400 - 310 PurchaseSimpleFullEquity22B

Dr. M. D.
Chase
Long Beach State University
Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 1
I. PURCHASE CONSOLIDATIONS: SIMPLE EQUITY METHOD VERSUS FULL EQUITY METHOD
A.
What is the Simple Equity Method?

1.
The simple equity method is a method to simplify the consolidated elimination entries by ignoring effect of the amortization
(the D entries under the method I have illustrated) on the investment account.
a.
In other words, at any given point in time under the simple equity method, the investment account will only reflect
adjustments due to picking up the parents share of NI and DIV; the amortization entries are not reflected in the
Investment account.
2.
This approach is permissible in a consolidated (>50% ownership) situation because the Investment account is going to be
3.
APB-18 (AKA the full equity method) must be applied for investments between 20 and 50 percent and for unconsolidated
eliminated.
subsidiaries.
EXAMPLE-1: Interperiod Purchase
On January 1, x1, "P" Company acquired 100% of the outstanding $10 par value common stock of "S" Company by issuing 5,000 shares of $10 par
common stock (which was trading at $70 per share on that date). In addition, "P" Company incurred out-of-pocket costs of $80,000 relating to
the acquisition, $30,000 of which was for registration of the shares issued with the SEC. The balances in the capital accounts of "P" and "S"
Company as of the acquisition date are as follows:
S
P
Common stock..................
$500,000
PIC...........................
$200,000
795,000
-0-
Retained earnings (1/1/x1).... 355,000
62,000
All assets and Liabilities of "S" Company have a current value equal to their book value except for the following:
Remaining
FMV
BV
Inventory....................
$ 82,000
Land.........................
60,000
Equipment...................
_ Life _
$ 90,000
175,000
. 145,000
2 months
Indefinite
115,000
5 years
Assume any goodwill paid for has a 15-year life from the date of acquisition. The only entry "P" has made on its books since the acquisition date
was to credit the investment account for the dividends of $10,000 it received from the subsidiary during 19x1.
-- The financial statements of each company for the year ended 12/31/x1, are as follows:
S
P
Cash................................
Accounts receivable, net............

Inventory...........................
85,000
$ 20,000
110,000
30,000
220,000
95,000
Investment in "S" Company......
420,000
Land................................
450,000
60,000
Building (cost).....................
725,000
255,000
Accumulated depreciation.........
(180,000)
(133,000)
Equipment (cost)..................
570,000
190,000
Accumulated depreciation............ (130,000)
( 74,000)
Accounts payable and accruals.
(260,000)
( 85,000)
Long-term debt......................
(220,000)
( 70,000)
Common stock........................
(550,000)
(200,000)
PIC.................................
(825,000)
Retained earnings. 12/31/x1
(415,000)
Balance........................
Dividends...........................
-0$
40,000
========
( 88,000)
-0$ 10,000
=======
Sales...............................
$ (960,000) $420,000)
Cost of goods sold..................

Marketing expenses..................
500,000
92,000
Administrative expenses.............
98,000
Interest expense....................
20,000
Income before income taxes
40,000
5,000
(250,000)
( 90,000)
150,000
54,000
Income tax expense @ 60%............

Net income........................$
220,000
65,000
100,000 $ 36,000
NOTE: this is not the BOY retained earnings balance,

you must determine how this balance was attained.
REQUIRED:
1. Analyze the investment
2. Correct any errors discovered based on the
analysis of the investment
3. Record the equity method entries that would be
made by "P" (e.g. full equity method)
4. Prepare the consolidated elimination entries
5. Prepare the consolidated work sheet
Dr. M. D. Chase
Solution:
1. Analyze the investment:
Cost ($70) (5000) + (50,000).......................... $
400,000
Purchased book value (100%)(200,000 + 62,000)..

