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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...........................

P

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
=======

S

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

(10........ (262..... 80.000 (5 yr life) Equipment (100%(115-145)) 85.000)........ PPA and quasi-reorganizations............ we must assume that the difference was in the initial recording of the investment...000) .....000).. 430..... Analyze the investment: Cost ($70) (5000) + (50..... 130..........000 + 62... D....... 270..000 To NCA accounts: Land (100% x 175-60)) 115................. $ 88. $ 138...... Excess of cost> book value...............000) ....000 Investment in "S".........000 "P" PIC ($60)(5........000 "P" C/S ($10)(5........ Correct recording entry: Investment in "S" . 300.....000 Entry made by "P": Investment in "S".......000 (30.. This suggests that the adjustments were probably as follows: RE BOY.. 10.... $ 62....000) $ 138.... 45..000 --Because we have now accounted for all the entries reportedly made by Parent..000) "P" C/S ($10)(5...000 = 420..000 ......000 Purchased book value (100%)(200....... $ 400........000 Deduct: Dividend recorded......000 --Recall that it was pointed out that the RE in the 12/31/x1 financials was different than the BOY RE..... 30.... M......... indicating that some adjustments must have been made to RE.. based on this information......000)......... Note that the excess of cost > BV must always be totally accounted for....... Cash.........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 Cash.......... it is probable that "P" is using the equity method.. Div.....000 Balance available to NCA.. 30... 400..... 36..............000 80..........000 "P" PIC ($60)(5.000).......... but it now has a balance of $420...000)......000..............000) Balance to Goodwill.($30...000 Add: NI (as reported).... 50.......... The only adjustments normally made to RE are for NI..... The CPA Examination problems won’t give you this warning! . The correct entries to record the receipt of the dividend would be: Equity method: Cash..000 NOTE: --This analysis tells us that the Investment should be recorded at $400.000 Investment in "S"...000 Excess accounted for..... 50...........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................Dr.000) This means that the dividend revenue was already closed to RE RE EOY. 10.....000 Note that you had to be alert enough to notice and compute the amount of the error…In this case you were warned in the requirements...10........000 2: Correct errors based on the Analysis of the investment To correct error: (a) Correct the investment account PIC................ Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 2 Solution: 1.000 (430.

............. Recall that the “simple” equity To amortize excess of cost over book value: Equity in "S" NI (inventory).... "S" retained earnings (BOY) 62.000 Equipment.... Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 3 3: Equity method entries to be booked by "P" (These are “P” entries.. Investment in "S". 36.......... M..000 .............. ............... 6....... 2..........000 (d) Amortize the purchase differential (excess) A/D-Equip (30/5yr) Investment in "S"..000 NOTE: The dividend entry has already been made when P% is >50%..... SIMPLE EQUITY METHOD a) Current year equity in net income and dividends Equipment..........115...........000 Equity in "S" NI...000 Depreciation expense......000 Accumulated depr--equipment. 30. 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.000 34....... 262.. 36.................. Land......000 Goodwill...000 "S" retained earnings (BOY).....000 262.... Investment is "S"...000 30....000 COS..........000 Investment in "S". 4 This will be illustrated below.. 45....000 8....000-8.............000 NOTE: These entries are ignored under the "simple equity method" ............000 Investment is "S". 36......000 Cost of goods sold.....000 8...... 36.. NOT the consolidation entries) To record equity in earnings: (recorded on books of parent only IAW APB-18) Investment in "S"..000 138.......... Investment in "S".000 138.....000 Land......000 Goodwill..Dr........000/5) 6.. D... Consolidated elimination entries FULL EQUITY METHOD (a) Current year equity in net income and dividends Equity in "S" net income... Equity in “S” NI: 100% (36........ 8..........000 c) Allocate the excess of cost > book value 8.. Cost of goods sold.. COS............ "S" common stock.....000 (b) Pro-rata share of BOY book value "S" common stock.000 + 6......000 Equity in "S" NI (Equipment (30.. 6.... Equity in "S" net income....................000 d) Amortize the purchase differential (excess) 6.......000 115..............000 Investment in "S"........000 Depreciation expense. 8.....000 Investment in "S"....000 6. 200..................000 (c) Allocate the excess of cost > book value Investment in "S". 8.......000 45.. b) Pro-rata share of BOY book value 200... 62.......... 34.......... method is a consolidation approach and only allowable 8..

