Dr. M.D. Chase
Advanced Accounting 320-27B
Long Beach State University
Purchase: Cost/Equity Method Comparisons
Page 1
I. PURCHASE ACCOUNTING USING THE COST METHOD: COST AND EQUITY METHOD COMPARISON
A. PURCHASE UNDER THE COST METHOD:
1.
Rather than learn a new set of eliminations, it is much simpler to convert the cost method to equity and use the same eliminations (modified
to account for the differences in accounting for income under each method).
NOTE: the procedures listed below assume the use of the simple equity method i.e. working paper entries are not booked year to year.
2.
GENERAL RULE: Bring the investment account to the same point in time as the equity accounts that it will be eliminated against (normally,
that will be the beginning of the year).
a. END OF YEAR ONE: It is not usually necessary to convert to the equity method at the end of the first year because the
investment in "S" account and the equity in "S" earnings account are both usually at the beginning of year balances. If they are
not, an adjustment cam be made. This adjustment is simply to facilitate using exactly the same procedures as learned in "equity
method" consolidations.
"A" entry -- eliminate the intercompany dividends only
Dividend income........... xxxx
Dividends.............
xxxx
[ "B","C", and "D" entries -- same as equity method]
b. YEARS SUBSEQUENT TO YEAR ONE: Make a worksheet entry to convert to the equity method. Note that the investment is being
carried at value as of date of purchase, or in subsequent years at its BOY value. The retained earnings will almost always be as
of the beginning of the year of reporting (i.e. the 12/31/X retained earnings will usually be as of 1/1/X unless the books have
been closed). Therefor the entry to convert from cost to equity will look like:
Investment in "S" (% ownership x Change in "S" retained earnings since date of acquisition)........
"P" retained earnings..........................................................................
.xxxxx
xxxx
NOTE: this entry adjusts the investment and retained earnings accounts to the values they would have been carried at if the equity method
had been employed; it has the additional benefit of adjusting both accounts to their BOY balances so that normal equity method
eliminations can be used.
COMPREHENSIVE EXAMPLE
Assume the following facts:
--"P" pays $145,000 for 90% of "S" common stock on 1/1/x1 with any excess of cost over BV to GW (10 year life)
--"S" C/S=$100,000; PIC=0 and "S" retained earnings = $50,000 at the date of acquisition (1/1/x1)
--the acquisition is to be accounted for as a purchase and any excess is attributable to PP&E with a ten year life
--"S" net income for year 1 is $30,000 and <$10,000> for year 2
--"S" dividends for year 1 are $10,000 and for year 2 are $5,000
--PRE-CLOSING trial balance information for "P" and "S" at 12/31/x1 and 12/31/x2 are reported below
EQUITY METHOD
COST METHOD
12/31/x1
12/21/x2
12/31/X1
12/31/X2
"P"
"S"
"P"
"S"
"P"
"S"
"P"
"S"
Net assets.............
227
170
251.5
155
227
170
251.5
155
Investment in "S"...
163
149.5
145
145
C/S $10 par............
(200)
(100)
(200)
(100)
(200)
(100)
(200)
(100)
RE (1/1/x1)............
(123)
( 50)
(190)
( 70)
(123)
( 50)
(172)
( 70)
Revenues...............
(100)
( 80)
(100)
( 50)
(100)
( 80)
(100)
( 50)
Expenses...............
60
50
80
60
60
50
80
60
Equity in "S" NI......
( 27)
9
Dividend Revenue.......
( 9)
( 4.5)
Dividends..............
10
5
10
5
Balance...........
-0-0-0-0-0-0-0-0REQUIRED:1. Analyze the investment
2. Present consolidated adjustment and elimination entries for years 1 and 2 under both the equity and cost methods:
3. Compute the following: Total NI; MI NI; Controlling interest NI;and MI under both the equity and cost methods:
Dr. M.D. Chase
Advanced Accounting 320-27B
Long Beach State University
Purchase: Cost/Equity Method Comparisons
Page 2
SOLUTION: COMPREHENSIVE EXAMPLE
1. Analyze the investment:
Cost..........................................
