Dr. M.D.

Chase
Advanced Accounting 807-54B

Long Beach State University

Sale of Ownership Interest

Page 1

Royal Company
The condensed financial statements (except statement of cash flows) of Royal Company and its subsidiary, Butler Company for the year ended
December 31, 19x5, are presented below:
Condensed Income Statements (unconsolidated)
Royal
Company
Sales.............................
$
[4,000,000]
Cost of Sales.....................
2,982,000
Operating expenses................
400,000
Dividend income...................
[ 75,000]
Subsidiary income.................
[ 232,000]
Interest expense..................
Net Income........................
$
[925,000]
Retained Earnings Statement
Balance, 1/1/x5...................
$
[2,100,000]
Net income........................
[925,000]
Dividends declared................
170,000
Balance, 12/31/x5.................
$
[2,855,000]
Balance Sheets
Assets:
Cash..............................
$
Accounts receivable...............
Inventories.......................
Machinery and equipment (net).....
Investment in Butler common stock
Investment in Butler bonds........
Total assets.................
Liabilities and Stockhoders' Equity:
Accounts payable..................
$
Bonds payable.....................
Unamortized discount on B/P.......
Common Stock......................
Paid-in capital in excess of par..
Retained earnings.................
Total liabilities and SHE.... $

_
$

_
Butler
Company
$
[1,700,000]
1,015,000
377,200

7,800
[ 300,000]

[ 640,000]
[300,000]
100,000
[ 840,000]

_
486,500
235,000
475,000
2,231,000
954,000
58,000
4,439,500

1,319,600

[ 384,000]
[ 120,000]

[ 62,000]

[1,200,000]
[2,855,000]
[4,439,000]

249,600
185,000
355,000
530,000

2,400
[ 250,000]
[ 50,000]
[ 840,000]
[1,319,600]

Additional information is provided below:

1. On January 3, 19x3, Royal acquired from John Roth, the sole stockholder of Butler Company, for $440,000 cash, a patent valued at $40,000
and 80% of the outstanding stock of Butler. The net book value of Butler's stock on the date of acquisition was $500,000 and the book values
of the individual assets and liabilities were equal to their fair market values. Royal charged the entire $440,000 to the account "Investment in
stock of Butler Company". The patent, for which no amortization has been charged, had a remaining legal life of four years as of January 3,
19x3.
2. For the six months ended June 30, 19x5, Butler had net income of $140,000. Royal recorded 80% of this amount on its books of account
prior to the time of sale.
3. On July 1, 19x5, Royal reduced its investment in Butler's common stock to 75%, by selling shares for $70,000 to an unaffiliated company at
a profit of $16,000. Royal recorded the proceeds as a credit to its investment account.

Dr. M.D. Chase

Advanced Accounting 807-54B

Long Beach State University

Sale of Ownership Interest

Page 2

4. During 19x4, Butler sold merchandise to Royal for $130,000, which was at a markup of 30% over Butler's cost. On January 1, 19x5, $52,000
of this merchandise remained in Royal's inventory. This merchandise was subsequently sold by Royal in February of 19x5 at a profit of $8,000.
5. In November 19x5, Royal sold merchandise to Butler for the first time. Royal's cost was $80,000, and the sale was made at 120% of cost.
Butler's inventory at December 31, 19x5 contained merchandise that was purchased from Royal at a cost to Butler of $24,000.
6. On December 31, 19x5, there was a $45,000 payment-in-transit from Butler Company. Accounts receivable and accounts payable include
intercompany receivables and payables.
7. In December 19x5, Butler declared and paid cash dividends of $100,000 to its stockholders.
8. On December 31, 19x5, Royal purchased for $58,000, 50% of the outstanding bonds issued by Butler. The bonds mature on December 31,
19x9, and were originally issued at a discount. On December 31, 19x5, the balance in Butler's account, "Unamortized discount on bonds
payable" was $2,400. It is the intention of the management of Royal to hold these bonds until their maturity.

