different consolidated entity perspective assumed by each.

(25.) The subsequent accounting for the investment differs, of course, depending on whether Company P uses the cost or equity method for internal purposes. Under the cost method, the separate financial statements of Company P would report $2,300 of net income for 20x8 and $3,100 of retained earnings at 31 December 20x8, as indicated in Panel A of Exhibit 2, but the $2,700 cost as the investment in Company S at 31 December 20x8. Under the equity method, the separate financial statements of Company P would report $2,558 of net income for 20x8, and $2,934 as the investment in Company S and $3,334 of retained earnings at 31 December 20x8. As indicated below, the same $2,558 of net income and $3,334 of retained earnings would be reported in the consolidated financial statements under the parent company theory.

(26.) This $1,200 total excess implied is attributable $720 to the parent company stockholders and $480 to the minority interest stockholders. The $200 excess of total fair value over total book value of subsidiary plant assets is attributable $120 to the parent company stockholders and $80 to the minority interest stockholders. Similarly, the $1,000 total goodwill implied is attributable $600 to the parent company stockholders and $400 to the minority interest stockholders. Alternatively, the $600 goodwill for a 60 percent-owned subsidiary under the parent company theory implies $600(100/60) or $1,000 of total goodwill implied under the entity theory.

(27.) At 1 January 20x8, two years after acquisition, $160 or 8/10 of the $200 subsidiary plant asset write-up at acquisition is unamortized, and $900 or 18/20 of the $1,000 subsidiary implied goodwill at acquisition is unamortized.

(28.) Similar issues arise in calculating the ratio of controlling stockholders' retained earnings to controlling stockholders' equity under the parent company theory vs. total retained earnings to total stockholders' equity under the entity theory.

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EXHIBIT 1

Underlying Information

On 1 January 20x6, three years ago, Company P established Company S by investing $1,800 in exchange for 60 percent of the no-par capital stock of Company S. At the same time, other parties invested $1,200 in exchange for the remaining 40 percent of the outstanding capital stock of Company S. Soon thereafter, Company S commenced operations, and became profitable almost immediately. It follows a policy of distributing 80 percent of its earnings as dividends. To simplify, subsequently there are no issuances or reacquisitions of capital stock, no asset impairment issues, and no intercompany transactions other than dividends. For internal purposes, Company P would record its investment in the stock of Company S at its $1,800 cost, and subsequently use either the cost or equity method to account for its investment in the stock of Company S.
EXHIBIT 2
Separate Company Statements
                                      Panel A: Company P
20x8 Income Statements                  (Cost Method)
Sales                                                     $3,900
Cost of goods sold
  Inventory, 1 January 20x8                 $  200
  Add: Purchases                             2,200
    Cost of goods available for sale        $2,400
  Less: Inventory, 31 December 20x8            300
    Cost of goods sold                                     2,100
Gross margin                                              $1,800
Operating expenses:
  Depreciation                               $ 400
  Other operating expenses                     300           700
Net operating income                                      $1,100
Dividend income [.60($2,000)]                              1,200
Equity in earnings of Company S
 [.60($,500)]
Net income                                                $2,300
                                      Panel B: Company P
20x8 Income Statements                 (Equity Method)
Sales                                                     $3,900
Cost of goods sold
  Inventory, 1 January 20x8                 $  200
  Add: Purchases                             2,200
    Cost of goods available for sale        $2,400
  Less: Inventory, 31 December 20x8            300
    Cost of goods sold                                     2,100
Gross margin                                               1,800
Operating expenses:
  Depreciation                               $ 400
  Other operating expenses                     300           700
Net operating income                                      $1,100
Dividend income [.60($2,000)]
Equity in earnings of Company S
 [.60($,500)]                                              1,500
Net income                                                $2,600
                                      Panel C:
20x8 Income Statements                Company S
Sales                                            $6,500
Cost of goods sold
  Inventory, 1 January 20x8            $  300
  Add: Purchases                        3,600
    Cost of goods available for sale   $3,900
