ACCESS Test Bank for Fundamentals of Advanced Accounting 9th Edition Hoyle
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
CHAPTER1 T l l
HE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
l l l l l l
ChapterlOutline
I. Fourlmethodslarelprincipallylusedltolaccountlforlanlinvestmentlinlequitylsecuritieslalonglwithl
alfairlvalueloption.
A. Fairlvaluelmethod:lappliedlbylanlinvestorlwhenlonlylalsmalllpercentageloflalcom
pany’slvotinglstocklislheld.
1. Thelinvestorlrecognizeslincomelwhenlthelinvesteeldeclareslaldividend.
2. Portfolioslarelreportedlatlfairlvalue.lIflfairlvalueslarelunavailable,linvestmentlislrepo
rtedlatlcost.
B. CostlMethod:lappliedltolinvestmentslwithoutlalreadilyldeterminablelfairlvalue.lWhenlthelfa
irlvalueloflanlinvestmentlinlequitylsecuritieslislnotlreadilyldeterminable,landlthelinvestment
lprovideslneitherlsignificantlinfluencelnorlcontrol,lthelinvestmentlmaylbelmeasuredlatlcost
.lThelinvestmentlremainslatlcostlunless
1. Aldemonstrablelimpairmentloccurslforlthelinvestment,lor
2. Anlobservablelpricelchangeloccurslforlidenticallorlsimilarlinvestmentsloflthelsamelissu
er.
Thelinvestorltypicallylrecognizeslitslshareloflinvesteeldividendsldeclaredlasldividendlincome.
C. Consolidation:lwhenlonelfirmlcontrolslanotherl(e.g.,lwhenlalparentlhaslalmajoritylintere
stlinlthelvotinglstockloflalsubsidiarylorlcontrollthroughlvariablelinterests,ltheirlfinanciallst
atementslarelconsolidatedlandlreportedlforlthelcombinedlentity.
D. Equitylmethod:lappliedlwhenlthelinvestorlhaslthelabilityltolexerciselsignificantlinflu
enceloverloperatinglandlfinanciallpoliciesloflthelinvestee.
1. Abilityltolsignificantlylinfluencelinvesteelislindicatedlbylseverallfactorslincludinglrepr
esentationlonlthelboardlofldirectors,lparticipationlinlpolicy-making,letc.
2. GAAPlguidelineslpresumelthelequitylmethodlislapplicablelifl20ltol50lpercentlofltheloutst
andinglvotinglstockloflthelinvesteelislheldlbylthelinvestor.
Currentlfinanciallreportinglstandardslallowlfirmsltolelectltoluselfairlvaluelforlanylnewlinvestmen
tlinlequitylshareslincludinglthoselwherelthelequitylmethodlwouldlotherwiselapply.lHowever,lthel
option,lonceltaken,lislirrevocable.lThelinvestorlrecognizeslbothlinvesteeldividendslandlchang
eslinlfairlvalueloverltimelaslincome.
1-1
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
mynursytest.store
,ACCESS Test Bank for Fundamentals of Advanced Accounting 9th Edition Hoyle
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
II. Accountinglforlanlinvestment:lthelequitylmethod
A. Thelinvestorladjustslthelinvestmentlaccountltolreflectlalllchangeslinlthelequityloflthelinves
teelcompany.
B. Thelinvestorlaccrueslinvesteelincomelwhenlitlislreportedlinlthelinvestee’slfinanciallstate
ments.
C. DividendsldeclaredlbylthelinvesteelcreatelalreductionlinlthelcarryinglamountloflthelInvest
mentlaccount.lThislbooklassumeslalllinvesteeldividendslareldeclaredlandlpaidlinlthelsam
elreportinglperiod.
III. Speciallaccountinglprocedureslusedlinlthelapplicationloflthelequitylmethod
A. Reportinglalchangeltolthelequitylmethodlwhenlthelabilityltolsignificantlylinfluencelanlinves
teelislachievedlthroughlalseriesloflacquisitions.
