 Hello and welcome to the session in which you would look at consolidation and the different method of consolidating financial statements. This topic is important because as time goes by, the complexities of the financial statements consolidation gets harder and harder. So it's very important for the students to understand the basic concepts, the basic theory behind consolidation. Why? It's going to make your life easier during consolidation. You'll be able to understand the journal entries. Why are we debiting certain accounts? Why are we crediting certain accounts? Why are we doing this? What's the end product? What is the theory behind what we are doing? So this topic is important, whether you are an accounting students or a CPA candidate, whether you are an accounting students or a CPA candidate. I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. I am a useful addition. I provide an alternative explanation, an alternative resource for you to complete your work. So simply put, I teach you the material, the review course will help you prepare for the exam. Think of me as a backup to your CPA review course. Your risk to try me is one month of subscription. Your potential gain is passing the exam itself. Are you willing to take that risk? And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other courses and CPA sections. If you haven't connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So financial statements, consolidation, as I was just saying, it gets more and more complicated with time, but the basic objective remain the same. And that's to combine all your assets, all your liabilities, all your revenues, expenses and equity in the consolidated financial statements. And this occurs, this process occurs through the worksheets, the worksheet and the consolidation entries. And as a result, we produce a single set of financial statements. Now, some topics needs kind of it's good to understand those topics. They need special attention. One of them is consolidated in their income. So what happens after we buy the company subsequently acquisition, we must report our consolidated net income, which is the net income of the parent and the subsidiary. So what we do first, we separately combine the revenues and expenses of the parent with those of the subsidiaries. Now, also we have to do, we might have to increase our expenses a little bit, especially if we purchase those assets from the subsidiary higher than the cost. So simply put, the subsidiary's expenses, they might have those expenses based on the original book value. So let's assume they purchased a building 10 years ago, or last year, or it doesn't matter when, for a million dollar, and they amortizing this for 10 years. This is their original cost. Therefore, their depreciation is $100,000 per year. Now, when we purchase this building, we paid for the same building 1.5. Therefore, if there's 10 years remaining, now we're going to be depreciating $150,000. So we're going to be depreciating an access of $50,000. This is called access amortization. So we have to include this access amortization through an adjustment. So this is when we do the adjustments to reflect the amortization of the access of the parent consideration over the subsidiaries. This is what we are discussing here. So we might have additional expenses. Now, not all consolidation will take that into account. The full equity method will do that. Also, if there's any intercompany transaction, like account receivable, we sold them something on account. They purchase from us something on account we can we can solve. We eliminate those intercompany accounting and intercompany's payables and receivable. Another account that we need to be comfortable with is investments. And we need to understand that it creates investment. It's a little bit more complicated than income, in my opinion. So remember, for internal record keeping purposes, we're going to have to select an accounting method. And we're going to see there are three of them. To monitor the relationship between the two companies through the investment account. Because the investment account is what is the representation of the parent investment in the subsidiaries. Now, the investment account, it's going to vary over time as a result of income, as well as a result of the method that we chose. And these differences would be reflected. The fact that periodic consolidation, only the consolidation process, not the combined entity figures. So so at the end of the day, the investment account, by the way, the investment account, regardless of which method we are using, the investment account would always be equal to zero. However, on the parent company, the investment account will differ depending on which method we are using. Again, we did not discuss the method yet. I just want to introduce you to the investment account. So in the consolidated, the investment account is always zero. It has to be zeroed out because what we purchased, we purchased through that investments accounts, we purchased their assets, their liabilities, and as a result, their equity, right? Because assets minus liabilities equal to equity, so it has to zero out. But the investment account might be different on the parent's company. Also, just like likewise, the income figure accrued by the parent is removed each period. So if we accrue any revenue from the subsidiary will have to be removed. And what's left is only the subsidiary's net income. And here are the three methods that we use. We have the equity method, we have the initial value method, and we have the partial equity method. Now, all three methods start with the same investment account. And that investment account represents what we paid for that company initially. It doesn't matter which method, when we purchase an asset, we record it at its cost, historical cost, which is consideration transfer. Now, after the acquisition, the three method will produce different figures, notice, on the parent's company only, not on the consolidated sheets. On the parent's company, we