  Less: Inventory, 31 December 20x8       600
    Cost of goods sold                            3,300
Gross margin                                      3,200
Operating expenses:
  Depreciation                          $ 200
  Other operating expenses                500       700
Net operating income                             $2,500
Dividend income [.60($2,000)]
Equity in earnings of Company S
 [.60($,500)]
Net income                                       $2,500
Panel A: company P                       Panel B: Company P
20x8 Income Statements                     (Cost Method)
1 January 20x8 balance
  Cost basis                                                 $1,500
  Equity basis [$1,500 + .60($400 -$0)]
Add: Net income for year                       $2,300
Less: Dividends                                   700         1,600
31 December 20x8 balance
  Cost basis                                                 $3,100
  Equity basis [$3,100 + .60($900-$0)]
Panel A: company P                            Panel C:
20x8 Income Statements                    (Equity Method)
1 January 20x8 balance
  Cost basis
  Equity basis [$1,500 + .60($400 -$0)]                    $1,740
Add: Net income for year                       $2,600
Less: Dividends                                   700       1,900
31 December 20x8 balance
  Cost basis
  Equity basis [$3,100 + .60($900-$0)]                     $3,640
Panel A: company P
20x8 Income Statements                   Company S
1 January 20x8 balance                              $ 400
  Cost basis
  Equity basis [$1,500 + .60($400 -$0)]
Add: Net income for year                  $2,500
Less: Dividends                            2,000      500
31 December 20x8 balance                            $ 900
  Cost basis
  Equity basis [$3,100 + .60($900-$0)]
Panel A: Company P                        Panel B: Company P
20x8 Income Statements                      (Cost Method)
Cash                                                            $600
Accounts receivable                                              500
Inventories                                                      300
Plant assets--net                                              4,000
Investment in Company S
  Cost basis                                                   1,800
  Equity basis [$1,800 + .60($900 - $0)]
  Total assets                                                $7,200
Accounts payable                                               $ 200
Capital stock                                   $3,900
Additional paid-in capital                           0
Retained earnings                                3,100
  Total stockholders' equity                                   7,000
  Total liabilities plus stockholders'
    equity                                                    $7,200
Panel A: Company P                             Panel C:
20x8 Income Statements                     (Equity Method)
Cash                                                         $ 600
Accounts receivable                                            500
Inventories                                                    300
Plant assets--net                                            4,000
Investment in Company S
  Cost basis
  Equity basis [$1,800 + .60($900 - $0)]                     2,340
  Total assets                                              $7,740
Accounts payable                                             $ 200
Capital stock                                   $3,900
Additional paid-in capital                           0
Retained earnings                                3,640
  Total stockholders' equity                                 7,540
  Total liabilities plus stockholders'
    equity                                                  $7,740
Panel A: Company P
20x8 Income Statements                    Company S
Cash                                                   $800
Accounts receivable                                     700
Inventories                                             600
Plant assets--net                                     2,000
Investment in Company S
  Cost basis
  Equity basis [$1,800 + .60($900 - $0)]
  Total assets                                       $4,100
Accounts payable                                       $200
Capital stock                              $3,000
Additional paid-in capital                      0
Retained earnings                             900
  Total stockholders' equity                          3,900
  Total liabilities plus stockholders'
    equity                                           $4,100
EXHIBIT 3
31 December 20x8 Consolidated Balance Sheet
                                                Panel A:
                                          Parent Company Theory
Cash [$600 + $800]
Accounts receivable [$500 + $700]
Inventories [$300 + $600]
Plant assets--net [$4,000 + $2,000]
    Total assets
Accounts payable [($200 + $200]
Minority interest [.40($3,000 + $0 +
  $900)]
Minority stockholders' equity
  Capital stock [.40($3,000)]
  Additional paid-in capital [.40($-0-)]
  Retained earnings [.40($900)]
    Total minority stockholders' equity
Controlling stockholders' equity
