Case .13

You have recently become the controller of Precision Corporation, a manufacturing enterprise that has begun a program of expansion through business combinations. On February 1,2005, two weeks prior to your controllership appointment, Precision had completed the acquisition of 85% of the outstanding common stock of Sloan Company for $255,000 cash, including out-of-pocket costs. You are engaged in a discussion with Precision’s chief accountant concerning the appropriate accounting method for Precision’s interest in Sloan Company’s operating results. The chief accountant strongly supports the cost method of accounting, offering the following arguments:

The cost method recognizes that Precision and Sloan are separate legal entities.

The existence of a 15% minority interest in Sloan requires emphasis on the legal separateness of the two companies.

A parent company recognizes revenue under the cost method only when the subsidiary declares dividends. Such dividend revenue is consistent with the revenue realization principle of financial accounting. The Intercompany Investment Income account recorded in the equity method of accounting does not fit the definition of realized revenue.

Use of the equity method of accounting might result in Precision’s declaring dividends to its shareholders out of “paper” retained earnings that belong to Sloan.

The cost method is consistent with other aspects of historical-cost accounting, because working paper eliminations, rather than journal entries in ledger accounts, are used to recognize amortization of differences between current fair values and carrying amounts of Sloan’s identifiable net assets.

Instructions

Prepare a rebuttal to each of the chief accountant’s arguments.