Dr. M.D.

Chase
Advanced Accounting 817-63B

Long Beach State University

MUTUAL HOLDINGS (AICPA adapted)
Page 1

I. COMPREHENSIVE EXAMPLE: CPA EXAMINATION QUESTION

1. On January 1, 19x6, P purchased a controlling interest in S. The trial balances for P and S at 12/31/x6, are shown below:
"P" Company
S Company
Cash..........................
$
37,900
$ 29,050
Marketable securities.........
33,000
18,000
Trade accounts receivable.....
210,000
88,000
Allowance for bad debts.......
[ 6,800]
[ 2,300]
Intercompany recievables......
24,000
Inventories...................
275,000
135,000
Machinery and equipment.......
514,000
279,000
Accumulated depreciation......
[298,200]
[196,700]
Investment in A at cost.......
100,000
Patents.......................
35,000
Dividends payable.............
[ 7,500]
Trade accounts payable........
[195,500]
[174,050]
Intercompany payables.........
[8,000]
Common stock ($10 par)........
[150,000]
Common stock ($ 5 par)........
[ 22,000]
PIC in excess of par..........
[ 36,000]
[ 14,000]
Retained earnings.............
[370,500]
[102,000]
Sales and service.............
[850,000]
[530,000]
Dividend income...............
[ 3,000]
0
Other income..................
[ 9,000]
[ 3,700]
Cost of goods sold............
510,000
374,000
Depreciation expense..........
65,600
11,200
Administrative and selling exp
130,000
_ 110,500
Balance......................
0
0
The following information is also available:
(a) P purchased 1,600 shares of S's outstanding stock on 1/1/19x5, for $48,000, and on 1/1/19x6, purchased an additional 1,400 shares for
$52,000.
(b)An analysis of the stockholder's equity accounts at 12/31/19x5, and 19x4, follows:
P Company
S Company
12/31
12/31
19x5
19x4
19x5
19x5
Common stock, $10 par $150,000
$150,000
Common stock, $ 5 par..
$ 20,000 $ 20,000
PIC in excess of par...
36,000
36,000
10,000
10,000
Retained earnings......
378,000
285,000
112,000
82,000
Totals............
$564,000
$471,000
$142,000 $112,000
(c) S's marketable securities consist of 1,500 shares of "P" common stock purchased on 6/15/x6, in the open market for $18,000. The
securities were purchased as a temporary investment and were sold on 1/15/x7 for $25,000.
(d) --On 12/10/x6, "P" declared a cash dividend of $ .50 per share, payable 1/10/x7, to stockholders of record on 12/20/x6.
--S paid a cash dividend of $1 per share on 6/30/x6.
--S distributed a 10% stock dividend on 9/30/x6; S stock was selling for $15 per share ex-dividend on 9/30/x6.
--S paid no dividends in 19x5.
(e) S sold machinery, with a book value of $4,000 and a remaining life of five years to "P" for $4,800 on 12/31/x6. The gain on the sale
was credited to the other income account.

Dr. M.D. Chase

Advanced Accounting 817-63B

Long Beach State University

MUTUAL HOLDINGS (AICPA adapted)
Page 2

(f) S includes all intercompany receivable and payable accounts in the trade accounts receivable and trade accounts payable accounts.
--During 19x6 the following intercompany sales were made:

"P" to S......................
S to "P"......................

$
$

Net
Sales
78,000
104,000
182,000

Included in "P"
Inventory at
12/31/x6
$
24,300
18,000
$
42,300

"P" sells merchandise to S at cost. S sells merchandise to "P" at the regular selling price to make a normal profit margin of 30%. There
were no intercompany sales in prior years.

1.
2.
3.
4.

Required:
How does "P" account for its investment in S?, how do you know?
Analyze the investment; any excess of cost over book value is to be allocated to a building with a 20-year life.
Prepare the necessary consolidated elimination and adjusting entries. Use the treasury stock method to account for mutual holdings.
Compute Consolidated Net Income; Minority Interest Net Income and Controlling Interest Net Income

Dr. M.D. Chase

Advanced Accounting 817-63B

Long Beach State University

MUTUAL HOLDINGS (AICPA adapted)
Page 3

Solution:
1. How does "P" account for its investment in S?, how do you know?
"P" uses the cost method based on the fact that the account "dividend income" appears in the trial balance, the investment is carried
at cost, unadjusted for equity interest in "S" net income and no other obvious inconsistencies exist.
2. Analyze the investment; any excess of cost over book value is to be allocated to goodwill with a 20-year life.
Investment 1: 1/1/x5
Cost (1,600 of 4,000 shares O/S)....... $
Purchased BV:C/S........
$
20,000
PIC........
10,000
RE.........
82,000
Total SHE $
112,000
% acquired:
16/40
Attributed to Building (20yr life)........... $