1. Initiallpurchase(s)lwilllbelaccountedlforlbylmeansloflthelfairlvaluelmethodl(orlatlcost)l
untillthelabilityltolsignificantlylinfluencelislattained.
2. Whenlthelabilityltolexerciselsignificantlinfluenceloccurslfollowinglalseriesloflstocklpurc
hases,lthelinvestorlapplieslthelequitylmethodlprospectively.lTheltotallfairlvaluelatltheld
atelsignificantlinfluencelislattainedlislcomparedltolthelinvestee’slbooklvalueltoldetermi
nelfuturelexcesslfairlvaluelamortizations.
B. Investeelincomelfromlotherlthanlcontinuingloperations
1. Thelinvestorlrecognizeslitslshareloflinvesteelreportedlotherlcomprehensivelinc
omel(OCI)lthroughlthelinvestmentlaccountlandlthelinvestor’slownlOCI.
2. Incomelitemslsuchlasldiscontinuedloperationslthatlarelreportedlseparatelylbylthelinve
steelshouldlbelshownlinlthelsamelmannerlbylthelinvestor.lThelmaterialitylofltheselothe
rlinvesteelincomelelementsl(aslitlaffectslthelinvestor)lcontinuesltolbelalcriterionlforlsep
arateldisclosure.
C. Investeellosses
1. Losseslreportedlbylthelinvesteelcreatelcorrespondingllosseslforlthelinvestor.
2. Alpermanentldeclinelinlthelfairlvalueloflanlinvestee’slstocklshouldlbelrecognizedlimm
ediatelylbylthelinvestorlaslanlimpairmentlloss.
3. Investeellosseslcanlpossiblylreducelthelcarryinglvalueloflthelinvestmentlaccountltolalz
erolbalance.lAtlthatlpoint,lthelequitylmethodlceasesltolbelapplicablelandlthelfair-
valuelmethodlislsubsequentlylused.
D. Reportinglthelsaleloflanlequitylinvestment
1. Thelinvestorlapplieslthelequitylmethodluntilltheldisposalldateltolestablishlalproperlbookl
value.
2. Followinglthelsale,lthelequitylmethodlcontinuesltolbelappropriateliflenoughlshareslarels
tilllheldltolmaintainlthelinvestor’slabilityltolsignificantlylinfluencelthelinvestee.lIflthatlabili
tylhaslbeenllost,lthelfair-valuelmethodlislsubsequentlylused.
IV. Excesslinvestmentlcostloverlbooklvaluelacquired
A. Thelpricelanlinvestorlpayslforlequitylsecuritiesloftenldifferslsignificantlylfromlthelinve
stee’slunderlyinglbooklvaluelprimarilylbecauselthelhistoricallcostlbasedlaccountingl
modelldoeslnotlkeepltrackloflchangeslinlalfirm’slfairlvalue.
B. Paymentslmadelinlexcessloflunderlyinglbooklvaluelcanlsometimeslbelidentifiedlwithlspec
ificlinvesteelaccountslsuchlaslinventorylorlequipment.
C. Anlextralacquisitionlpricelcanlalsolbelassignedltolanticipatedlbenefitslthatlarelexpectedlt
olbelderivedlfromlthelinvestment.lInlaccounting,ltheselamountslarelpresumedltolreflectla
nlintangiblelassetlreferredltolaslgoodwill.lGoodwilllislcalculated
1-2
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
mynursytest.store
,ACCESS Test Bank for Fundamentals of Advanced Accounting 9th Edition Hoyle
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
aslanylexcesslpaymentlthatlislnotlattributableltolspecificlidentifiablelassetslandlliabilitiesloflt
helinvestee.lBecauselgoodwilllislanlindefinite-livedlasset,litlislnotlamortized.
V. Deferralloflintra-entitylgrosslprofitlinlinventory
A. Thelinvestor’slshareloflintra-
entitylprofitslinlendinglinventorylarelnotlrecognizedluntilltheltransferredlgoodslareleitherlco
nsumedlorluntilltheylarelresoldltolunrelatedlparties.