  Capital stock                                  $3,900
  Additional paid-in capital                          0
  Retained earnings                               3,640
    Total controlling stockholders'
      equity
    Total stockholders' equity
    Total liabilities plus stockholders'
      equity
                                                    Panel B:
                                                  Entity Theory
Cash [$600 + $800]                        $1,400
Accounts receivable [$500 + $700]          1,200
Inventories [$300 + $600]                    900
Plant assets--net [$4,000 + $2,000]        6,000
    Total assets                          $9,500
Accounts payable [($200 + $200]            $ 400
Minority interest [.40($3,000 + $0 +       1,560
  $900)]
Minority stockholders' equity
  Capital stock [.40($3,000)]                        $1,200
  Additional paid-in capital [.40($-0-)]                  0
  Retained earnings [.40($900)]                         360
    Total minority stockholders' equity
Controlling stockholders' equity
  Capital stock                                      $3,900
  Additional paid-in capital                              0
  Retained earnings                                   3,640
    Total controlling stockholders'
      equity                                  --
    Total stockholders' equity             7,540
    Total liabilities plus stockholders'  $9,500
      equity
Cash [$600 + $800]                        $1,400
Accounts receivable [$500 + $700]          1,200
Inventories [$300 + $600]                    900
Plant assets--net [$4,000 + $2,000]        6,000
    Total assets                          $9,500
Accounts payable [($200 + $200]            $ 400
Minority interest [.40($3,000 + $0 +
  $900)]
Minority stockholders' equity
  Capital stock [.40($3,000)]
  Additional paid-in capital [.40($-0-)]
  Retained earnings [.40($900)]
    Total minority stockholders' equity
Controlling stockholders' equity          $1,560
  Capital stock
  Additional paid-in capital
  Retained earnings
    Total controlling stockholders'
      equity                               7,540
    Total stockholders' equity            $9,100
    Total liabilities plus stockholders'  $9,500
      equity
EXHIBIT 4
20x8 Consolidated Income Statement
                                                   Panel A:
                                             Parent Company Theory
Sales [$3,900 + $6,500]
Cost of goods sold:
  Inventory, 1 January 20x8 [$200 + $300]            $ 500
  Add: Purchases [$2,200 + $3,600]                   5,800
   Cost of goods available for sale                 $6,300
  Inventory, 31 December 20x8 [$300 + $600]            900
   Cost of goods sold
Gross margin
Operating expenses:
  Depreciation [$400 + $200]                         $ 600
  Other operating expenses [$300 + $500]               800
    Total other expenses
Total net income
Consolidated net income
Minority interest in consolidated net
  income [.40($2,500)]
Consolidated net income
Controlling interest in consolidated net
 income
                                                        Panel B:
                                                      Entity Theory
Sales [$3,900 + $6,500]                      $10,400
Cost of goods sold:
  Inventory, 1 January 20x8 [$200 + $300]                 $ 500
  Add: Purchases [$2,200 + $3,600]                        5,800
   Cost of goods available for sale                      $6,300
  Inventory, 31 December 20x8 [$300 + $600]                 900
   Cost of goods sold                          5,400
Gross margin                                  $5,000
Operating expenses:
  Depreciation [$400 + $200]                              $ 600
  Other operating expenses [$300 + $500]                    800
    Total other expenses                       1,400
Total net income                              $3,600
Consolidated net income
Minority interest in consolidated net
  income [.40($2,500)]                         1,000

Consolidated net income                       $2,600
Controlling interest in consolidated net
 income
Sales [$3,900 + $6,500]                      $10,400
Cost of goods sold:
  Inventory, 1 January 20x8 [$200 + $300]
  Add: Purchases [$2,200 + $3,600]
   Cost of goods available for sale
  Inventory, 31 December 20x8 [$300 + $600]
   Cost of goods sold                          5,400
Gross margin                                 $ 5,000
Operating expenses:
  Depreciation [$400 + $200]
  Other operating expenses [$300 + $500]
    Total other expenses                       1,400
Total net income
Consolidated net income                       $3,600
Minority interest in consolidated net
  income [.40($2,500)]                         1,000
Consolidated net income
Controlling interest in consolidated net
 income                                       $2,600
EXHIBIT 5
20x8 Consolidated Retained Earnings Statement
                                                   Panel A:
                                             Parent Company Theory
1 January 20x8 balance:
  Minority interest [.40($400)]
  Controlling interest [$1,500 + .60($400)]
