Standard Company has a relatively high profit margin on its sales, and Jewel Company has a substantially lower profit margin. Standard holds 55 percent of Jewel’s common stock and includes Jewel in its consolidated statements. Standard and Jewel reported sales of $100,000 and $60,000, respectively, in 20X4. Sales increased to $120,000 and $280,000 for the two companies in 20X5. The average profit margins of the two companies remained constant over the two years at 60 percent and 10 percent, respectively.
Standard’s treasurer was aware that the subsidiary was awarded a major new contract in 20X5 and anticipated a substantial increase in net income for the year. She was disappointed to learn that consolidated net income allocated to the controlling interest had increased by only 38 percent even though sales were 2.5 times higher than in 20X4. She is not trained in accounting and does not understand the fundamental processes used in preparing Standard’s consolidated income statement. She does know, however, that the earnings per share figures reported in the consolidated income statement are based on income allocated to the controlling interest and she wonders why that number isn’t higher.
As a member of the accounting department, you have been asked to prepare a memo to the treasurer explaining how consolidated net income is computed and the procedures used to allocate income to the parent company and to the subsidiary’s noncontrolling shareholders. Include in your memo citations to or quotations from the authoritative literature. To assist the treasurer in gaining a better understanding, prepare an analysis showing the income statement amounts actually reported for 20X4 and 20X5.