D.000) (313.000 0 Accounts Payable Common Stock (Parent) 0 0 Goodwill Deferred Taxes 625.C) (A.000 0 138.000 Building 725.000) (74.000 157.000 (A) (26.000 0 (C) 0 315.000) 500.000) PIC (Sub) 0 0 (550.000) 736.000) 0 (6.000) 0 (C) (138.000 20.000 0 0 PIC Parent 980. Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 4 12/31/2001 Cons No Adjustment/ Eliminations Income Minority Controlling Retained Consolidated Balance Debit Credit Statement Interest Earnings Sheet P S 85.000) Equipment 570.380.000 95.000) 0 (AA) (795.000 (D) SEC/Stock Issue Costs (355.000) (A.000 255.000 110.000) (AA) Marketing Exp 92.000 A/D Equip (130.000) 0 (795.000 0 0 0 0 0 Inventory 220.000) (70.Dr.000 40.000 (345.000) Common Stock (Sub) Cost of Sales 0 (30.000) 0 0 0 0 0 (260.000 0 (B) 0 (62.000) 0 0 (B) (262.C) (200.000) (133.000) 722.000 Investment in Sub 390.000) (85.000 0 0 (D) 0 0 (960.000 .000) 0 (355.000 0 0 (A.000 0 0 A/D Building (180.000 220.000 105.000 60.000) (420.000 36.000) 115.000 (C) 8.000) 0 0 0 0 (C) 45.C) 0 (AA) (550. M.000) Retained Earnings S 45.000 0 0 140.000 0 (290.000) (B) 200.000 190.000) 0 0 Sales (C) 0 Long-Term Debt Retained Earnings P BOY 6.000 AdminExp 98.000 65.000 30.000 (204.000) (B) 62.000 Cash and Cash Equiv AR (net) MES Land 450.000 (1.000) 0 0 (220.

000) Tax Refund Receivable 0 0 0 (134.000) 0 .000 (A) 40.000 150.000 (134. D.000) (449.000 5.000) 40. Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 5 Interest Income Interest Expense Tax Expense 0 0 0 20.000 10.000 (472.000 54.000 Equity In "S" NI Dividends Declared 204.000) 0 0 (449.000 (C) 0 (A) (10.000 DTL from Purchase 0 0 0 DTE from Purchase 0 0 0 472.000 25. M.000) Balance: Consolidated Net Income To MI: To CI: 0 This distribution is in balance 0 134.Dr.

D.. 200.....000 50.......000) (18. Cost of goods sold... D.000 15..000) Common stock.............. Assuming "P" follows APB No.600 Prop/Plant/Equip (net)..... State the GAAP with respect to recording interperiod purchases B... Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 1 EXAMPLE 2: INTERPERIOD PURCHASE (80%)--EQUITY METHOD "P" purchases 80% of "S" on 7/1/1 for $106.. (60...000** Liabilities.....400 Trial Balance _ _ Investment in "S"..500 47.. _ 12/31/1 $ 78.000) Expenses.000 10.. M......000 assume a ten year life on all depreciable items Required: A....000) (90... C.000) (18.. 16 very closely. Assuming "S" is required to close its books on 7/1/1...000) 70... (250...000) (150.000) Sales.500 (40...000 **FMV of "S" PP&E on 7/1/1 is $80.........000 (40..........000) (50.000 105... analyze the investment and prepare consolidated elimination entries.000 350. P S 12/31/1 S 7/1/1 ? Current Assets..000 60... What is the controlling interest income carried to the consolidated ...000) $ 85.000 Dividends declared. analyze the investment and prepare the consolidated elimination entries on 12/31/x1 under both the simple equity method and the full equity method. What is minority interest income? E.000) Retained earnings (1/1/1) (100... (500.. $ 187.Dr.000) (50... 5.