Add: Consolidated net income:
  Minority interest [.40($2,500)]
  Controlling interest                              $2,600
Less: Dividends:
  Minority interest [.40($2,000)]
  Controlling interest                                (700)
31 December 20x8 balance:
  Minority interest [.40($900)]
  Controlling interest [$3,100 + .60($900)]
                                                       Panel B:
                                                     Entity Theory
1 January 20x8 balance:
  Minority interest [.40($400)]                          $ 160
  Controlling interest [$1,500 + .60($400)]  $1,740      1,740
Add: Consolidated net income:
  Minority interest [.40($2,500)]                       $1,000
  Controlling interest                                   2,600
Less: Dividends:
  Minority interest [.40($2,000)]                         (800)
  Controlling interest                        1,900       (700)
31 December 20x8 balance:
  Minority interest [.40($900)]                          $ 360
  Controlling interest [$3,100 + .60($900)]  $3,640      3,640
1 January 20x8 balance:
  Minority interest [.40($400)]
  Controlling interest [$1,500 + .60($400)]  $1,900
Add: Consolidated net income:
  Minority interest [.40($2,500)]
  Controlling interest                        3,600
Less: Dividends:
  Minority interest [.40($2,000)]
  Controlling interest                       (1,500)
31 December 20x8 balance:
  Minority interest [.40($900)]
  Controlling interest [$3,100 + .60($900)]  $4,000
EXHIBIT 6
20x8 Consolidated Cash Flow Statement
                                                        Panel A:
                                                  Parent Comapny Theory
Operating activities:
  Net income
  Add deductions not using chash:
    Depreciation                                         $  600
    Minority interest                                     1,000
  Add (deduct) changes in noncash
    working capital:
    Decrease (increase) in accounts receivable a           (700)
    Decrease (increase) in inventories                     (400)
    Increase (decrease) in accounts payable a               100
      Net cash flow from operating activities
Investing activities:
  Purchase of plant and equipment                             --
  Sale of plant and equipment                                 --
    Net cash flow from investing activities
Financing activities:
  Issuance (retirement) of common stock                       --
  Issuance (retirement) of bonded debt a                 (1,000)
  Dividends declared and paid
    To Company P shareholders                              (700)
    To Company S minority shareholders
      [.40($2,000)]                                        (800)
      Net cash flow financing activities
Net increase (decrease) in cash
Cash at beginning of year a
Cash at end of year
Cash flow from operations could be derived
using the direct method, as follows:
Collections from customers [$10,400 - $700]
Payments to inventory suppliers
[$5,400 - $400 + $100]
Payments of other operating
expenses [$300 + $500]
Net cash provided by
operating activities
Operating activities:
  Net income                                      $2,600
  Add deductions not using chash:
    Depreciation
    Minority interest
  Add (deduct) changes in noncash
    working capital:
    Decrease (increase) in accounts receivable a
    Decrease (increase) in inventories
    Increase (decrease) in accounts payable a        600
      Net cash flow from operating activities     $3,200
Investing activities:
  Purchase of plant and equipment
  Sale of plant and equipment
    Net cash flow from investing activities            0
Financing activities:
  Issuance (retirement) of common stock
  Issuance (retirement) of bonded debt a
  Dividends declared and paid
    To Company P shareholders
    To Company S minority shareholders
      [.40($2,000)]
      Net cash flow financing activities          (2,500)
Net increase (decrease) in cash                    $ 700
Cash at beginning of year a                          700
Cash at end of year                               $1,400
Cash flow from operations could be derived
using the direct method, as follows:
Collections from customers [$10,400 - $700]
Payments to inventory suppliers
[$5,400 - $400 + $100]
Payments of other operating
expenses [$300 + $500]
Net cash provided by
operating activities
                                                    Panel B:
                                                  Entity Theory
Operating activities:
  Net income
  Add deductions not using chash:
    Depreciation                                     $ 600
    Minority interest                                   --
  Add (deduct) changes in noncash
    working capital:
    Decrease (increase) in accounts receivable a      (700)
    Decrease (increase) in inventories                (400)
    Increase (decrease) in accounts payable a          100
      Net cash flow from operating activities
Investing activities:
  Purchase of plant and equipment                        --
  Sale of plant and equipment                            --
