2. 2-2
The Equity Method—Equity Accrual
Assume PT ABC acquires significant
influence over PT XYZ by purchasing 20
percent of the common stock of the PT XYZ
at the beginning of the year. PT XYZ reports
income for the year of Rp60,000,000. PT
ABC records its Rp12,000,000 share of PT
XYZ’s income with the following entry:
3. 2-3
The Equity Method—Equity Accrual
Investment in PT XYZ Stock
(Rp60,000,000 X .2) Rp12,000,000
Income from Investee Rp12,000,000
4. 2-4
Equity Method—Recognition of
Dividends
• Dividends from an investment are not
recognized as income under the equity
method because the investor’s share of
the investee’s income is recognized as
it is earned by the investee.
5. 2-5
Equity Method—Recognition of
Dividends
• Instead, such dividends are viewed as
distributions of previously recognized
income that already has been capitalized
in the carrying amount of the investment.
6. 2-6
Equity Method—Recognition of
Dividends
In effect, all dividends from the investee are
treated as liquidating dividends under the
equity method. Thus, if PT ABC owns 20
percent of PT XYZ’s common stock and PT
XYZ declares and pays a Rp20,000,000
dividend, the following entry is recorded on
the books of PT ABC to record its share of
the dividend:
8. 2-8
Equity Method—
Acquisition at Interim Date
• When an investment is purchased, the
investor begins accruing income from the
investee under the equity method at the date
of acquisition.
• No income earned by the investee before the
date of acquisition of the investment may be
accrued by the investor.
9. 2-9
Equity Method—Acquisition at Interim
Date (Continued)
• When the purchase occurs between balance
sheet dates, the amount of income earned by
the investee from the date of the acquisition
to the end of the fiscal period may need to be
estimated by the investor in recording the
equity accrual.
10. 2-10
Equity Method—Acquisition at Interim
Date (Continued)
• For example, if the acquisition (20 percent
interest) was transacted on October 1 and
the investee earned Rp60,000,000 for the
entire year, the investor would have an equity
accrual of Rp3,000,000 (i.e., Rp60,000,000 X
.20 X 3/12 = Rp3,000,000).
11. 2-11
Equity Method—Acquisition at Interim
Date (Continued)
WARNING: Watch out for “liquidating
dividends” when acquisitions
are transacted at interim dates.
12. 2-12
Investment Cost Versus
Underlying Book Value
• When one corporation buys the common
stock of another, the purchase price normally
is based on the market price of the shares
acquired rather than the book values of the
investee’s assets and liabilities.
13. 2-13
Investment Cost Versus
Underlying Book Value
• As a result, there often is a difference
between the cost of the investment to the
investor and the book value of the investor’s
proportionate share of the underlying net
assets of the investee.
• This difference is referred to as a differential.
14. 2-14
Investment Cost Versus
Underlying Book Value
• The differential represents the amount paid
by the investor in excess of the book value of
the investment and is included in the
investment amount.
15. 2-15
Investment Cost Versus
Underlying Book Value
• Hence, the amortization or reduction of the
differential involves the reduction of the
investment account.
• At the same time, the investor’s net income
must be reduced by an equal amount to
recognize that a portion of the amount paid
for the investment has expired.
16. 2-16
Investment Cost Versus
Underlying Book Value
• There are several reasons the cost of an
investment might exceed the book value
of the underlying net assets and give rise
to a positive differential.
17. 2-17
Investment Cost Versus
Underlying Book Value
• One reason is that the investee’s assets
may be worth more than their book value.
• Another reason could be the existence of
unrecorded goodwill associated with the
excess earning power of the investee.
18. 2-18
Investment Cost Versus
Underlying Book Value
• Purchase differentials related to a limited life
asset (e.g., equipment) should be amortized
over the life of the related asset.
19. 2-19
Investment Cost Versus
Underlying Book Value
• If the purchase differential has a debit
balance, the equity method entry to amortize
the purchase differential will be the opposite
of the “equity accrual” entry, that is, with
respect to the accounts debited or credited.
• Examples are provided on next slide.
20. 2-20
Investment Cost Versus
Underlying Book Value
• Any portion of the differential that is related to
land is not amortized since land has an
unlimited life.
• Any portion of the differential that represents
goodwill (referred to as equity method
goodwill) is neither amortized nor written
down for impairment.
21. 2-21
Investment Cost Versus
Underlying Book Value
• However, an impairment loss on the
investment itself should be recognized if it
suffers a decline in the value that is other
than temporary.
22. 2-22
Equity Method--Cost Exceeds Book
Value
PT Andika purchases 40 percent of the common
stock of PT Barata on January 1, 20X1, for
Rp200,000,000. PT Barata has net assets with a book value
of Rp400,000,000 and a fair value of Rp465,000,000.