B. Downstreamlsalesloflinventory
1. “Downstream”lrefersltoltransferslmadelbylthelinvestorltolthelinvestee.
2. Intra-
entitylgrosslprofitslfromlsaleslarelinitiallyldeferredlunderlthelequitylmethodlandlthenlr
ecognizedlaslincomelatltheltimeloflthelinventory’sleventualldisposal.
3. Thelamountloflgrosslprofitltolbeldeferredlislthelinvestor’slownershiplpercentagelmulti
pliedlbylthelmarkuplonlthelmerchandiselremaininglatlthelendloflthelyear.
C. Upstreamlsalesloflinventory
1. “Upstream”lrefersltoltransferslmadelbylthelinvesteeltolthelinvestor.
2. Underlthelequitylmethod,ltheldeferrallprocesslforlintra-
entitylgrosslprofitslislidenticallforlupstreamlandldownstreamltransfers.lThelprocedure
slarelseparatelylidentifiedlinlChapterlOnelbecauselthelhandlingldoeslvarylwithinlthelco
nsolidationlprocess.
AnswersltolDiscussionlQuestions
Theltextbooklincludesldiscussionlquestionsltolstimulatelstudentlthoughtlandldiscussion.lTheselquesti
onslarelalsoldesignedltolallowlstudentsltolconsiderlrelevantlissueslthatlmightlotherwiselbeloverlooked.l
Somelofltheselquestionslmaylbeladdressedlbylthelinstructorlinlclassltolmotivatelstudentldiscussion.lSt
udentslshouldlbelencouragedltolbeginlbyldefininglthelissue(s)linleachlcase.lNext,lauthoritativelaccoun
tinglliteraturel(FASBlASC)lorlotherlrelevantlliteraturelcanlbelconsultedlaslalpreliminarylsteplinlarrivingl
atllogicallactions.lFrequently,lthelFASBlAccountinglStandardslCodificationlwilllprovidelthelnecessaryl
support.
Unfortunately,linlaccounting,ldefinitivelresolutionsltolfinanciallreportinglquestionslarelnotlalwayslavail
able.lStudentsloftenlseemltolbelievelthatlalllaccountinglissueslhavelbeenlresolvedlinlthelpastlsolthatlac
countingleducationlislonlylalmatterlofllearningltolapplylhistoricallylprescribedlprocedures.lHowever,linl
actuallpractice,lthelonlylreallanswerlisloftenlthelonelthatlprovideslthelfairestlrepresentationloflthelfirm’sl
transactions.lIflanlauthoritativelsolutionlislnotlavailable,lstudentslshouldlbeldirectedltollistlallloflthelissu
eslinvolvedlandlthelconsequencesloflpossiblelalternativelactions.lThelvariouslfactorslpresentedlcanlb
elweighedltolproducelalviablelsolution.
Theldiscussionlquestionslareldesignedltolhelplstudentsldeveloplresearchlandlcriticallthinkinglskillslinla
ddressinglissueslthatlgolbeyondlthelpurelylmechanicallelementsloflaccounting.
DidlthelCostlMethodlInvitelManipulation?
Thelcostlmethodloflaccountinglforlinvestmentsloftenlcausedlallackloflobjectivitylinlreportedlincomelfigu
res.lWithlallargelblockloflthelinvestee’slvotinglshares,lanlinvestorlcouldlinfluencelthelamountlandltimingl
oflthelinvestee’sldividendldeclarations.lThus,lwhenlenjoyinglalgoodlearningslyear,lanlinvestorlmightlin
fluencelthelinvesteeltolwithholdldeclaringlaldividendluntillneededlinlalsubsequentlyear.lAlternatively,lifl
thelinvestorljudgedlthatlitslcurrentlyearlearningsl“neededlalboost,”litlmightlinfluencelthelinvesteeltoldec
larelalcurrentlyearldividend.lThelequitylmethodleffectivelylremoveslmanagers’labilityltolincreaselcurre
ntlincomel(orldeferlincomeltolfuturelperiods)lthroughltheirlinfluenceloverltheltiminglandlamountsloflinve
steeldividendldeclarations.