    Net cash flow from investing activities
Financing activities:
  Issuance (retirement) of common stock                  --
  Issuance (retirement) of bonded debt a             (1,000)
  Dividends declared and paid
    To Company P shareholders                          (700)
    To Company S minority shareholders
      [.40($2,000)]                                    (800)
      Net cash flow financing activities
Net increase (decrease) in cash
Cash at beginning of year a
Cash at end of year
Cash flow from operations could be derived
using the direct method, as follows:
Collections from customers [$10,400 - $700]
Payments to inventory suppliers
[$5,400 - $400 + $100]
Payments of other operating
expenses [$300 + $500]
Net cash provided by
operating activities
Operating activities:
  Net income                                      $3,600
  Add deductions not using chash:
    Depreciation
    Minority interest
  Add (deduct) changes in noncash
    working capital:
    Decrease (increase) in accounts receivable a
    Decrease (increase) in inventories
    Increase (decrease) in accounts payable a       (400)
      Net cash flow from operating activities     $3,200
Investing activities:
  Purchase of plant and equipment
  Sale of plant and equipment
    Net cash flow from investing activities            0
Financing activities:
  Issuance (retirement) of common stock
  Issuance (retirement) of bonded debt a
  Dividends declared and paid
    To Company P shareholders
    To Company S minority shareholders
      [.40($2,000)]
      Net cash flow financing activities          (2,500)
Net increase (decrease) in cash                    $ 700
Cash at beginning of year a                          700
Cash at end of year                               $1,400
Cash flow from operations could be derived
using the direct method, as follows:
Collections from customers [$10,400 - $700]       $9,700
Payments to inventory suppliers                   (5,700)
[$5,400 - $400 + $100]
Payments of other operating
expenses [$300 + $500]                              (800)
Net cash provided by
operating activities                               $3,200
(a)Assumed amounts.


EXHIBIT 7

Additional Informaion and Allocation of Excess -- Purchased Subsidiary

Assume all the same information in the separate company financial statments of company P acquires 60 percent of the outstanading no-par capital stock of company S on 1 January 20x6 at a cost of $2,700, when Company S was an already established company with $3,000 of capital stock, $0 of additional paid-in capital, and $300 of retained earnings. Additonally, on that date, fair value exceeds book value of Company S's plant assets by $200. Accordingly, Company S is now a purchased subsidiary, not a newly established subsidiary, with appreciated plant assets and positive goodwill. The resulting $270 excess of cost over book value of investment at acquisition is computed and follows:
                                        Panel A:
At Acquisition                    Parent Company Theory
Cost of 60% interest                                     $2,700
Implied value of 100% interest
  [$2,700(100/60)]
1 January 20x6 owner's equity of
  Company S
  Capital stock                          $1,800
  Additional paid-in capital                  0
  Retained earnings                         180
100% equity in book value of net
  identifiable assets
60% equity in book value of net
  identifiable assets                                     1,980
Excess of cost over book value                            $ 720
Excess implied [$720(100/60)]
Excess of fair value over book
  value of plant assets
60% of excess of fair value over
  book value of plant assets                                120
Goodwill purchased                                        $ 600
Goodwill implied [$600(100/60)]
                                  Panel B:
At Acquisition                    Entity Theory
Cost of 60% interest
Implied value of 100% interest
  [$2,700(100/60)]                               $4,500
1 January 20x6 owner's equity of
  Company S
  Capital stock                   $3,000
  Additional paid-in capital           0
  Retained earnings                  300
100% equity in book value of net
  identifiable assets                             3,300
60% equity in book value of net
  identifiable assets
Excess of cost over book value
Excess implied [$720(100/60)]                    $1,200
Excess of fair value over book
  value of plant assets                             200
60% of excess of fair value over
  book value of plant assets
Goodwill purchased
Goodwill implied [$600(100/60)]                  $1,000


At acquisition, subisidiary plant assets and goodwill have ramaining useful lvies of 10 years and 20 years, respectively, and are amortized straight-line to zero. To simplify, continue to assume that there are no subsequent purchases or disposals of plant assets, no asset impairment issues, no issuances or reacquistions of capital stock, no intercompany transactions other than dividends, and that Company S follows a policy of distributing 80 percent of its earnings as dividends.
