Solution Manual - Advanced Accounting, 5th Edition Author:
Hopkins and Halsey All 1-19 Chapters Covered 100% Complete
A+ Study Guide Latest Version
, Advanc ed Ac c ounting Fifth Edition
Solution Manual
C hapter 1— Ac c ounting for Interc orporate Investments
1. a. If the investor ac quired 100% of the investee at book value, the Equity Investment ac c
ount is equal to the Stoc kholders’ Equity of the investee c ompany. It, therefore, inc ludes
the assets and liabilities of the investee c ompany in one ac c ount. The investor’s balanc e
sheet, therefore, inc ludes the Stoc kholders’ Equity of the investee c ompany, and, implic
itly, its assets and liabilities. In the c onsolidation proc ess, the balanc e sheets of the
investor and investee c ompany are brought together. C onsolidated Stoc kholders’ Equity
will be the same as that whic h the investor c urrently reports; only total assets and total
liabilities will c hange.
b. If the investor owns 100% of the investee, the equity inc ome that the investor reports is
equal to the net inc ome of the investee, thus implic itly inc luding its revenues and
expenses. Replac ing the equity inc ome with the revenues and expenses of the investee c
ompany in the c onsolidation proc ess will yield the same net inc ome.
2. FASB ASC 323-10 provides the following guidanc e with respec t to the ac c ounting for
rec eipt of dividends using the equity method:
The equity method tends to be most appropriate if an investment enables the investor to
influenc e the operating or financ ial dec isions of the investee. The investor then has a
degree of responsibility for the return on its investment, and it is appropriate to inc
lude in the results of operations of the investor its share of the earnings or losses of
the investee. (¶323-10-05-5)
The equity method is an appropriate means of rec ognizing inc reases or dec reases measured
by generally ac c epted ac c ounting princ iples (GAAP) in the ec onomic resourc es underlying
the investments. Furthermore, the equity method of ac c ounting more c losely meets the objec
tives of ac c rual ac c ounting than does the c ost method bec ause the investor rec ognizes its
share of the earnings and losses of the investee in the periods in whic h they are reflec ted in
the ac c ounts of the investee. (¶323-10-05-4)
Under the equity method, an investor shall rec ognize its share of the earnings or losses of an
investee in the periods for whic h they are reported by the investee in its financ ial statements
rather than in the period in whic h an investee dec lares a dividend (¶323-10- 35-4).
2023
Solutions Manual, C hapter 1-1
1
,3. The rec ognition of equity inc ome does not mean that c ash has been rec eived. In fac t,
dividends paid by the investee to the investo r are typic ally a small perc entage of its reported
net inc ome. The projec tion of future net inc ome that inc ludes equity inc ome as a signific ant
c omponent might not, therefore, imply signific ant generation of c ash.
4. The ac c ounting for Altria’s investment in ABI depends on the degree of influenc e or c ontrol
it c an exert over that c ompany. A c lassific ation of “no influenc e” does not appear
appropriate sinc e Altria owns 10.1% of the outstan ding c ommon stoc k and also “ac tive
representation on ABI’s Board of Direc tors (“ABI Board”) and c ertain ABI Board c
ommittees. Through this representation, Altria partic ipates in ABI polic y making proc esses.” A
c lassific ation of “signific ant influenc e” seems most appropriate given the fac ts, and this c
lassific ation warrants ac c ounting for the investment using the equity method of ac c ounting.
5. a. An investor may write down the c arrying amount of its Equity Investment if the fair value
of that investment has dec lined below its c arrying value and that dec line is deemed to be
other than temporary.
b. There is c onsiderable judgment in determining whether a dec line in fair value is other than
temporary. The write-down amounts to a predic tion that the future fair value of the
investment will not rise above the c urrent c arrying amount. If a c ompany deems the dec
line to be temporary, it does not write down the investment, and a loss is not rec ognized
in its inc ome statement. If the dec line is deemed to be other than temporary, the
investment is written down and a loss is reported. C ompanies c an use this flexibility to dec
ide whether to rec ognize a loss in the c urrent year or to postpone it to a future year.
6. Under the equity method, an investor rec ognizes its share of the earnings or losses of an
investee in the periods for whic h they are reported by the investee in its financ ial statements.
FASB ASC 323-10-35-7 states that “Intra-entity profits and losses shall be eliminated until
realized by the investor or investee as if the investee were c onsolidated.” These interc ompany
items are eliminated to avoid double c ounting and prematurely rec ognizing inc ome.