.8)....] .... In addition to A. statements. 40................... either method is GAAP.... 920 920 Because the investment account will be eliminated and not appear on the consolidated fin......... as under APB-18... .......... A.......000 "S" Retained earnings (40+20)(..8)(50...... C.. but it will carry the investment account at the same balance that would exist under APB-18....000 Investment in "S".] (5.... 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....000 Excess of cost > book value..8)-920.400/10)(.. B.. B1. Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 2 EXAMPLE 2--Interperiod Purchase Solution A... 920 W...... 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............400 18...... the full equity would require the following additional entries: Clearly.. 18....000 _88...........080 B...8)...000)(. Investment in "S" .... conversion to full equity (sophisticated equity) method will become a necessity in some circumstances ... This can be accomplished by debiting an account such as "purchased net income"........ Amortize the purchase differential Equity in "S" net income (depr....E............400 Investment in "S"....... 4.. This is particularly important if any portion of the investment is sold. 4.. 4... 48......... CONSOLIDATED ELIMINATION ENTRIES Full Equity Method Simple Equity Method A...400 D....400 Attributable to: Current assets... 18............. D....................Dr.40.....400 Purchased book value: C/S (... (BOOKS CLOSED AT DATE OF PURCHASE) Cost.... 106................ Eliminate current investment account entries: Equity in "S" net income (60-5-45)(...and D are the same as simple equity. the investment account reflects all amortizations......... 18......000 Div....8)..... Under full equity.......C..E.. It is illustrated here principally for the purpose of illustration.........000 Equity in "S" net income..... the full equity method is more time consuming and repetitive... M..5yr)..... Equipment..... [or R.. 7... This is the procedure that would be used under APB-18 (the equity method).....000 Investment in "S". 8. 3...... Note that the primary difference is the 'amount' at which the investment account is carried.. [or R. -018.000 Investment in "S"..............000 Equity in "S" net income (60-5-45)(...............000 Eliminate the pro rata share of the "S" SHE "S" Common Stock (50..B...... Requiring the subsidiary to close its books in mid-year is not GAAP unless it coincided with the fiscal year. Amortize the excess of cost > book value Operation expenses (18.. Bring the investment account up to date as of EOY Investment in "S". 920 Equipment. decl.080 Div.000 X.8) 88........... equip). As we will see in the Special Issues topics that follow.C.......... decl. and D above.8).000).. 48...000)(.000 (1/1 to 7/1) R/E (40+90-10-60)(.8... Eliminate current year investment account entries 8....400 B2.........

.8)....400 Purchased net income.... 72. 4....E....... the simple equity method would require entries W and X as illustrated: X..... Amortize the purchase differential Equity in "S" net income (depr...000 Investment in "S".080 Div..] (5. 40...400 Attributable to: (first ... 3....000 Allocate the excess of cost > book value per analysis A/D Equipment 18. Equip.000 "S" Retained earnings (40k)(.. the investment account reflects all amortizations....400 C2.... 16.. the minority interest share is based on the entire year..) However.... 920 Equipment.......400/10)(.........400 Amortize the excess of cost > book value Operation expenses (18.. B.......and D are the same as simple equity..5yr).400 ***Purchased net income.)..... (BOOKS NOT CLOSED AT DATE OF PURCHASE) Cost.000) = $6.....E............ Investment in "S".. C....... 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.......... 8. Eliminate the pro rata share of the "S" SHE "S" Common Stock (50...Dr........ The income is "backed out" by debiting an account called 'purchased net income' for the appropriate amount. 40.... Eliminate current year investment account entries Equity in "S" net income (60-5-45)(. CONSOLIDATED ELIMINATION ENTRIES: Full Equity Method Simple Equity Method A.E...... 4.......... 920 W. [or R.....000)(. let’s see what would happen if we did close the books...000)(. 4.........8)..... 34...... [or R...000 In addition to the ABCD entries....... Purchased book value: 106....... Under the simple equity method it reflects only the effects of net income and dividends 34........ decl.......000 32..000* Equipment. 7.. 8.... or: (.. as under APB-18.(40.................. R.... 18..000 Div. (This would close the nominal accounts to “S” RE. decl. D...000)(..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........ for illustrative purposes... 8.080 B.........000 Equity in "S" net income.2)(30..000 Equity in "S" net income (60-5-45)(.. 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. Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 3 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. D.... M... If the books are not closed at acquisition............8).. Note that the primary difference is the 'amount' at which the investment account is carried.000.....2)(60-50) = $2....000)(....000 Investment in "S"...000 Excess of Cost > book value..C. Under full equity.......8)-920.. Eliminate current investment account entries: A.000 Investment in "S"... If the books are closed at acquisition..8)..8).....5 year income: (90-10-60)(..... computed as follows: (...... 16.000 Investment in "S".....8)... Later we will contrast this to the correct process (books not closed)...........000 72...........] ...... 32.400 C/S (50........... Bring the investment account up to date as of end of period Investment in "S".... You would then ..8) 34........

. 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).... Computation of Controlling Interest Income (no intercompany transactions) 1..080 (8.... Whether or not the books are closed..... Add:"P" equity in "S" net income .. E.000-920) .. D.000 7..Dr.080 $87.000 $80. $80.....080 $88. Chase Long Beach State University Advanced Accounting-310-22B Investment Analysis and Distributions of Net Income Page 4 have to “back out” the income earned during the part of the year you did not have an equity interest in “S”.. M.000 8.