might have a different investment account number. We might have a different income recognizing from the subsidiary's activities. And as a result, if we have a different income, we might have a different retained earnings. But this only happens on the consolidated, I'm sorry, on the parent company, on the consolidated, on the total, it doesn't matter which method we use. They all should be the same. Let's take a look, an overview about the three methods, starting with the equity method, the method that we should be most comfortable and familiar with, because if you understand the equity method, you will easily understand the partial equity. If you understand the equity and the partial equity, the initial value is a piece of cake. Right? So the equity method is using full accrual. And hopefully, you know what full accrual is. It's basically maintaining the parent's investment and account for related income over time. So simply put, when the subsidiaries report their income, the parent company will accrue it. So as soon as the subsidiaries earns it, the parent company will accrue it. How does it accrue it? What entry do we make when the subsidiaries reported their income? Remember, we debit investment, we credit income. So we debit investment. So we increase our investment in the subsidiaries and we increase our income. Also, the equity method accounts for access amortization. So remember what I said earlier, if we purchase a building for 1.5 million and the value of the building at the subsidiaries was a million, as a result, what happened is we have an access amortization of 50,000 per year. Assuming we are depreciating this building over 10 years. So what happened as a result? Usually, we're going to debit income, reduce income and reduce our investment for that access amortization. It's the opposite of when we accrue income, when we accrue income. Also, if there is any unrealized gross profit on intercompany transaction, we defer those. For example, if we sold them or they purchase from us inventory or if we sold them inventory and that inventory is not resold yet. Well, guess what? We're going to have a deferred profit. Therefore, we debit income, credit investment. Same thing as this entry, which is the opposite of the one we accrue net income. Also, when there's a dividend, the dividend to remember under the equity method, we debit dividend or eventually we receive cash and we credit the investment. So we reduce the investment by the amount of the dividend. So notice what's happening under the equity method. We are keeping track of our investment account as changes in the equity of the subsidiaries. It creates simply put a parallel between the parents investment and the changes in the underlying equity of the acquired company. They make a profit. We increase our investment. They pay dividend, we reduce our investment. This method is referred to sometime as the single line consolidation. It's popular where management would require or would want to measure the subsidiary, subsidiary, subsidiary profit under the accrual based income figures. This is the equity method. The partial equity method, obviously by the name of it, it should be similar to the equity method, which is similar. So every time they earn the income, we accrue it. So the income is simply put debit investment, credit income from the subsidiary. Every time they declare dividend, we debit, dividend, credit investment for the subsidiaries. However, we don't do the other two adjustments, which is the access amortization and the deferral. So we don't make those other adjustments. Okay. So we end up with a net income figure as computed from the parents company approximating consolidated total, but without the effort of the full application method of the equity method. Okay. So you will see this one. We do an example, but this is what's going to end up happening. Now, again, the total for both companies will be the same. The consolidated. What's going to differ is those consolidating entries, consolidation entries. The initial value method, in contrast to the other two method, we don't recognize any income as it's earned. So we don't use the accrual method. So what we do is we wait until they pay the dividend. So we recognize the dividend income as they pay it. And usually from the time they declare it until the time they pay, that's very short. Therefore, simply put, the initial method to a great degree, it recognizes or it's measuring the subsidiary's performance under the cash method. So if you hear the word initial value method, think of the cash value, the cash basis of accounting, because we recognize income as we receive it in form of dividends. So why do we use the initial value method? It's easy. It's very easy. Just we wait until we receive the cash from them. It's ease of application. We don't need to measure the subsidiary's performance on an accrual basis. So it's not needed. So simply put, we want to measure their performance on the cash basis. This is when we use this method. So make sure you are familiar with all three methods. Make sure you have a good understanding of the equity method, because the partial equity will become easier. The initial value, it's easiest of the two. Now, obviously we have to work an example illustrating those three methods. And preferably one example showing you the difference between the three. But because this is what I just went over is theory. You know, it's good if you were able to follow, but what's even better. If I work an example showing you all three methods at the end of this recording, I'm going to remind you whether you're an accounting student or a CPA candidate, farhatlectures.com is an alternative resource, a backup system to your CPA preparation. You're going to learn, you're going to invest in yourself once for the CPA. Once you pass it, you no longer have to renew this investment. So do it wisely. Don't shortchange yourself. The CPA is worth it. Your risk to try me is one month of subscription. 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