2023
1-2 Advanc ed Ac c ounting, 5th
Edition
, 7. FASB ASC 323-10-15 requires the use of the equity method of ac c ounting for an investor
whose investment in voting stoc k gives it the ability to exerc ise signific ant influenc e over
operating and financ ial polic ies of an investee. Sec tion 15-6 states that “Ability to exerc ise
signific ant influenc e over operating and financ ial polic ies of an investee may be indic ated in
several ways, inc luding the following: Representation on the board of direc tors, Partic ipation
in polic y-making proc esses, Material intra-entity transac tions, c hange of managerial personnel,
Tec hnologic al dependenc y, and Extent of ownership by an investor in relation to the c onc
entration of other shareholdings (but substantial or majority ownership of the voting stoc k of an
investee by another investor does not nec essarily prec lude the ability to exerc ise signific ant
influenc e by the investor)” (emphasis added). It is c lear, in this c ase, that the investee is c
ritic ally dependent upon the te c hnology lic ensed to it by the investor. The investor should,
therefore, ac c ount for its investment using the equity method.
8. Even though the investor owns 30% of the investee, it should not use the equity method as it c
annot exert signific ant influenc e over the investee. Further, sinc e the investee is not a public c
ompany (all of the remaining stoc k is privately held), the investor should use the c ost method
to ac c ount for this investment as the fair value method presumes a public ly traded stoc k with
suffic ient liquidity to reasonably determine a fair value.
9. a. The losses did not affec t Enron’s inc ome statement. Sinc e the investees were insolvent,
Enron’s Equity Investment was reduc ed to zero (it had not made any loans or other
advanc es to the investee c ompanies). As a result, Enron disc ontinued reporting for these
Equity Investments using the equity method and, therefore, did not rec ognize its
proportionate share of investee losses.
b. “… only after its share of that net inc ome equals the share of net losses not rec ognized
during the period the equity method was suspended” means that the investee has rec
ouped all of the losses that have been reported. Sinc e the investor c eases to ac c ount
for its Equity Investment using the equity method onc e the balanc e reac hes zero
(assuming that it has not guaranteed the debts of the investee c ompany), this generally
implies that the investee’s Stoc kholders’ Equity is below zero (i.e., a defic it). The investor
resumes its ac c ounting for the Equity investment using the e quity method onc e the
investee’s Stoc kholders’ Equity is positive. It is at that point when the investee c ompany
has rec ouped all of its prior losses (assuming that the investee c ompany has not raised
additional equity c apital).
2023
Solutions Manual, C hapter 1-3
1
Hopkins and Halsey All 1-19 Chapters Covered 100% Complete
A+ Study Guide Latest Version
, Advanc ed Ac c ounting Fifth Edition
Solution Manual
C hapter 1— Ac c ounting for Interc orporate Investments
1. a. If the investor ac quired 100% of the investee at book value, the Equity Investment ac c
ount is equal to the Stoc kholders’ Equity of the investee c ompany. It, therefore, inc ludes
the assets and liabilities of the investee c ompany in one ac c ount. The investor’s balanc e
sheet, therefore, inc ludes the Stoc kholders’ Equity of the investee c ompany, and, implic
itly, its assets and liabilities. In the c onsolidation proc ess, the balanc e sheets of the
investor and investee c ompany are brought together. C onsolidated Stoc kholders’ Equity
will be the same as that whic h the investor c urrently reports; only total assets and total
liabilities will c hange.
b. If the investor owns 100% of the investee, the equity inc ome that the investor reports is
equal to the net inc ome of the investee, thus implic itly inc luding its revenues and
expenses. Replac ing the equity inc ome with the revenues and expenses of the investee c
ompany in the c onsolidation proc ess will yield the same net inc ome.
2. FASB ASC 323-10 provides the following guidanc e with respec t to the ac c ounting for
rec eipt of dividends using the equity method:
The equity method tends to be most appropriate if an investment enables the investor to
influenc e the operating or financ ial dec isions of the investee. The investor then has a
degree of responsibility for the return on its investment, and it is appropriate to inc
lude in the results of operations of the investor its share of the earnings or losses of
the investee. (¶323-10-05-5)
The equity method is an appropriate means of rec ognizing inc reases or dec reases measured
by generally ac c epted ac c ounting princ iples (GAAP) in the ec onomic resourc es underlying
the investments. Furthermore, the equity method of ac c ounting more c losely meets the objec
tives of ac c rual ac c ounting than does the c ost method bec ause the investor rec ognizes its
share of the earnings and losses of the investee in the periods in whic h they are reflec ted in
the ac c ounts of the investee. (¶323-10-05-4)
Under the equity method, an investor shall rec ognize its share of the earnings or losses of an
investee in the periods for whic h they are reported by the investee in its financ ial statements
rather than in the period in whic h an investee dec lares a dividend (¶323-10- 35-4).