Excess of cost> book value.........................
(262,000)
138,000
Attributable to:
It is essential to notice that this is a credit

(reduction) in value resulting from a decline in value
of the equipment
To FMV accounts:
Inventory (100% x (90-82))
8,000
Balance available to NCA.......
130,000
To NCA accounts:
Land (100% x 175-60))
115,000
(5 yr life) Equipment (100%(115-145))
85,000
(30,000)
Balance to Goodwill............
Note that the excess of cost > BV must always be

totally accounted for;
45,000
Excess accounted for.....
$ 138,000
NOTE: --This analysis tells us that the Investment should be recorded at $400,000, but it now has a balance of $420,000 and we know that
the only entry the parent has made is to adjust the investment account to record the receipt of the dividend; based on this
information, it is probable that "P" is using the equity method. The correct entries to record the receipt of the dividend would be:
Equity method:
Cash........................
10,000
Investment in "S"......
10,000
--Recall that it was pointed out that the RE in the 12/31/x1 financials was different than the BOY RE, indicating that some adjustments
must have been made to RE. The only adjustments normally made to RE are for NI, Div, PPA and quasi-reorganizations. This
suggests that the adjustments were probably as follows:
RE BOY............................
$ 62,000
Add: NI (as reported)............ 36,000

Deduct: Dividend recorded.... (10,000) This means that the dividend revenue was already closed to RE
RE EOY............................
$ 88,000
--Because we have now accounted for all the entries reportedly made by Parent, we must assume that the difference was in the initial
recording of the investment.
Correct recording entry:
Investment in "S" ......................
400,000
"P" C/S ($10)(5,000)...............
50,000
"P" PIC ($60)(5,000) - ($30,000)...

Cash...............................
270,000
80,000
Entry made by "P":

Investment in "S"....................... 430,000
(430,000 - 10,000 = 420,000)
"P" C/S ($10)(5,000)...............
50,000
"P" PIC ($60)(5,000) ..............
300,000
Cash...............................
80,000
2: Correct errors based on the Analysis of the investment

To correct error: (a) Correct the investment account
PIC..................................... 30,000
Investment in "S"..................
30,000
Note that you had to be alert enough to notice and

compute the amount of the errorIn this case you
were warned in the requirements. The CPA
Examination problems wont give you this warning!
Dr. M. D. Chase
3: Equity method entries to be booked by "P" (These are P entries, NOT the consolidation entries)
To record equity in earnings: (recorded on books of parent only IAW APB-18)
Investment in "S"....................... 36,000
Equity in "S" NI...................
36,000
NOTE: These entries are ignored under the "simple

equity method" . Recall that the simple equity
To amortize excess of cost over book value:

Equity in "S" NI (inventory).................
method is a consolidation approach and only allowable
8,000
Equity in "S" NI (Equipment (30,000/5)
6,000
Investment in "S"..................
2,000
NOTE: The dividend entry has already been made
when P% is >50%.
FYI: At any point in time the balance in the
investment account will be off by the cumulative
amortizations of excess of cost over book value.
This will be illustrated below.
Consolidated elimination entries

FULL EQUITY METHOD
(a) Current year equity in net income and dividends

Equity in "S" net income......
34,000
Investment in "S"........
Equity in "S" net income...... 36,000

34,000
(b) Pro-rata share of BOY book value

"S" common stock..............
"S" common stock..............
"S" retained earnings (BOY) 62,000

262,000
(c) Allocate the excess of cost > book value
Cost of goods sold............
262,000
Land..........................115,000
45,000
Goodwill...................... 45,000
30,000
138,000
(d) Amortize the purchase differential (excess)

A/D-Equip (30/5yr)
COS........................... 8,000
115,000
Equipment................
200,000
c) Allocate the excess of cost > book value
8,000
Goodwill......................
36,000
"S" retained earnings (BOY). . 62,000
Land..........................
b) Pro-rata share of BOY book value
200,000
COS...........................
SIMPLE EQUITY METHOD

a) Current year equity in net income and dividends
Equipment................
30,000
138,000
d) Amortize the purchase differential (excess)
6,000
Accumulated depr--equipment...
6,000
8,000
Cost of goods sold............
8,000
Depreciation expense.....
Investment is "S"........
Equity in S NI: 100% (36,000-8,000 + 6,000
6,000
Depreciation expense.....
6,000
8,000
Investment is "S"........
8,000
Dr. M. D. Chase
12/31/2001
Cons
No
Adjustment/
Eliminations
Income
Minority
Controlling
Retained
Consolidated
Balance
Debit
Credit
Statement
Interest
Earnings
Sheet
85,000
20,000
110,000
30,000
140,000
Inventory
220,000
95,000
Investment in Sub
390,000
Cash and Cash Equiv