1-3
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
mynursytest.store
, ACCESS Test Bank for Fundamentals of Advanced Accounting 9th Edition Hoyle
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
Atlfirstlglancelitlmaylseemlthatlthelfairlvaluelmethodlallowslmanagersltolmanipulatelincomelbecauselin
vesteeldividendslarelrecordedlaslincomelbylthelinvestor.lHowever,ldividendslpaidltypicallylarelaccom
paniedlbylaldecreaselinlfairlvaluel(alsolrecognizedlinlincome),lthuslleavinglreportedlnetlincomelunaffec
ted.
DoeslthelEquitylMethodlReallylApplylHere?
Theldiscussionlinlthelcaselbetweenltheltwolaccountantslisllimitedltolthelreasonlforlthelinvestmentlacqu
isitionlandlthelcurrentlpercentageloflownership.lInstead,ltheylshouldlbelexamininglthelactuallinteractio
nlthatlcurrentlylexistslbetweenltheltwolcompanies.lAlthoughlthelabilityltolexerciselsignificantlinfluencel
overloperatinglandlfinanciallpolicieslappearsltolbelalratherlvaguelcriterion,lASCl323l"Investments—
EquitylMethodlandlJointlVentures,"lclearlylspecifieslactualleventslthatlindicatelthisllevelloflauthorityl(p
aragraphl323-10-15-6):
Abilityltolexerciselthatlinfluencelmaylbelindicatedlinlseverallways,lsuchlaslrepresentationlonlthelboardl
ofldirectors,lparticipationlinlpolicy-makinglprocesses,lmateriallintra-
entityltransactions,linterchangeloflmanageriallpersonnel,lorltechnologicalldependency.lAnotherlimpo
rtantlconsiderationlislthelextentloflownershiplbylanlinvestorlinlrelationltolthelconcentrationloflotherlshar
eholdings,lbutlsubstantiallorlmajoritylownershiploflthelvotinglstockloflanlinvesteelcompanylbylanotherli
nvestorldoeslnotlnecessarilylprecludelthelabilityltolexerciselsignificantlinfluencelbylthelinvestor.
Inlthislcase,lthelaccountantslwouldlbelwiseltoldeterminelwhetherlDennislBostitchlorlanylotherlmemberl
oflthelHighlandlLaboratoriesladministrationlislparticipatinglinlthelmanagementloflAbraham,lInc.lIflanyli
ndividuallfromlHighland'slorganizationlislonlAbraham’slboardlofldirectorslorlislparticipatinglinlmanage
mentldecisions,lthelequitylmethodlwouldlseemltolbelappropriate.
Likewise,liflsignificantltransactionslhaveloccurredlbetweenlthelcompaniesl(suchlaslloanslbylHighlandlt
olAbraham),lthelabilityltolapplylsignificantlinfluencelbecomeslmuchlmorelevident.
However,liflJameslAbrahamlcontinuesltoloperatelAbraham,lInc.,lwithllittlelorlnolregardlforlHighland,lth
elequitylmethodlshouldlnotlbelapplied.lThislpossibilitylseemslespeciallyllikelylinlthislcaselsincelonelsto
ckholder,lJameslAbraham,lcontinuesltolholdlalmajorityl(2/3)loflthelvotinglstock.lThus,levidenceloflthela
bilityltolapplylsignificantlinfluencelmustlbelpresentlbeforelthelequitylmethodlislviewedlaslapplicable.lTh
elmerelholdinglofl1/3loflthelstocklislnotlconclusive.
1-4
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
mynursytest.store
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
CHAPTER1 T l l
HE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
l l l l l l
ChapterlOutline
I. Fourlmethodslarelprincipallylusedltolaccountlforlanlinvestmentlinlequitylsecuritieslalonglwithl
alfairlvalueloption.