2023
Solutions Manual, C hapter 1-1
1
,3. The rec ognition of equity inc ome does not mean that c ash has been rec eived. In fac t,
dividends paid by the investee to the investo r are typic ally a small perc entage of its reported
net inc ome. The projec tion of future net inc ome that inc ludes equity inc ome as a signific ant
c omponent might not, therefore, imply signific ant generation of c ash.
4. The ac c ounting for Altria’s investment in ABI depends on the degree of influenc e or c ontrol
it c an exert over that c ompany. A c lassific ation of “no influenc e” does not appear
appropriate sinc e Altria owns 10.1% of the outstan ding c ommon stoc k and also “ac tive
representation on ABI’s Board of Direc tors (“ABI Board”) and c ertain ABI Board c
ommittees. Through this representation, Altria partic ipates in ABI polic y making proc esses.” A
c lassific ation of “signific ant influenc e” seems most appropriate given the fac ts, and this c
lassific ation warrants ac c ounting for the investment using the equity method of ac c ounting.
5. a. An investor may write down the c arrying amount of its Equity Investment if the fair value
of that investment has dec lined below its c arrying value and that dec line is deemed to be
other than temporary.
b. There is c onsiderable judgment in determining whether a dec line in fair value is other than
temporary. The write-down amounts to a predic tion that the future fair value of the
investment will not rise above the c urrent c arrying amount. If a c ompany deems the dec
line to be temporary, it does not write down the investment, and a loss is not rec ognized
in its inc ome statement. If the dec line is deemed to be other than temporary, the
investment is written down and a loss is reported. C ompanies c an use this flexibility to dec
ide whether to rec ognize a loss in the c urrent year or to postpone it to a future year.
6. Under the equity method, an investor rec ognizes its share of the earnings or losses of an
investee in the periods for whic h they are reported by the investee in its financ ial statements.
FASB ASC 323-10-35-7 states that “Intra-entity profits and losses shall be eliminated until
realized by the investor or investee as if the investee were c onsolidated.” These interc ompany
items are eliminated to avoid double c ounting and prematurely rec ognizing inc ome.
2023
1-2 Advanc ed Ac c ounting, 5th
Edition
, 7. FASB ASC 323-10-15 requires the use of the equity method of ac c ounting for an investor
whose investment in voting stoc k gives it the ability to exerc ise signific ant influenc e over
operating and financ ial polic ies of an investee. Sec tion 15-6 states that “Ability to exerc ise
signific ant influenc e over operating and financ ial polic ies of an investee may be indic ated in
several ways, inc luding the following: Representation on the board of direc tors, Partic ipation
in polic y-making proc esses, Material intra-entity transac tions, c hange of managerial personnel,
Tec hnologic al dependenc y, and Extent of ownership by an investor in relation to the c onc
entration of other shareholdings (but substantial or majority ownership of the voting stoc k of an
investee by another investor does not nec essarily prec lude the ability to exerc ise signific ant
influenc e by the investor)” (emphasis added). It is c lear, in this c ase, that the investee is c
ritic ally dependent upon the te c hnology lic ensed to it by the investor. The investor should,
therefore, ac c ount for its investment using the equity method.
8. Even though the investor owns 30% of the investee, it should not use the equity method as it c
annot exert signific ant influenc e over the investee. Further, sinc e the investee is not a public c
ompany (all of the remaining stoc k is privately held), the investor should use the c ost method
to ac c ount for this investment as the fair value method presumes a public ly traded stoc k with
suffic ient liquidity to reasonably determine a fair value.
9. a. The losses did not affec t Enron’s inc ome statement. Sinc e the investees were insolvent,
Enron’s Equity Investment was reduc ed to zero (it had not made any loans or other
advanc es to the investee c ompanies). As a result, Enron disc ontinued reporting for these
Equity Investments using the equity method and, therefore, did not rec ognize its
proportionate share of investee losses.
b. “… only after its share of that net inc ome equals the share of net losses not rec ognized
during the period the equity method was suspended” means that the investee has rec
ouped all of the losses that have been reported. Sinc e the investor c eases to ac c ount
for its Equity Investment using the equity method onc e the balanc e reac hes zero
(assuming that it has not guaranteed the debts of the investee c ompany), this generally
implies that the investee’s Stoc kholders’ Equity is below zero (i.e., a defic it). The investor
resumes its ac c ounting for the Equity investment using the e quity method onc e the
investee’s Stoc kholders’ Equity is positive. It is at that point when the investee c ompany
has rec ouped all of its prior losses (assuming that the investee c ompany has not raised
additional equity c apital).
2023
Solutions Manual, C hapter 1-3
1