                                          Pane A:
Subsidiary Plant Assets            Parent Company Theory
Plant asset write-up, 1 January            $120
  20x6
Amortization fraction                    x 1/10
Additional depreciation expense
  per year [1/10]                          $ 12
Years since acquisition                     x 3
Accumulated amortization of plant
  asset write-up [3/10]                     $36
Unamortized plant asset write-up,
  31 December 20x8 [7/10]                  $ 84
                                     Panel B:
Subsidiary Plant Assets            Entity Theory
Plant asset write-up, 1 January         $200
  20x6
Amortization fraction                 x 1/10
Additional depreciation expense
  per year [1/10]                        $20
Years since acquisition                  x 3
Accumulated amortization of plant
  asset write-up [3/10]                  $60
Unamortized plant asset write-up,
  31 December 20x8 [7/10]               $140
                                                Panel A:
Goodwill                                  Parent Company Theory
Goodwill, 1 January 20x6                          $600
Amortization fraction                           x 1/20
Goodwill amortizatin expense per year             $ 30
[1/20]
Years since acquisition                            x 3
Accumulated goodwill amortization [3/20]          $ 90
Unamortized goodwill, 31 December 20x8
  [17/20]                                         $510
                                            Panel B:
Goodwill                                  Entity Theory
Goodwill, 1 January 20x6                     $1,000
Amortization fraction                        x 1/20
Goodwill amortizatin expense per year          $ 50
[1/20]
Years since acquisition                         x 3
Accumulated goodwill amortization [3/20]      $ 150
Unamortized goodwill, 31 December 20x8
  [17/20]                                     $ 850
EXHIBIT 8
Subsequent Effects--Purchased Subsidiary
                                                 Panel A:
Minority Interest Deduction               Parent Company Theroy
Deduction for minority interest--newly
 established subsidiary
Less: Additional depreciation expense
Less: Additional goodwill amortization
Deduction for minority interest--
 purchased subsidiary                                    $1,000
20x8 Consolidated Net Income
Total net income--newly established
 subsidiary
 [See Panel A of Exhibit 4]
Consolidated net income--newly
 established subsidiary
 [See Panel B of Exhibit 4]
Less: Additional depreciation expense                       $12
Less: Additional goodwill amortization                       30
Total net income--purchased subsidiary
Consolidated net income--purchased
 subsidiary
Less: Minority interest (above)
Consolidated net income--purchased
 subsidiary
Controlling interest in consolidated net
 net income--purchased subsidiary
                                                     Panel B:
Minority Interest Deduction                       Entity Theory
Deduction for minority interest--newly
 established subsidiary                   $1,000
Less: Additional depreciation expense                         8
Less: Additional goodwill amortization                       20
Deduction for minority interest--
 purchased subsidiary
20x8 Consolidated Net Income
Total net income--newly established
 subsidiary
 [See Panel A of Exhibit 4]               $3,600
Consolidated net income--newly
 established subsidiary
 [See Panel B of Exhibit 4]
Less: Additional depreciation expense                       $20
Less: Additional goodwill amortization        42             50
Total net income--purchased subsidiary    $3,558
Consolidated net income--purchased
 subsidiary
Less: Minority interest (above)            1,000
Consolidated net income--purchased
 subsidiary                               $2,558
Controlling interest in consolidated net
 net income--purchased subsidiary
Minority Interest Deduction
Deduction for minority interest--newly
 established subsidiary                   $1,000
Less: Additional depreciation expense
Less: Additional goodwill amortization        28
Deduction for minority interest--
 purchased subsidiary                       $972
20x8 Consolidated Net Income
Total net income--newly established
 subsidiary
 [See Panel A of Exhibit 4]