A. Fairlvaluelmethod:lappliedlbylanlinvestorlwhenlonlylalsmalllpercentageloflalcom
pany’slvotinglstocklislheld.
1. Thelinvestorlrecognizeslincomelwhenlthelinvesteeldeclareslaldividend.
2. Portfolioslarelreportedlatlfairlvalue.lIflfairlvalueslarelunavailable,linvestmentlislrepo
rtedlatlcost.
B. CostlMethod:lappliedltolinvestmentslwithoutlalreadilyldeterminablelfairlvalue.lWhenlthelfa
irlvalueloflanlinvestmentlinlequitylsecuritieslislnotlreadilyldeterminable,landlthelinvestment
lprovideslneitherlsignificantlinfluencelnorlcontrol,lthelinvestmentlmaylbelmeasuredlatlcost
.lThelinvestmentlremainslatlcostlunless
1. Aldemonstrablelimpairmentloccurslforlthelinvestment,lor
2. Anlobservablelpricelchangeloccurslforlidenticallorlsimilarlinvestmentsloflthelsamelissu
er.
Thelinvestorltypicallylrecognizeslitslshareloflinvesteeldividendsldeclaredlasldividendlincome.
C. Consolidation:lwhenlonelfirmlcontrolslanotherl(e.g.,lwhenlalparentlhaslalmajoritylintere
stlinlthelvotinglstockloflalsubsidiarylorlcontrollthroughlvariablelinterests,ltheirlfinanciallst
atementslarelconsolidatedlandlreportedlforlthelcombinedlentity.
D. Equitylmethod:lappliedlwhenlthelinvestorlhaslthelabilityltolexerciselsignificantlinflu
enceloverloperatinglandlfinanciallpoliciesloflthelinvestee.
1. Abilityltolsignificantlylinfluencelinvesteelislindicatedlbylseverallfactorslincludinglrepr
esentationlonlthelboardlofldirectors,lparticipationlinlpolicy-making,letc.
2. GAAPlguidelineslpresumelthelequitylmethodlislapplicablelifl20ltol50lpercentlofltheloutst
andinglvotinglstockloflthelinvesteelislheldlbylthelinvestor.
Currentlfinanciallreportinglstandardslallowlfirmsltolelectltoluselfairlvaluelforlanylnewlinvestmen
tlinlequitylshareslincludinglthoselwherelthelequitylmethodlwouldlotherwiselapply.lHowever,lthel
option,lonceltaken,lislirrevocable.lThelinvestorlrecognizeslbothlinvesteeldividendslandlchang
eslinlfairlvalueloverltimelaslincome.
1-1
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
mynursytest.store
,ACCESS Test Bank for Fundamentals of Advanced Accounting 9th Edition Hoyle
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
II. Accountinglforlanlinvestment:lthelequitylmethod
A. Thelinvestorladjustslthelinvestmentlaccountltolreflectlalllchangeslinlthelequityloflthelinves
teelcompany.
B. Thelinvestorlaccrueslinvesteelincomelwhenlitlislreportedlinlthelinvestee’slfinanciallstate
ments.
C. DividendsldeclaredlbylthelinvesteelcreatelalreductionlinlthelcarryinglamountloflthelInvest
mentlaccount.lThislbooklassumeslalllinvesteeldividendslareldeclaredlandlpaidlinlthelsam
elreportinglperiod.
III. Speciallaccountinglprocedureslusedlinlthelapplicationloflthelequitylmethod
A. Reportinglalchangeltolthelequitylmethodlwhenlthelabilityltolsignificantlylinfluencelanlinves
teelislachievedlthroughlalseriesloflacquisitions.
1. Initiallpurchase(s)lwilllbelaccountedlforlbylmeansloflthelfairlvaluelmethodl(orlatlcost)l
untillthelabilityltolsignificantlylinfluencelislattained.