48,000

44,800
3,200

Investment 2: 1/1/x6
Cost (1,400 of 4,000 shares O/S).......$ 52,000
Purchased BV:C/S........$ 20,000
PIC........ 10,000
RE......... 112,000
Total SHE $142,000
% acquired:
14/40
49,700
Attributed to Building (20yr life)...........$ 2,300
3. Prepare the necessary consolidated elimination and adjusting entries. Use the treasury stock method to account for mutual holdings.
* Convert to equity method (no conversion necessary on the second investment because this is the year of acquisition; refer to Advanced
Accounting-27 "Purchase Accounting Using the Cost Method")
Investment in S ("P"%)(Change in S RE date of Acq to BOY;(.4)(112,000-82,000)........ 12,000
"P" RE..............................................................................
12,000
** Bring the Retained earnings accounts back to BOY balance: (as there are no dividends accounts, the books have been partially closed
(dividends have been closed to RE; to insure proper allocations to MI, RE should be returned to BOY balance.
Dividends "P" books (15,000)($.5)........................................................ 7,500
Dividends S books (4,000)($1).......................................................... 4,000
"P" RE..............................................................................
7,500
S RE..............................................................................
7,500
A) Eliminate intercompany dividends:
Dividend income (.75)(4,000)($1).........................................................
Dividends (S books)...............................................................

3,000
3,000

Dividends payable (.1)(15,000)($.5)......................................................

750
Dividends ("P" books) ( to correct error on S books)..............................
750
Correct entries on S books would have been:
Dividend declared: Dividend receivable............
750
Dividend income............
750
These entries were not made; therefore the adjustment is as illustrated
NOTE:The intercompany stock dividend requires no adjustment but should note the change in shares owned through a
(refer to Advanced Accounting 51-B)

Memo entry: A 10% stock dividend has increased the number of shares owned by 300 shares (.75)(4,000)(.1)

memo entry

Dr. M.D. Chase

Advanced Accounting 817-63B

Long Beach State University

MUTUAL HOLDINGS (AICPA adapted)
Page 4

B) Eliminate the pro-rata share of the investment account:

S C/S (22,000)(.75)....................................................................
S PIC (14,000)(.75)....................................................................
S RE (102,000 + 4,000)(.75)...........................................................
Investment in S...................................................................

16,500
10,500
79,500
106,500

C) Allocate the excess of cost over bookvalue per analysis of investment:

A/D Building (3,200 investment #1 + 2,300 investment #2)..........
5,500
Investment in S...................................................................
5,500
NOTE: the investment account should be eliminated at this point; if it is not an error is present
D) Amortize the excess of cost over bookvalue per analysis:
"P" RE (3,200/20)(1yr) to adjust RE for past amortizations............
Depreciation expense (3,200/20 + 2,300/20) current year deprec
A/D Building............................................................................

160
275
435

E) Eliminate mutual investment of S in "P" as T/S at cost; short-term so not retired

Treasury stock...........................................................................
18,000
MES (the investment was carried as MES and not as investment in "P")...
18,000
F) Eliminate gain on intercompany sale of depreciable PP&E:
Other income (was not recorded as gain on sale) (4,800 - 4,000)...........
800
Machinery (must be carried at basis of selling affiliate less current deprec 800
G) Eliminate intercompany receivables and payables:
Trade accounts payable ..................................................................
24,000
Intercompany payables (per trial balance)................................................
8,000
Trade accounts receivable...........................................................
Intercompany receivables (per trial balance)........................................

8,000
24,000

H) Eliminate sales of intercompany merchandise at gross:

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

182,000

I) Eliminate profit in ending inventory:

Cost of goods sold (18,000)(.3)..........................................................
Inventory...........................................................................

182,000

5,400
5,400

4. Compute Consolidated Net Income; Minority Interest Net Income and Controlling Interest Net Income

Per trial balance

[850,000]
[530,000]
[ 3,000]
0
[ 9,000]
[ 3,700]
510,000
374,000
65,600
11,200
130,000
110,500
[153,400]*
[ 38,000]

Adjustments/Eliminations
H 182,000

Sales and service.............

Dividend income...............
Other income..................
F
800
Cost of goods sold............
I
5,400
H [182,000]
Depreciation expense..........
Administrative and selling exp
D
275
Internally generated income.
*
(excludes dividend income)
Consolidated net income..................................................................
To MI (.25)[(38,000 +0 -(800+5,400)]................................................
To Controlling interest: 153,400 +0 -275 +(.75)(38,000 +0 -(800+5,400)..............

Consolidated
Net Income
[ 1,198,000]
[

11,900]
707,400
76,800
240,775

184,925]
7,950
176,975