Consolidated net income--newly
 established subsidiary
 [See Panel B of Exhibit 4]               $3,600
Less: Additional depreciation expense
Less: Additional goodwill amortization        70
Total net income--purchased subsidiary
Consolidated net income--purchased
 subsidiary                               $3,530
Less: Minority interest (above)              972
Consolidated net income--purchased
 subsidiary
Controlling interest in consolidated net
 net income--purchased subsidiary         $2,558
Net income                                            $2,558
Depreciation                                   $ 612           $620
Goodwill amortization expense                     30             50
Minority interest                              1,000             --
Decrease (increase) in accounts receivable     (700)          (700)
Decrease (increase) in inventories             (400)          (400)
Increase (decrease) in accounts payable          100     642    100
  Net cash flow from operations                       $3,200
Subsidiary capital stock                              $3,000
Subsidiary additional paid-in capital                      0
Unadjusted Company S retained earnings                   900
Unamortized write-up of subsidiary plant
  assets
Unamortized goodwill
  Total                                               $3,900
Minority interest (40%)                               $1,560
1 January 20x8 balance:
  Minority interest
    [.40($400 + $200(8/10) + $1,000(18/20)]                   $ 584
  Controlling interest [$1,500
  + .60($400 - $300 - $200[2/10]
  - $1,000[2/20])]                                    $1,476  1,476
Add: Consolidated net income:
  Minority interest                                           $ 972
  Controlling interest                        $2,558          2,558
Less: Dividends:
  Minority interest [.40($2,000)]                             (800)
  Controlling interest                         (700)   1,858  (700)
31 December 20x8 balance:
  Minority interest
    [.40($900 + $200[7/10] + $1,000[17/20])]                  $ 756
  Controlling interest [$3,100
  + .60($900 - $300 - $200[3/10]
  - $1,000[3/20])]                                    $3,334  3,334
Net income                                     $3,530
Depreciation
Goodwill amortization expense
Minority interest
Decrease (increase) in accounts receivable
Decrease (increase) in inventories
Increase (decrease) in accounts payable         (330)
  Net cash flow from operations                $3,200
Subsidiary capital stock                       $3,000
Subsidiary additional paid-in capital               0
Unadjusted Company S retained earnings            900
Unamortized write-up of subsidiary plant
  assets                                          140
Unamortized goodwill                              850
  Total                                        $4,890
Minority interest (40%)                        $1,956
1 January 20x8 balance:
  Minority interest
    [.40($400 + $200(8/10) + $1,000(18/20)]
  Controlling interest [$1,500
  + .60($400 - $300 - $200[2/10]
  - $1,000[2/20])]                             $2,060
Add: Consolidated net income:
  Minority interest
  Controlling interest                          3,530
Less: Dividends:
  Minority interest [.40($2,000)]
  Controlling interest                        (1,500)
31 December 20x8 balance:
  Minority interest
    [.40($900 + $200[7/10] + $1,000[17/20])]
  Controlling interest [$3,100
  + .60($900 - $300 - $200[3/10]
  - $1,000[3/20])]                             $4,090
EXHIBIT 9
Financial Ratios under Parent Company
and Entity Theories
Panel A: As Reported (Parent Company
Theory)
                                              Magellan      Cedar
                                             Petroleum  Income Fund
                                                1999        1998
Total net income before minority
interest deduction (A)                     $ 2,623,009    $ 269,898
Less: Minority interest deduction            1,677,797       89,950
Consolidated net income as reported (B)      $ 945,212    $ 179,948
Dividends declared -- common stock (C)             $ 0     $557,504
Common dividend payout ratio (C)/(B)             0.00%      309.81%
Consolidated total assets (D)             $ 44,233,970  $15,323,315
