SOLUTIONS MANUAL for Advanced Accounting, 15th Edition by Joe Ben Hoyle, Schaefer and Doupnik | Complete 19 Chapters

Solution Manual For All Chapters
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SOLUTION MANUAL FOR l l




ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS
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SCHAEFER AND TIMOTHY DOUPNIK
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CHAPTER 1-19 l




CHAPTER1 l




THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
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Chapter Outline l




I. Four methods are principally used to account for an investment in equity securities along
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with a fair value option.
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A. Fair value method: applied by an investor when only a small percentage of a
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company‘s voting stock is held.
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1. The investor recognizes income when the investee declares a dividend.
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2. Portfolios are reported at fair value. If fair values are unavailable, investment is l l l l l l l l l l l l


reported at cost. l l l




B. Cost Method: applied to investments without a readily determinable fair value. When
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the fair value of an investment in equity securities is not readily determinable, and the
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investment provides neither significant influence nor control, the investment may be
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measured at cost. The investment remains at cost unless
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1. A demonstrable impairment occurs for the investment, or
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2. An observable price change occurs for identical or similar investments of the same
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issuer. l




The investor typically recognizes its share of investee dividends declared as dividend
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income.
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C. Consolidation: when one firm controls another (e.g., when a parent has a majority l l l l l l l l l l l l


interest in the voting stock of a subsidiary or control through variable interests, their
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financial statements are consolidated and reported for the combined entity.
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D. Equity method: applied when the investor has the ability to exercise significant
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influence over operating and financial policies of the investee.
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1. Ability to significantly influence investee is indicated by several factors including
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representation on the board of directors, participation in policy-making, etc.
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2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
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, outstanding voting stock of the investee is held by the investor. l l l l l l l l l l




Current financial reporting standards allow firms to elect to use fair value for any new
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investment in equity shares including those where the equity method would otherwise apply.
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However, the option, once taken, is irrevocable. The investor recognizes both investee
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dividends and changes in fair value over time as income.
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II. Accounting for an investment: the equity method
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A. The investor adjusts the investment account to reflect all changes in the equity of the
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investee company.
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B. The investor accrues investee income when it is reported in the investee‘s financial
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statements.
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C. Dividends declared by the investee create a reduction in the carrying amount of the
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Investment account. This book assumes all investee dividends are declared and paid in
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the same reporting period.
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III. Special accounting procedures used in the application of the equity method
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A. Reporting a change to the equity method when the ability to significantly influence an
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investee is achieved through a series of acquisitions.
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1. Initial purchase(s) will be accounted for by means of the fair value method (or at
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cost) until the ability to significantly influence is attained.
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2. When the ability to exercise significant influence occurs following a series of stock
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purchases, the investor applies the equity method prospectively. The total fair value
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at the date significant influence is attained is compared to the investee‘s book value
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to determine future excess fair value amortizations.
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B. Investee income from other than continuing operations
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1. The investor recognizes its share of investee reported other comprehensive
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income (OCI) through the investment account and the investor‘s own OCI.
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2. Income items such as discontinued operations that are reported separately by the l l l l l l l l l l l


investee should be shown in the same manner by the investor. The materiality of
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these other investee income elements (as it affects the investor) continues to be a
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criterion for separate disclosure.
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C. Investee losses l


1. Losses reported by the investee create corresponding losses for the investor.
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2. A permanent decline in the fair value of an investee‘s stock should be recognized
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immediately by the investor as an impairment loss.
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3. Investee losses can possibly reduce the carrying value of the investment account to l l l l l l l l l l l l


a zero balance. At that point, the equity method ceases to be applicable and the fair-
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value method is subsequently used. l l l l


D. Reporting the sale of an equity investment l l l l l l


1. The investor applies the equity method until the disposal date to establish a proper
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book value.
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2. Following the sale, the equity method continues to be appropriate if enough shares l l l l l l l l l l l l


are still held to maintain the investor‘s ability to significantly influence the investee. If
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that ability has been lost, the fair-value method is subsequently used.
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,Solution Manual For All Chapters
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IV. Excess investment cost over book value acquired l l l l l l


A. The price an investor pays for equity securities often differs significantly from the
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investee‘s underlying book value primarily because the historical cost based
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accounting model does not keep track of changes in a firm‘s fair value.
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B. Payments made in excess of underlying book value can sometimes be identified with l l l l l l l l l l l l


specific investee accounts such as inventory or equipment.
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C. An extra acquisition price can also be assigned to anticipated benefits that are
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expected to be derived from the investment. In accounting, these amounts are
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presumed to reflect an intangible asset referred to as goodwill. Goodwill is calculated as
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any excess payment that is not attributable to specific identifiable assets and liabilities
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of the investee. Because goodwill is an indefinite-lived asset, it is not amortized.
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V. Deferral of intra-entity gross profit in inventory l l l l l l