Cost of investment to PT Andika Rp200,000,000
Book value of PT Andika ’s share of
PT Barata’s net assets
(.40 x Rp400,000,000) (160,000,000)
Differential Rp 40,000,000
23. 2-23
Cost of Investment
Rp200,000,000
Fair value of net
identifiable assets
(40% x
Rp465,000,000)
Rp186,000,000
Total differential
Rp40,000,000
Excess of cost over
fair value of net
identifiable assets
Rp14,000,000
Excess of fair value
over book value of
net identifiable
assets
Rp26,000,000
Book value of net
identifiable assets
(40% x
Rp400,000,000)
Rp160,000,000
Equity Method--Cost Exceeds Book Value
24. 2-24
Equity Method--Cost Exceeds Book Value
PT Barata reports net income of Rp80,000,00 in 20X1.
Investment in PT Barata Stock 32,000,000
Income from Investee 32,000,000
Record equity-method income.
40% x
Rp80,000,000
25. 2-25
Equity Method--Cost Exceeds Book Value
PT Barata declares and pays a dividend of
Rp20,000000 in 20X1.
40% x
Rp20,000,000
PT Barata reports net income of Rp80,000,000 in 20X1.
Investment in PT Barata Stock 32,000,000
Income from Investee 32,000,000
Record equity-method income.
Cash 8,000,000
Investment in PT Barata Stock 8,000,000
Record dividend from PT Barata.
26. 2-26
Equity Method--Cost Exceeds Book Value
The Rp40,000,000 excess paid by PT Andika is assigned to
Land, Rp6,000,000, Equipment, Rp20,000,000, and Goodwill,
Rp14,000,000. Equipment and goodwill are amortized, but
land is not.
Equipment (Rp20,000,000 ÷ 5 years) Rp4,000,000
Income from Investee 4,000,000
Investment in PT Barata Stock 4,000,000
Amortize differential.
27. 2-27
Equity Method--Disposal of Assets
If PT Barata had purchased the land in 20X0 for Rp5,000,000 and
sells the land in 20X2 for Rp125,000,000. PT Barata recognizes a
gain on the sale of Rp50,000,000, and PT Andika’s share is
Rp20,000,000 (40%).
PT Andika’s share of PT Barata 's reported gain Rp20,000,000
Portion of PT Andika’s differential related to land (6,000,000)
Gain to be recognized by PT Andika Rp14,000,000
Income from Investee 6,000,000
Investment in PT Barata Stock 6,000,000
Remove differential related to PT Barata’s land sold.
28. 2-28
Equity Method--Purchase Additional Shares
PT ABC purchases 20 percent of PT XYZ’s common
stock on January 2, 20X1, and another 10 percent on
July 1, 20X1, and the stock purchases are at book value.
Income, January 2 to June 30: Rp25,000,000 x .20 Rp 5,000,000
Income, July 1 to December 31: Rp35,000,000 x .30 10,500,000
Income from Investment, 20X1 Rp15,500,000
Investment in PT XYZ Stock 15,500,000
Income from Investee 15,500 ,000
29. 2-29
Equity Method--Purchase Additional Shares
PT XYZ declares and pays a Rp10,000,000
dividend on January 15 and again on July 15.
January 15 dividend: Rp10,000,000 x .20 Rp 2,000,000
July 15 dividend: Rp 10,000,000 x .30 3,000,000
Reduction in Investment, 20X1 Rp 5,000,000
Cash 2,000,000
Investment in PT XYZ Stock 2,000,000
January 15, 20X1
Cash 3,000,000
Investment in PT XYZ Stock 3,000,000
July 15, 20X1
30. 2-30
Equity Method--Change to Equity Method
PT Aroma purchases 15 percent of PT Zuraida’s
common stock on January 2, 20X1 and another 10
percent on January 2, 20X4. PT Aroma switches to the
equity method on January 2, 20X4.
Originally under Restated under
Year Net Income Dividends Cost Equity
PT Zuraida Investment Income Reported by PT Aroma
20X1 Rp15,000,000 Rp 10,000,000 Rp 1,500,000 Rp 2,250,000
20X2 18,000,000 10,000,000 1,500,000 2,700,000
20X3 22,000,000 10,000,000 1,500,000 3,300,000
Rp 55,000,000 Rp 30,000,000 Rp 4,500,000 Rp 8,250,000
31. 2-31
The investment account and retained earnings of PT
Aroma are restated as if the equity method had been
applied from the date of the original acquisition.
Investment in PT Zuraida Common Stock3,750,000
Retained Earnings 3,750,000
Restate investment account from cost to
equity method.
Rp8,250,000 -
Rp 4,500,000
Equity Method--Change to Equity Method
33. 2-33
Disposal of Differential-Related
Assets
• If the investee disposes of any asset to which
the differential relates, that portion of the
differential must be removed from the
investment account on the investor’s books.
34. 2-34
Disposal of Differential-Related
Assets
• When this is done, the investor’s share of the
investee’s gain or loss on disposal of the
asset must be adjusted to reflect the fact that
the investor paid more for its proportionate
share of that asset than did the investee.
35. 2-35
Impairment of Investment Value
• As with many assets, accounting standards
require that equity-method investments be
written down if their value is impaired.