Controlling interest retained earnings
balance (E)                              $(18,404,824)          $ 0
Controlling retained earnings/total                           0.00%
assets (E)/(D)                                 -41.61%        0.00%
Panel B: As Proposed (Entity Theory)
Consolidated net income as reported (B)      $ 945,212     $179,948
Add: Minority interest deduction             1,677,797       89,950
Total net income before minority
interest deduction (A)                     $ 2,623,009     $269,898
Dividends declared -- common stock                 $ 0     $557,504
Dividends declared -- minority interest        686,567    340,660 2
Total dividends declared (F)                 $ 686,567     $898,164
Dividend payout ratio (F)/(A)                   26.17%      332.78%
Controlling interest retained earnings
balance (E)                              $(18,404,824)        $ 0 3
Minority interest retained earnings
balance                                    3,383,500 1          0 3
  Total retained earnings balance (G)    $(15,021,324)          $ 0
  Total retained earnings/total assets
  (G)/(D)                                      -33.96%        0.00%
                                            Good Times
                                           Restaurants
                                              1998
Total net income before minority
interest deduction (A)                        $ 40,000
Less: Minority interest deduction              266,000
Consolidated net income as reported (B)    $ (226,000)
Dividends declared -- common stock (C)             $ 0
Common dividend payout ratio (C)/(B)           0.00% 4
Consolidated total assets (D)              $ 6,578,000
Controlling interest retained earnings
balance (E)                              $ (9,171,000)
Controlling retained earnings/total           -139.42%
assets (E)/(D)                                -139.42%
Panel B: As Proposed (Entity Theory)
Consolidated net income as reported (B)    $ (226,000)
Add: Minority interest deduction               266,000
Total net income before minority
interest deduction (A)                        $ 40,000
Dividends declared -- common stock                 $ 0
Dividends declared -- minority interest      440,000 2
Total dividends declared (F)                 $ 440,000
Dividend payout ratio (F)/(A)              1,100.00% 4
Controlling interest retained earnings
balance (E)                              $ (9,171,000)
Minority interest retained earnings
balance                                            0 5
  Total retained earnings balance (G)    $ (9,171,000)
  Total retained earnings/total assets
  (G)/(D)                                     -139.42%
(1)Estimated by multiplying the
$6,890,000 retained earnings balance at
30 June 1999 of Magellan Petroleum
Australia Limited by $1,678,000/
($1,739,000 + $1,678,000), where
$1,739,000 is Magellan Petroleum
Corporation's equity in Magellan
Petroleum Australia Limited net income
and $1,678,000 is the minority interest
in Magellan Petroleum Australia Limited
net income. Magellan Petroleum Australia
Limited was established by Magellan
Petroleum Corporation as a subsidiary in
1964.
(2)Distributions declared to minority
interest estimated by dividend payment's
to minority interest.
(3)As real estate investment trusts,
both Cedar Income Fund, Ltd., and
Cedar Income Fund Limited Partnership in
which Cedar Income Fund, Ltd. is the
sole general partner, distribute all
their earnings to their owners, hence
have no undistributed net earnings at
year end.
(4)Ignores $40,000 of common stock
issued as a dividend to preferred
stockholders.
(5)Minority interest retained earnings
balance not determinable from published
financial statements. For partially
owned restaurants, however,
distributions to owners equal defined
cash flows that exceed earnings, hence
no earnings are retained, per 28 August
2000 telephone conversation with Ms. Sue
Knutson, Controller of Good Times
Restaurants.
COPYRIGHT 2001 American Accounting Association
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2001 Gale, Cengage Learning. All rights reserved.

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Author:Nurnberg, Hugo
Publication:Accounting Horizons
Geographic Code:1USA
Date:Jun 1, 2001
Words:14386
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