AR (net)
MES
Land
450,000
60,000
Building
725,000
255,000
105,000
(C)
315,000
36,000
(A)
(26,000)
(B)
(262,000)
(C)
(138,000)
115,000
0
0
A/D Building
(180,000)
(133,000)
Equipment
570,000
190,000
A/D Equip
(130,000)
(74,000)
(313,000)
736,000
(204,000)
0
0
(260,000)
(85,000)
(220,000)
(70,000)
(C)
45,000
(290,000)
(A,C)
(A,C)
(200,000)
(B)
200,000
(B)
(62,000)
(B)
62,000
(A,C)
(AA)
(550,000)
0
(AA)
(795,000)
0
(355,000)
Retained Earnings S
45,000
(345,000)
0
(795,000)
PIC (Sub)
(550,000)
Common Stock (Sub)
Cost of Sales
0
(30,000)
Sales
(C)
Long-Term Debt
Retained Earnings P BOY
6,000
PIC Parent
980,000
Accounts Payable
Common Stock (Parent)
0
Goodwill
Deferred Taxes
625,000
0
0
(D)
(960,000)
(420,000)
500,000
220,000
(1,380,000)
722,000
(C)
8,000
(D)
SEC/Stock Issue Costs
(355,000)
0
(6,000)
(AA)
Marketing Exp
92,000
65,000
AdminExp
98,000
40,000
157,000
0
138,000
Dr. M. D. Chase
Interest Income
Interest Expense
Tax Expense
20,000
5,000
25,000
150,000
54,000
Equity In "S" NI
Dividends Declared
204,000
(A)
40,000
10,000
(C)
(A)
(10,000)
40,000
DTL from Purchase
DTE from Purchase
472,000
(472,000)
Tax Refund Receivable
0
0
(134,000)
Balance:
Consolidated Net Income
To MI:
To CI:
0
This distribution is in balance
134,000
(134,000)
0
0
(449,000)
(449,000)
0
Dr. M. D. Chase
EXAMPLE 2: INTERPERIOD PURCHASE (80%)--EQUITY METHOD
"P" purchases 80% of "S" on 7/1/1 for $106,400
Trial Balance
_
_
12/31/1
7/1/1
Current Assets........... $
187,600
Prop/Plant/Equip (net)...
200,000
50,000**
Liabilities..............
(60,000)
(18,000)
(18,000)
Common stock.............
(250,000)
(50,000)
(50,000)
Retained earnings (1/1/1) (100,000)

Sales....................
(500,000)
Expenses.................
Cost of goods sold.......
12/31/1
78,000
(40,000)
(90,000)
85,500
47,500
(40,000)
(150,000)
70,000
10,000
15,000
350,000
60,000
105,000
Dividends declared.......
5,000
**FMV of "S" PP&E on 7/1/1 is $80,000

assume a ten year life on all depreciable items
Required:
A. State the GAAP with respect to recording interperiod purchases
B. Assuming "S" is required to close its books on 7/1/1, analyze the investment and prepare the consolidated elimination entries on 12/31/x1
under both the simple equity method and the full equity method.
C. Assuming "P" follows APB No. 16 very closely, analyze the investment and prepare consolidated elimination entries.
D. What is minority interest income?
E. What is the controlling interest income carried to the consolidated
Dr. M. D. Chase
EXAMPLE 2--Interperiod Purchase Solution

A. APB-16 paragraph 96 requires that the purchasing company account for income of the subsidiary for the entire year by including the
subsidiaries entire yearly income and then "backing out" that income to which it is not entitled. This can be accomplished by debiting an
account such as "purchased net income".
B1. Requiring the subsidiary to close its books in mid-year is not GAAP unless it coincided with the fiscal year. This is the procedure that
would be used under APB-18 (the equity method). It is illustrated here principally for the purpose of illustration.
(BOOKS CLOSED AT DATE OF PURCHASE)
Cost...........................................................
106,400
Purchased book value: C/S (.8)(50,000)................
.40,000
(1/1 to 7/1)
R/E (40+90-10-60)(.8)............
48,000 _88,000
Excess of cost > book value.......................
18,400
Attributable to:
Current assets................
Equipment.....................
-018,400
18,400
B2. CONSOLIDATED ELIMINATION ENTRIES