Trial Balance
12/31/x5
Account
Royal
Cash...............................
486,000
Accounts receivable................
235,000
Inventories........................
475,000
Machinery and equipment............
2,231,000
Investment in stock of Butler...... 954,000
Investment in bonds of Butler......
58,000
Accounts payable...................
[384,000]
Bonds payable......................
Unamortized discount on B/P........
Common Stock.......................
[1,200,000]
Contributed Capital................
Retained earnings 1/1/x5..........
[2,100,000]
Dividends..........................
170,000
Sales..............................
[4,000,000]
Cost of Sales......................
2,982,000
Operating expenses.................
400,000
Dividend income....................
[ 75,000]
Subsidiary income..................
[ 232,000]
Interest expense...................
0.00

Butler
249,600
185,000
355,000
530,000

[62,000]
[120,000]
2,400
[250,000]
[50,000]
[640,000]
100,000
[1,700,000]
1,015,000
377,200

7,800
0.00

REQUIRED:
a. What method of accounting is the parent using? How do you know?
b. Analyze the investment
c. compute Royals' ownership percentage at 12/31/x5
d. analyze the sale of the 5% interest in Butler on 7/1/x5
e. analyze the bond investment; compute gain/loss on retirement
f. present the consolidated elimination entries
g. compute total net income, MI net income and controlling interest net income
h. present the consolidated working papers for 12/31/x5 in good form

Dr. M.D. Chase

Advanced Accounting 807-54B

Long Beach State University

Sale of Ownership Interest

Page 3

SOLUTION:
a. What method of accounting is the parent using? How do you know?
The trial balance (and income statement) contain the account "dividend income" suggesting that Royal is using the cost method
however, this does not jibe with the balance of the investment account which would have remained at $400,000 original cost under
the cost method; Butler company has been taking an equity interest in Butler income as well as recording dividend income; this is not
in accordance with GAAP so we need to be aware of possible correction of errors situation with this problem.
b. Analyze the investment
Cost ($440,000 of which, $40,000 allocable to the patent *)...... $
Purchased BV: C/S:
$
250,000
PIC:
50,000
RE:
200,000
$
500,000 (.8).............................
Excess of cost over book value.............................
Attributable to:
Purchased net income...................
0
FMV accounts (CA; MES; Liabilities)...
0

400,000

400,000
-0-

-0-0-

* Check to see if patent has been recorded; it has not, therefore make the Journal entry to put the patent on the books.
Record the patent on the books:
Patent (FMV).....................................
40,000
Investment in Butler........................
40,000
Record accrued amortization to patent:
Royal-RE (40,000/4)(2years).... .................
Amort. expense(40,000/4)(current year
Patent......................................

20,000
10,000
30,000

c. compute Royals' ownership percentage at 12/31/x5

No computation is necessary; you are told that on 7/1/x5 Royal reduced its ownership percentage to 75%. This means that Royal
must accrue an 80% share of income for the first six months of year five and a 75% share of net income for the last six
months of the year.
d. analyze the sale of the 5% interest in Butler on 7/1/x5
Basis in investment in Butler on 7/1/x5:
Butler Stockholders Equity 1/1/x5:
Common Stock........................
$
250,000
Paid-in capital in excess of par....
50,000
Retained earnings (1/1/x5)..........
640,000
Basis in investment in Butler on 1/1/x5
$
940,000
Add: Butler earnings 1/1/x5-7/1/x5 ($140,000)
140,000
Basis in investment in Butler on 7/1/x5...........
$
1,080,000
Percentage of investment sold.....................
.05
Basis in Butler investment sold........................
$
54,000
Add:Amort. not booked to inv acct......................
0
Sales price............................................
70,000
Gain on sale of 5% interest in Butler..................
$
16,000

Note: there is no equity interest in these

earnings; that portion is viewed as "sold" to MI

Dr. M.D. Chase

Advanced Accounting 807-54B

Long Beach State University

Sale of Ownership Interest

e. analyze the bond investment; compute gain/loss on retirement

date of intercompany acquisition of bonds..............................
Unamortized sales [discount] or premium on date acquired by affiliate....
percentage of bonds held by affiliate...............................
unamortized sales discount allocable to intercompany bonds.........
Purchase [premium] or discount on date acquired by affiliate.............
[Gain] or loss on retirement of intercompany bonds.......................