145,000
Purchased BV (.9)(100 + 50)...................135,000
Excess of Cost over Book value........ 10,000
Attributable to:
PP&E ...............................10,000
2.(A) Equity method adjustment and elimination entries,
12/31/x1
a. Eliminate current year investment account entries:
Equity in "S" NI (.9)(30)................ 27,000
Dividends (.9)(10).....................
Investment in "S"......................
9,000
18,000
b. Eliminate pro rata share of "S" SHE
"S" C/S (.9)(100)......................
90,000
"S" RE (.9)(50)..........................
45,000
Investment in "S"........................
135,000
c. Allocate excess of cost over BV
PP&E .......................................
10,000
Investment in "S".......................
10,000
d. Amortize the excess of cost over BV
Depreciation Exp (10)(1/10) 1,000
A/D PP&E……………
Cost method adjustment and elimination entries, 12/31
**Convert to equity method:
Not necessary in first year under cost method
a. Eliminate intercompany dividend/dividend revenue
Dividend revenue (.9)(10) ..........
9,000
Dividends.........................
9,000
b. Eliminate pro rata share of "S" SHE
"S" C/S (.9)(100)...................
90,000
"S" RE (.9)(50).....................
45,000
Investment in "S".................
135,000
c. Allocate excess of cost over BV
PP&E ...............................
10,000
Investment in "S"...............
10,000
d. Amortize the excess of cost over BV
Depreciation Exp (10)(1/10)
1,000
A/D PP&E……………
1,000
1,000
2.(B) Equity method adjustment and elimination entries, 12/31/x2
a. Eliminate current year investment account entries:
Investment in "S"........................
13,500
Dividends (.9)(5)......................
4,500
Equity in "S" NI(.9)(10 loss)..........
9,000
b. Eliminate pro rata share of "S" SHE
"S" C/S (.9)(100)........................
90,000
"S" RE (.9)(50+30-10)....................
63,000
Investment in "S"......................
c. Allocate excess of cost over BV
PP&E .......................................
10,000
Investment in "S".......................
d. Amortize the excess of cost over BV
Depreciation Exp (10)(1/10)......... 1,000
"P" RE (reinstate last yr adj)..........
A/D PP&EGW.........................................
153,000
10,000
1,000
2,000
Cost method adjustment and elimination entries, 12/31/2
**Convert to equity method:
Investment in "S"(.9)(70-50)..........
"P" RE..............................
18,000
18,000
a. Eliminate intercompany dividend/dividend revenue
Dividend revenue (.9)(5)............
4,500
Dividends.........................
4,500
b. Eliminate pro rata share of"S" SHE
"S" C/S (.9)(100)...................
90,000
"S" RE (.9)(50+30-10)...............
63,000
Investment in "S".................
153,000
c. Allocate excess of cost over BV
GW .................................
10,000
Investment in "S".................
10,000
d. Amortize the excess of cost over BV
Depreciation Exp 10)(1/10)........... 1,000
"P" RE (to reinstate last yr adj).. 1,000
PP&E. .............................
2,000
3. Compute the following: Total NI; MI NI; Controlling interest NI;and MI under both the equity and cost methods:
Dr. M.D. Chase
Advanced Accounting 320-27B
Long Beach State University
Purchase: Cost/Equity Method Comparisons
Page 3
12/31/x1
Equity
Cost
Total NI.................................
$69,000
$69,000
MI NI....................................
3,000
3,000
Controlling interest NI...........
66,000
66,000
MI.......................................
17,000
17,000
12/31/x2
Equity
$ 9,000
(1,000)
10,000
15,500
Cost
$ 9,000
(1,000)
10,000
15,500
NOTE: THE RESULTS ARE IDENTICAL IRRESPECTIVE OF THE METHOD USED.