Full Equity Method
Simple Equity Method

A.
Eliminate current year investment account entries

8,000
Equity in "S" net income (60-5-45)(.8)-920...
7,080
Div. decl. [or R.E.] (5,000)(.8)...
4,000
Div. decl. [or R.E.] ...................
4,000
Investment in "S"..................
B.
4,000
Eliminate the pro rata share of the "S" SHE

"S" Common Stock (50,000)(.8)...........
40,000
"S" Retained earnings (40+20)(.8).......
48,000
Investment in "S"..................
C.
A. Eliminate current investment account entries:
Equity in "S" net income (60-5-45)(.8)
88,000
Investment in "S".......................
3,080
B,C,and D are the same as simple equity. Note that

the primary difference is the 'amount' at which the
investment account is carried. Under full equity, as
under APB-18, the investment account reflects all
amortizations. Under the simple equity method it
reflects only the effects of net income and dividends
Allocate the excess of cost > book value per analysis

Accumulated depreciation-Equipment......
18,400
Investment in "S"..................
18,400
D. Amortize the excess of cost > book value

Operation expenses (18,400/10)(.5yr).... 920
Equipment..........................
920
W. Bring the investment account up to date as of EOY

Investment in "S"............................8,000
Equity in "S" net income................
8,000
X. Amortize the purchase differential

Equity in "S" net income (depr. equip).......
Investment in "S" ......................
920
920
Because the investment account will be eliminated

and not appear on the consolidated fin. statements,
either method is GAAP. In addition to A,B,C, and D
above, the full equity would require the following
additional entries:
Clearly, the full equity method is more time consuming and repetitive, but it will carry the investment account at the same balance that
would exist under APB-18. This is particularly important if any portion of the investment is sold. As we will see in the Special Issues
topics that follow; conversion to full equity (sophisticated equity) method will become a necessity in some circumstances
Dr. M. D. Chase
Example 3: Mid-year purchases
APB-16 paragraph 96 requires the investment to be treated as if it had been made at the beginning of the year and then "back out" any
net income to which the parent is not entitled. The income is "backed out" by debiting an account called 'purchased net income' for the
appropriate amount.
(BOOKS NOT CLOSED AT DATE OF PURCHASE)
Cost......................................................
Purchased book value:
106,400
C/S (50,000)(.8)............
R.E.(40,000)(.8)............
40,000
32,000 72,000
Excess of Cost > book value..................
34,400
Purchased net income.....
16,000*
Equipment................
18,400
Attributable to:
(first .5 year income: (90-10-60)(.8)
34,400
C2. CONSOLIDATED ELIMINATION ENTRIES:
Full Equity Method
Simple Equity Method
A. Eliminate current investment account entries:
A. Eliminate current year investment account entries

Equity in "S" net income (60-5-45)(.8)..
8,000
Equity in "S" net income (60-5-45)(.8)-920...
7,080
Div. decl. [or R.E.] (5,000)(.8)...
4,000
Div. decl. [or R.E.] ...................
4,000
Investment in "S"..................
4,000
Investment in "S".......................
B. Eliminate the pro rata share of the "S" SHE

"S" Common Stock (50,000)(.8)...........
40,000
"S" Retained earnings (40k)(.8).........
32,000
Investment in "S"..................
C.
72,000
Allocate the excess of cost > book value per analysis

A/D Equipment
18,400
***Purchased net income.........
16,000
Investment in "S"..................
D.
3,080
B,C,and D are the same as simple equity. Note that

the primary difference is the 'amount' at which the
investment account is carried. Under full equity, as
under APB-18, the investment account reflects all
amortizations. Under the simple equity method it
reflects only the effects of net income and dividends
34,400
Amortize the excess of cost > book value

Operation expenses (18,400/10)(.5yr).... 920
Equipment..........................
920
W. Bring the investment account up to date as of end of period

