Chapter 7, Problem 7.41AP

Modified Equity Method

Using the data in P7-33, on December 31, 20X7, Prime Company recorded the following entry on its books to adjust its investment in Lane Company from the fully adjusted equity method to the modified equity method:

Required

1. Adjust the data reported by Prime in the trial balance in Problem P7-33 for the effects of the adjusting entry presented above.
2. Prepare the journal entries that would have been recorded on Prime’s books during 20X7 if it had always used the modified equity method.
3. Prepare all consolidation entries needed to complete a consolidation worksheet as of December 31, 20X7, assuming Prime has used the modified equity method.
4. Complete a three-part consolidation worksheet as of December 31, 20X7.

To determine

Introduction:When intercompany transfer of asset occurs, the parent company must make adjustments in preparing consolidated financial statements as long as the asset is held by acquiring company, when the asset is transferred at book value no special adjustments are needed. But when the asset is transferred at more or less than the book value, the unrealized gain or loss is deferred until the asset is sold to unrelated party. Moreover, in the consolidation the gain or loss will be eliminated.

The adjustments in trial balance to show effect of the given entry.

Answer to Problem 7.41AP

The amount of differential as of January 1, 20X8 $120,000

Explanation of Solution

	Debit $	credit $
Income from L company	2,000
Investment in L company	38,400
Retained earnings		40,400

Particulars	P company		L company
	Debit $	credit $	Debit $	credit $
Cash and accounts receivables	151,000		55,000
Inventory	240,000		100,000
Land	100,000		80,000
Buildings and equipment	500,000		150,000
Investment in Lane company $201,600 + 38,400	240,000
Cost of goods sold	160,000		80,000
Depreciation and amortization	25,000		15,000
Other expenses	20,000		10,000
Dividends declared	60,000		35,000
Accumulated depreciation		230,000		60,000
Accounts payable		60,000		25,000
Bonds payable		200,000		50,000
Common stock		300,000		100,000
Retained earnings $379,600 + 40,400		420,000		140,000
Sales		250,000		150,000
Income from subsidiary $38,000 − 2,000		36,000
Total	1,496,000	1,496,000	525,000	525,000

To determine

Introduction:When intercompany transfer of asset occurs, the parent company must make adjustments in preparing consolidated financial statements as long as the asset is held by acquiring company, when the asset is transferred at book value no special adjustments are needed. But when the asset is transferred at more or less than the book value, the unrealized gain or loss is deferred until the asset is sold to unrelated party. Moreover, in the consolidation the gain or loss will be eliminated.

The entries that would have been recorded on P’s books during 20X7 if it had always used the modified equity method.

Explanation of Solution

Particulars	Debit $	Credit $
To record share in L company income
Investment in L company	36,000
Income from L company		36,000
(investment in L company recognized)
To record receipt of dividends from L
Cash	28,000
Investment in L company		28,000
(Received cash dividends from L)

Working Note:

1. Income from subsidiary recognized, by debiting to investment account and credit to income from subsidiary account
2. Cash dividends received from subsidiary recognized and credited to investment account.

To determine

Introduction:When intercompany transfer of asset occur, the parent company must make adjustments in preparing consolidated financial statements as long as the asset is held by acquiring company, when the asset is transferred at book value no special adjustments are needed. But when the asset is transferred at more or less than the book value, the unrealized gain or loss is deferred until the asset is sold to unrelated party. Moreover in the consolidation the gain or loss will be eliminated.

The consolidation entries required to prepare a three-part consolidated worksheet at December 31, 20X7

Answer to Problem 7.41AP

Particulars	Debit $	Credit $
1. Elimination of beginning investment
Common stock	100,000
Retained earnings	140,000
Income from L	36,000
NCI in Net income of L	9,000
Dividends declared		35,000
Investment in L		200,000
NCI in Net assets of L		50,000
(beginning investment in L eliminated by reversal)
2. Excess value of differential reclassification
Retained earnings	14,400
Goodwill	32,000
Investment in L		40,000
NCI in net assets of L		6,400
(recognition of differential on land and goodwill)
3. Elimination of intercompany receivables and payables
Accounts payable	4,000
Cash and accounts receivable		4,000
(intercompany other receivables and payables eliminated by setoff)
4. Elimination of gain on purchase of land
Retained earnings	8,000
NCI in net income of L	2,000
Land		10,000
(gain on purchase of land eliminated)
5. Elimination of gain on equipment asset basis
Retained earnings	18,000
Equipment	5,000
Accumulated depreciation		23,000
(gain on equipment recognized)
6. Excess depreciation recognized
Accumulated depreciation	2,000
Depreciation expenses		2,000
(gain on purchase of land eliminated)
(excess depreciation recognized)

Explanation of Solution

1. Elimination of beginning investment

Investment in S Corp $\$200,000=(\$100,000+140,000+36,000+9,000-35,000)\times .80$

Non-controlling interest $\$50,000=(\$100,000+140,000+36,000+9,000-35,000)\times .20$

2. Differential on goodwill and retained earnings recognized $\$32,000=\$50,000-18,000$
3. Intercompany receivable and payable eliminated by setoff
4. Gain on purchase of land eliminated by revering the gained value $\$10,000=\$18,000-8,000$
5. Gain on sale of equipment is eliminated by crediting and extra depreciation recognized.

To determine

Introduction:When intercompany transfer of asset occur, the parent company must make adjustments in preparing consolidated financial statements as long as the asset is held by acquiring company, when the asset is transferred at book value no special adjustments are needed. But when the asset is transferred at more or less than the book value, the unrealized gain or loss is deferred until the asset is sold to unrelated party. Moreover in the consolidation the gain or loss will be eliminated.

The three part consolidation worksheet for December 31, 20X7.

Answer to Problem 7.41AP

Balance as per three part consolidated work sheet

Retained earnings $402,600, Net assets $1,088,000

Explanation of Solution

			Elimination
Items	P	L	Debit $	Credit $	Consolidation
Sales	250,000	150,000			400,000
Less:
Cost of goods sold	(160,000)	(80,000)			(240,000)
Depreciation expenses	(25,000)	(15,000)		2,000	(38,000)
Other expenses	(20,000)	(10,000)			(30,000)
Income from S Corp	36,000		36,000
Consolidated net income					92,000
Non-controlling interest			9,000		(9,000)
Net income carry forward	81,000	45,000	45,000	2,000	83,000
Retained earnings	42,000	140,000	140,000
			14,400
			8,000
			18,000		379,600
Net income	81,000	45,000	45,000	2,000	83,000
Less dividends declared	(60,000)	(35,000)		35,000	(60,000)
Retained earnings Dec 31	441,000	150,000	225,400	37,000	402,600
Cash and receivables	151,000	55,000		4,000	202,000
Inventory	240,000	100,000			340,000
Land	100,000	80,000		10,000	170,000
Buildings & equipment	500,000	150,000	5,000		655,000
Less: Accumulated Depr.	(230,000)	(60,000)	2,000	23,000	(311,000)
Investment in L	240,000			200,000
				40,000
Goodwill			32,000		32,000
Total Assets	1,001,000	325,000	39,000	277,000	1,088,000
Accounts payable	60,000	25,000	4,000		81,000
Bonds payable	200,000	50,000			250,000
Common stock	300,000	100,000	100,000		300,000
Retained earnings	441,000	150,000	225,400	37,000	402,600
NCI in Net assets of S			2,000	50,000	54,400
				6,400
Total Liabilities & equity	1,001,000	325,000	331,400	93,400	1,088,000