2. Whenlthelabilityltolexerciselsignificantlinfluenceloccurslfollowinglalseriesloflstocklpurc
hases,lthelinvestorlapplieslthelequitylmethodlprospectively.lTheltotallfairlvaluelatltheld
atelsignificantlinfluencelislattainedlislcomparedltolthelinvestee’slbooklvalueltoldetermi
nelfuturelexcesslfairlvaluelamortizations.
B. Investeelincomelfromlotherlthanlcontinuingloperations
1. Thelinvestorlrecognizeslitslshareloflinvesteelreportedlotherlcomprehensivelinc
omel(OCI)lthroughlthelinvestmentlaccountlandlthelinvestor’slownlOCI.
2. Incomelitemslsuchlasldiscontinuedloperationslthatlarelreportedlseparatelylbylthelinve
steelshouldlbelshownlinlthelsamelmannerlbylthelinvestor.lThelmaterialitylofltheselothe
rlinvesteelincomelelementsl(aslitlaffectslthelinvestor)lcontinuesltolbelalcriterionlforlsep
arateldisclosure.
C. Investeellosses
1. Losseslreportedlbylthelinvesteelcreatelcorrespondingllosseslforlthelinvestor.
2. Alpermanentldeclinelinlthelfairlvalueloflanlinvestee’slstocklshouldlbelrecognizedlimm
ediatelylbylthelinvestorlaslanlimpairmentlloss.
3. Investeellosseslcanlpossiblylreducelthelcarryinglvalueloflthelinvestmentlaccountltolalz
erolbalance.lAtlthatlpoint,lthelequitylmethodlceasesltolbelapplicablelandlthelfair-
valuelmethodlislsubsequentlylused.
D. Reportinglthelsaleloflanlequitylinvestment
1. Thelinvestorlapplieslthelequitylmethodluntilltheldisposalldateltolestablishlalproperlbookl
value.
2. Followinglthelsale,lthelequitylmethodlcontinuesltolbelappropriateliflenoughlshareslarels
tilllheldltolmaintainlthelinvestor’slabilityltolsignificantlylinfluencelthelinvestee.lIflthatlabili
tylhaslbeenllost,lthelfair-valuelmethodlislsubsequentlylused.
IV. Excesslinvestmentlcostloverlbooklvaluelacquired
A. Thelpricelanlinvestorlpayslforlequitylsecuritiesloftenldifferslsignificantlylfromlthelinve
stee’slunderlyinglbooklvaluelprimarilylbecauselthelhistoricallcostlbasedlaccountingl
modelldoeslnotlkeepltrackloflchangeslinlalfirm’slfairlvalue.
B. Paymentslmadelinlexcessloflunderlyinglbooklvaluelcanlsometimeslbelidentifiedlwithlspec
ificlinvesteelaccountslsuchlaslinventorylorlequipment.
C. Anlextralacquisitionlpricelcanlalsolbelassignedltolanticipatedlbenefitslthatlarelexpectedlt
olbelderivedlfromlthelinvestment.lInlaccounting,ltheselamountslarelpresumedltolreflectla
nlintangiblelassetlreferredltolaslgoodwill.lGoodwilllislcalculated
1-2
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
mynursytest.store
,ACCESS Test Bank for Fundamentals of Advanced Accounting 9th Edition Hoyle
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
aslanylexcesslpaymentlthatlislnotlattributableltolspecificlidentifiablelassetslandlliabilitiesloflt
helinvestee.lBecauselgoodwilllislanlindefinite-livedlasset,litlislnotlamortized.
V. Deferralloflintra-entitylgrosslprofitlinlinventory
A. Thelinvestor’slshareloflintra-
entitylprofitslinlendinglinventorylarelnotlrecognizedluntilltheltransferredlgoodslareleitherlco
nsumedlorluntilltheylarelresoldltolunrelatedlparties.
B. Downstreamlsalesloflinventory
1. “Downstream”lrefersltoltransferslmadelbylthelinvestorltolthelinvestee.