Investment in "S"............................
8,000
Equity in "S" net income................
8,000
In addition to the ABCD entries, the simple equity method would

require entries W and X as illustrated:
X. Amortize the purchase differential

Equity in "S" net income (depr. Equip.)......
Investment in "S".......................
920
920
Computation of Minority Interest Income (no intercompany transactions)

It is not GAAP to close the books of the acquired company at the time of acquisition. (This would close the nominal accounts to S RE.)
However, for illustrative purposes, lets see what would happen if we did close the books. Later we will contrast this to the correct
process (books not closed).
If the books are closed at acquisition, the year end distribution of income to the minority interest would consist of their percentage times the
earnings of the last portion of the year, computed as follows: (.2)(60-50) = $2,000
Minority Interest Income = [MI%(SIGNI
(assuming no intercompany transactions
Where: MI% = Minority Interest percentage of ownership of "S"
SIGNI = Subsidiary Internally Generated Net Income
2. If the books are not closed at acquisition, the minority interest share is based on the entire year, or: (.2)(30,000) = $6,000. You would then
Dr. M. D. Chase
have to back out the income earned during the part of the year you did not have an equity interest in S.
E. Computation of Controlling Interest Income (no intercompany transactions)

1. Whether or not the books are closed, the controlling interest income carried forward to the controlling retained earnings is computed as
follows:
Controlling Interest Income = PIGNI + P%(S Adjusted Net Income)
(assuming no intercompany transactions
Where:
PIGNI = P Internally Generated Net Income

P% = P percentage of ownership of subsidiary
S Adjusted Net Income = SIGNI as computed above
Full equity method
Simple equity method:

"P" internally generated net income (500-70-350)...
Add:"P" equity in "S" net income ...................
$80,000
$80,000
8,000
7,080
$88,080
$87,080
(8,000-920)

400 - 310 PurchaseSimpleFullEquity22B

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Dr. M. D.

What is the Simple Equity Method?

Retained earnings (1/1/x1).... 355,000

Accounts receivable, net............

Investment in "S" Company......

Accumulated depreciation............ (130,000)

Accounts payable and accruals.

Retained earnings. 12/31/x1

Cost of goods sold..................

Income before income taxes

Income tax expense @ 60%............

NOTE: this is not the BOY retained earnings balance,

Purchased book value (100%)(200,000 + 62,000)..

It is essential to notice that this is a credit

Balance available to NCA.......

(5 yr life) Equipment (100%(115-145))

Note that the excess of cost > BV must always be

Excess accounted for.....

Add: NI (as reported)............ 36,000

"P" C/S ($10)(5,000)...............

"P" PIC ($60)(5,000) - ($30,000)...

Entry made by "P":

(430,000 - 10,000 = 420,000)

"P" C/S ($10)(5,000)...............

"P" PIC ($60)(5,000) ..............

2: Correct errors based on the Analysis of the investment

Note that you had to be alert enough to notice and

NOTE: These entries are ignored under the "simple

To amortize excess of cost over book value:

method is a consolidation approach and only allowable

Equity in "S" NI (Equipment (30,000/5)

NOTE: The dividend entry has already been made

This will be illustrated below.

Consolidated elimination entries

(a) Current year equity in net income and dividends

Equity in "S" net income...... 36,000

(b) Pro-rata share of BOY book value

"S" common stock..............

"S" retained earnings (BOY) 62,000

(c) Allocate the excess of cost > book value

Cost of goods sold............

(d) Amortize the purchase differential (excess)

c) Allocate the excess of cost > book value

"S" retained earnings (BOY). . 62,000

SIMPLE EQUITY METHOD

d) Amortize the purchase differential (excess)

Cost of goods sold............

Equity in S NI: 100% (36,000-8,000 + 6,000

Cash and Cash Equiv

Common Stock (Sub)

Retained Earnings P BOY

Common Stock (Parent)

SEC/Stock Issue Costs

DTL from Purchase

DTE from Purchase

Tax Refund Receivable

Retained earnings (1/1/1) (100,000)

**FMV of "S" PP&E on 7/1/1 is $80,000

EXAMPLE 2--Interperiod Purchase Solution

Purchased book value: C/S (.8)(50,000)................

Excess of cost > book value.......................

B2. CONSOLIDATED ELIMINATION ENTRIES