Face Value

Sales
Discount

Page 4

12/31/x5
2,400
.5
1,200 (sales discount)
[2,000] (purchase discount)
[ 800]

Purchase
Discount

1,200

--The difference is 800

--It is a gain because the entity is "better off" i.e. has more cash

800
2,000
f. present the consolidated elimination entries
*Convert to equity method: It appears that Royal has been accruing income; utilize normal equity method eliminations and verify that the
"Investment in Butler" account is eliminated.
a. eliminate the current year investment account entries (those entries that the parent "booked" IAW APB-18 (equity method) or SFAS-12
(cost method) accounting; No nominal account information is provided in reference to the sale of a subsidiary interest so it
must be assumed that income and expenses were incurred uniformly throughout the year.
Equity in income of Royal...................
232,000
Change in RE of Investment from date of Acquistion
Dividend income (100,0000(.75)..............
75,000
to BOY (300,000)(.75)+(140,000)(.05) Note that we
Dividends..............................
75,000
have two acquisitions to account for.
Investment in Butler...................
225,000
Income sold to MI.........140k)(.05)...
7,000
b. eliminate the parents pro rata share of the subsidiary SHE accounts (RE; C/S; PIC in excess of par)
(P%)"S" C/S (.75)(250,000)..................
187,500
(P%)"S" PIC in excess of par(.75)(50,000)...
37,500
(P%)"S" RE...(.75)(640,000).................
480,000
Investment in "S"......................
705,000
c. Correct error in recording sale of 5% interest on 7/1/x5:
Entry booked
Cash........................................ 70,000
Investment in Butler.......
70,000
Gain...................................
-0-

Correct entry
70,000
54,000
16,000

d. Eliminate effects of upstream sale of merchandise in year x4 (now in BOY inventory)

RE-Royal (.8)(12,000).......................
9,600
RE-Butler(.2)(12,000).......................
2,400
Cost of goods sold.....................
12,000

e. Eliminate current year sale of merchandise inventory (downstream in EOY inventory)

Cost of goods sold..........................
4,000
Inventory..............................
4,000
Sales (80,000)(1.2).........................
Cost of goods sold.....................

96,000
96,000

Correction: working papers

-016,000
16,000
(let x=cost)
Sales Price =52,000 = 1.3x
x = 40,000
profit = 12,000

(let x=cost) 24,000 = 1.2x

x=
20,000
sales price =
24,000
profit =
4,000

Dr. M.D. Chase

Advanced Accounting 807-54B
f. Eliminate payment in transit:
Cash........................................
Accounts receivable....................

Long Beach State University

Sale of Ownership Interest

Page 5

45,000
45,000

g. Eliminate the bond investment:

Eliminate current year amortization of bond premium or discount
Investment is S bonds...............
Interest revenue........................

**

-0-**
-0-

Eliminate investment in bonds and bonds payable

B/P (face value).............................
60,000
Gain on bond retirement................
Investment in bonds (CV BOY/Purchaser).
Unamortized Sales discount.............

800
58,000
1,200

Eliminate intercompany revenues and expenses:

Interest revenue.............................
-0-**
Interest expense........................

-0-

bonds just purchased, no accruals are required this

period)

Eliminate intercompay receivables and payables related to the bonds:

Interest payable.............................
-0-**
Interest receivable.....................
-0-

g. compute total net income, MI net income and controlling interest net income
Adjustments/Eliminations
Royal
Butler
Dr
Cr
Sales..............................
[4,000,000] [1,700,000]
96,000
Cost of Sales......................
2,982,000
1,015,000
4,000
[ 12,000]**
[ 96,000]
Operating expenses.................
400,000
377,200
Dividend income....................
[ 75,000]
75,000
Subsidiary income..................
[ 232,000]
232,000
Interest expense...................
7,800
Internally generated net income: [ 925,000]
[ 300,000]
Amortization Expense...............
10,000
Gain on sale of investment.........
[ 16,000]
Gain on bond retirement............
[
800]**
417,000
[124,800]
Total net income..........................................................................
To MI: (MI%)(MIIGNI+UPCR-UPDR)-Purchased NI=(.25)(300,000+12,000+800)-7,000...........
To Controlling interest: PIGNI+P%(SADJNI)+DNCR-DNDR+income sold to minority interest:
925,000+(.75)(312,800)+112,000-417,000+7,000=861,600..................................
**
Italics indicate upstream items

h. present the consolidated working papers for 12/31/x3 in good form

Consolidated
Net Income
[5,604,000]
3,893,000
777,200

7,800
10,000
[16,000]
[ 800]
[932,800]
71,200
861,600