2. Intra-
entitylgrosslprofitslfromlsaleslarelinitiallyldeferredlunderlthelequitylmethodlandlthenlr
ecognizedlaslincomelatltheltimeloflthelinventory’sleventualldisposal.
3. Thelamountloflgrosslprofitltolbeldeferredlislthelinvestor’slownershiplpercentagelmulti
pliedlbylthelmarkuplonlthelmerchandiselremaininglatlthelendloflthelyear.
C. Upstreamlsalesloflinventory
1. “Upstream”lrefersltoltransferslmadelbylthelinvesteeltolthelinvestor.
2. Underlthelequitylmethod,ltheldeferrallprocesslforlintra-
entitylgrosslprofitslislidenticallforlupstreamlandldownstreamltransfers.lThelprocedure
slarelseparatelylidentifiedlinlChapterlOnelbecauselthelhandlingldoeslvarylwithinlthelco
nsolidationlprocess.
AnswersltolDiscussionlQuestions
Theltextbooklincludesldiscussionlquestionsltolstimulatelstudentlthoughtlandldiscussion.lTheselquesti
onslarelalsoldesignedltolallowlstudentsltolconsiderlrelevantlissueslthatlmightlotherwiselbeloverlooked.l
Somelofltheselquestionslmaylbeladdressedlbylthelinstructorlinlclassltolmotivatelstudentldiscussion.lSt
udentslshouldlbelencouragedltolbeginlbyldefininglthelissue(s)linleachlcase.lNext,lauthoritativelaccoun
tinglliteraturel(FASBlASC)lorlotherlrelevantlliteraturelcanlbelconsultedlaslalpreliminarylsteplinlarrivingl
atllogicallactions.lFrequently,lthelFASBlAccountinglStandardslCodificationlwilllprovidelthelnecessaryl
support.
Unfortunately,linlaccounting,ldefinitivelresolutionsltolfinanciallreportinglquestionslarelnotlalwayslavail
able.lStudentsloftenlseemltolbelievelthatlalllaccountinglissueslhavelbeenlresolvedlinlthelpastlsolthatlac
countingleducationlislonlylalmatterlofllearningltolapplylhistoricallylprescribedlprocedures.lHowever,linl
actuallpractice,lthelonlylreallanswerlisloftenlthelonelthatlprovideslthelfairestlrepresentationloflthelfirm’sl
transactions.lIflanlauthoritativelsolutionlislnotlavailable,lstudentslshouldlbeldirectedltollistlallloflthelissu
eslinvolvedlandlthelconsequencesloflpossiblelalternativelactions.lThelvariouslfactorslpresentedlcanlb
elweighedltolproducelalviablelsolution.
Theldiscussionlquestionslareldesignedltolhelplstudentsldeveloplresearchlandlcriticallthinkinglskillslinla
ddressinglissueslthatlgolbeyondlthelpurelylmechanicallelementsloflaccounting.
DidlthelCostlMethodlInvitelManipulation?
Thelcostlmethodloflaccountinglforlinvestmentsloftenlcausedlallackloflobjectivitylinlreportedlincomelfigu
res.lWithlallargelblockloflthelinvestee’slvotinglshares,lanlinvestorlcouldlinfluencelthelamountlandltimingl
oflthelinvestee’sldividendldeclarations.lThus,lwhenlenjoyinglalgoodlearningslyear,lanlinvestorlmightlin
fluencelthelinvesteeltolwithholdldeclaringlaldividendluntillneededlinlalsubsequentlyear.lAlternatively,lifl
thelinvestorljudgedlthatlitslcurrentlyearlearningsl“neededlalboost,”litlmightlinfluencelthelinvesteeltoldec
larelalcurrentlyearldividend.lThelequitylmethodleffectivelylremoveslmanagers’labilityltolincreaselcurre
ntlincomel(orldeferlincomeltolfuturelperiods)lthroughltheirlinfluenceloverltheltiminglandlamountsloflinve
steeldividendldeclarations.