36. 2-36
Impairment of Investment Value
• If the market value of the investment declines
materially below its equity-method carrying
amount, and the decline in value is
considered other than temporary, the carrying
amount of the investment should be written
down to the market value and a loss
recognized.
37. 2-37
Impairment of Investment Value-con’t
• The new lower value serves as a starting
point for continued application of the equity
method.
• Subsequent recoveries in the value of the
investment may not be recognized.
38. 2-38
Changes in Number of Shares Held
• A change in the number of common shares
held by an investor resulting from a stock
dividend, split, or reverse split is treated in
the same way as under the cost method.
39. 2-39
Changes in Number of Shares Held
• No formal accounting recognition is required
on the books of the investor.
• On the other hand, purchases and sales of
shares do require formal recognition.
40. 2-40
Purchases of Additional Shares
• A purchase of additional shares of common
stock already held by an investor and
accounted for using the equity method simply
involves adding the cost of the new shares to
the investment account and applying the
equity method in the normal manner from the
date of acquisition forward.
41. 2-41
Purchases of Additional Shares-
Con’t
• The new and old investments in the same
stock are combined for financial reporting
purposes.
• Income accruing to the new shares can be
recognized by the investor only from the date
of acquisition forward.
42. 2-42
Determination of Significant Influence
• The general rule established in PSAK 15 is
that the equity method is appropriate where
the investor, by virtue of its common stock
interest in an investee, is able to exercise
significant influence over the operating and
financial policies of the investee.
43. 2-43
Determination of Significant Influence
• In the absence of other evidence, common
stock ownership of 20 percent or more is
viewed as indicating that the investor is able
to exercise significant influence over the
investee.
44. 2-44
Unrealized Intercompany Profits
• Intercompany sales do not result in the
realization of income until the intercompany
profit is confirmed in some way, usually
through a transaction with an unrelated party.
45. 2-45
Unrealized Intercompany Profits
• Thus, unrealized intercompany profits must
be eliminated from both consolidated
financial statement amounts as well as equity
method amounts.
• The term for the application of the equity
method that includes the adjustment for
unrealized intercompany profits is “fully
adjusted equity method.”
46. 2-46
Unrealized Intercompany Profits
• Unrealized intercompany profits overstate
earnings. Thus the equity method entry to
remove the unrealized profit will be the
opposite of the “equity accrual” entry, that
is, with respect to the accounts debited or
credited.
Examples are provided on the next slide.
47. 2-47
Unrealized Intercompany Profits
• To record equity method income of
Rp24,000,000.
Investment in PT Investee Rp24,000,000
Income from PT Investee Rp24,000,000
48. 2-48
Unrealized Intercompany Profits
• To remove unrealized intercompany profit of
Rp2,000,000 (assumed).
Income from PT Investee Rp 2,000,000
Investment in PT Investee Rp 2,000,000
49. 2-49
Chapter Three to Chapter Ten
• Three different approaches are followed by
companies (in practice) in accounting for their
consolidated subsidiary during the year:
• The fully adjusted equity method
(a.k.a., the equity method).
• The basic equity method.
• The cost method.
50. 2-50
Chapter Three to Chapter Ten
• The cost method and the fully adjusted
equity method (a.k.a., the equity method)
were previously discussed in this chapter.
• The basic equity method is used in Chapters
3 to 10 and is discussed in the next slide.
51. 2-51
Chapter Three to Chapter Ten
• In essence, the basic equity method is a
modified version of the equity method
discussed in this chapter.
• Specifically, the basic equity method avoids
“unrealized profit transactions” that will be
eliminated during the consolidation process.
52. 2-52
Chapter Three to Chapter Ten
• While the basic equity method is “Not GAAP,”
use of the basic equity method may help
provide some “clerical savings” for the parent
company—as well as students and teachers.
53. 2-53
You Will Survive Chapter 2 !!!
• There are two sets of accounting
records (i.e., books) to analyze.
• You should always ask yourself –
does the information relate to the
investor or the investee or both ?
54. 2-54
You Will Survive Chapter 2 !!!
• If consolidation is required, the investor may
be referred to as the “parent company” and
the investee may be referred to as the
“subsidiary” company.
• The cost method and the equity method are
both accounting methods and reporting
methods, that is, they are used during the
year as well as at year-end, respectively.
55. 2-55
You Will Survive Chapter 2 !!!
• Unless consolidation is required, the investor
would usually use the same method for
accounting and reporting purposes.
56. 2-56
You Will Survive Chapter 2 !!!
• If consolidation is required, all balances
related to either the cost method or the equity
method are eliminated when preparing the
consolidated financial statements—thus
either method may be used during the year.
57. 2-57
You Will Survive Chapter 2 !!!
• There is only one “trick” to the cost
method—liquidating dividends.
• Remember—dividends do not accrue.
• Remember—only use post-acquisition
earnings.
58. 2-58
You Will Survive Chapter 2 !!!
• Think of the equity method in terms of three
levels (and start with the bottom level):
• Top level--Unrealized profits
• Middle level—Differential
• Base or bottom level--Book value