A. The investor‘s share of intra-entity profits in ending inventory are not recognized until the
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transferred goods are either consumed or until they are resold to unrelated parties.
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B. Downstream sales of inventory l l l


1. ―Downstream‖ refers to transfers made by the investor to the investee. l l l l l l l l l l


2. Intra-entity gross profits from sales are initially deferred under the equity method l l l l l l l l l l l


and then recognized as income at the time of the inventory‘s eventual disposal.
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3. The amount of gross profit to be deferred is the investor‘s ownership percentage l l l l l l l l l l l l


multiplied by the markup on the merchandise remaining at the end of the year.
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C. Upstream sales of inventory l l l


1. ―Upstream‖ refers to transfers made by the investee to the investor. l l l l l l l l l l


2. Under the equity method, the deferral process for intra-entity gross profits is l l l l l l l l l l l


identical for upstream and downstream transfers. The procedures are separately
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identified in Chapter One because the handling does vary within the consolidation
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process. l




Answers to Discussion Questions l l l




The textbook includes discussion questions to stimulate student thought and discussion. These
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questions are also designed to allow students to consider relevant issues that might otherwise be
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overlooked. Some of these questions may be addressed by the instructor in class to motivate
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student discussion. Students should be encouraged to begin by defining the issue(s) in each case.
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Next, authoritative accounting literature (FASB ASC) or other relevant literature can be consulted
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as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting Standards
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Codification will provide the necessary support.
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Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
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available. Students often seem to believe that all accounting issues have been resolved in the past
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so that accounting education is only a matter of learning to apply historically prescribed procedures.
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However, in actual practice, the only real answer is often the one that provides the fairest
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representation of the firm‘s transactions. If an authoritative solution is not available, students should
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be directed to list all of the issues involved and the consequences of possible alternative actions.
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The various factors presented can be weighed to produce a viable solution.
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The discussion questions are designed to help students develop research and critical thinking skills
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in addressing issues that go beyond the purely mechanical elements of accounting.
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, Did the Cost Method Invite Manipulation?
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The cost method of accounting for investments often caused a lack of objectivity in reported income
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figures. With a large block of the investee‘s voting shares, an investor could influence the amount
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and timing of the investee‘s dividend declarations. Thus, when enjoying a good earnings year, an
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investor might influence the investee to withhold declaring a dividend until needed in a subsequent
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year. Alternatively, if the investor judged that its current year earnings ―needed a boost,‖ it might
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influence the investee to declare a current year dividend. The equity method effectively removes
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managers‘ ability to increase current income (or defer income to future periods) through their
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influence over the timing and amounts of investee dividend declarations.
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At first glance it may seem that the fair value method allows managers to manipulate income
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because investee dividends are recorded as income by the investor. However, dividends paid
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typically are accompanied by a decrease in fair value (also recognized in income), thus leaving
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reported net income unaffected.
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Does the Equity Method Really Apply Here?
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The discussion in the case between the two accountants is limited to the reason for the investment
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acquisition and the current percentage of ownership. Instead, they should be examining the actual
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interaction that currently exists between the two companies. Although the ability to exercise
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significant influence over operating and financial policies appears to be a rather vague criterion,
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ASC 323 "Investments—Equity Method and Joint Ventures," clearly specifies actual events that
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indicate this level of authority (paragraph 323-10-15-6):
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Ability to exercise that influence may be indicated in several ways, such as representation on the
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board of directors, participation in policy-making processes, material intra-entity transactions,
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interchange of managerial personnel, or technological dependency. Another important
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consideration is the extent of ownership by an investor in relation to the concentration of other
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shareholdings, but substantial or majority ownership of the voting stock of an investee company by
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another investor does not necessarily preclude the ability to exercise significant influence by the
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investor.
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In this case, the accountants would be wise to determine whether Dennis Bostitch or any other
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member of the Highland Laboratories administration is participating in the management of
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Abraham, Inc. If any individual from Highland's organization is on Abraham‘s board of directors or is
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participating in management decisions, the equity method would seem to be appropriate.
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Likewise, if significant transactions have occurred between the companies (such as loans by
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Highland to Abraham), the ability to apply significant influence becomes much more evident.
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However, if James Abraham continues to operate Abraham, Inc., with little or no regard for Highland,
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the equity method should not be applied. This possibility seems especially likely in this case since
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one stockholder, James Abraham, continues to hold a majority (2/3) of the voting stock. Thus,
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evidence of the ability to apply significant influence must be present before the equity method is
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viewed as applicable. The mere holding of 1/3 of the stock is not conclusive.
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