1-3
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
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, ACCESS Test Bank for Fundamentals of Advanced Accounting 9th Edition Hoyle
l l l l l l l l l l
Chapterl01l-lThelEquitylMethodloflAccountinglforlInvestmentsl–
lHoyle,lSchaefer,lDoupnik,lFundamentalsloflAdvancedlAccounting,l9/e
Atlfirstlglancelitlmaylseemlthatlthelfairlvaluelmethodlallowslmanagersltolmanipulatelincomelbecauselin
vesteeldividendslarelrecordedlaslincomelbylthelinvestor.lHowever,ldividendslpaidltypicallylarelaccom
paniedlbylaldecreaselinlfairlvaluel(alsolrecognizedlinlincome),lthuslleavinglreportedlnetlincomelunaffec
ted.
DoeslthelEquitylMethodlReallylApplylHere?
Theldiscussionlinlthelcaselbetweenltheltwolaccountantslisllimitedltolthelreasonlforlthelinvestmentlacqu
isitionlandlthelcurrentlpercentageloflownership.lInstead,ltheylshouldlbelexamininglthelactuallinteractio
nlthatlcurrentlylexistslbetweenltheltwolcompanies.lAlthoughlthelabilityltolexerciselsignificantlinfluencel
overloperatinglandlfinanciallpolicieslappearsltolbelalratherlvaguelcriterion,lASCl323l"Investments—
EquitylMethodlandlJointlVentures,"lclearlylspecifieslactualleventslthatlindicatelthisllevelloflauthorityl(p
aragraphl323-10-15-6):
Abilityltolexerciselthatlinfluencelmaylbelindicatedlinlseverallways,lsuchlaslrepresentationlonlthelboardl
ofldirectors,lparticipationlinlpolicy-makinglprocesses,lmateriallintra-
entityltransactions,linterchangeloflmanageriallpersonnel,lorltechnologicalldependency.lAnotherlimpo
rtantlconsiderationlislthelextentloflownershiplbylanlinvestorlinlrelationltolthelconcentrationloflotherlshar
eholdings,lbutlsubstantiallorlmajoritylownershiploflthelvotinglstockloflanlinvesteelcompanylbylanotherli
nvestorldoeslnotlnecessarilylprecludelthelabilityltolexerciselsignificantlinfluencelbylthelinvestor.
Inlthislcase,lthelaccountantslwouldlbelwiseltoldeterminelwhetherlDennislBostitchlorlanylotherlmemberl
oflthelHighlandlLaboratoriesladministrationlislparticipatinglinlthelmanagementloflAbraham,lInc.lIflanyli
ndividuallfromlHighland'slorganizationlislonlAbraham’slboardlofldirectorslorlislparticipatinglinlmanage
mentldecisions,lthelequitylmethodlwouldlseemltolbelappropriate.
Likewise,liflsignificantltransactionslhaveloccurredlbetweenlthelcompaniesl(suchlaslloanslbylHighlandlt
olAbraham),lthelabilityltolapplylsignificantlinfluencelbecomeslmuchlmorelevident.
However,liflJameslAbrahamlcontinuesltoloperatelAbraham,lInc.,lwithllittlelorlnolregardlforlHighland,lth
elequitylmethodlshouldlnotlbelapplied.lThislpossibilitylseemslespeciallyllikelylinlthislcaselsincelonelsto
ckholder,lJameslAbraham,lcontinuesltolholdlalmajorityl(2/3)loflthelvotinglstock.lThus,levidenceloflthela
bilityltolapplylsignificantlinfluencelmustlbelpresentlbeforelthelequitylmethodlislviewedlaslapplicable.lTh
elmerelholdinglofl1/3loflthelstocklislnotlconclusive.
1-4
©lMcGrawlHilllLLC.lAlllrightslreserved.lNolreproductionlorldistributionlwithoutlthelpriorlwrittenlconsentloflMcGrawlHilllLLC.
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