Solution Manual For All Chapters
f f f f
SOLUTION MANUAL FOR f f
ADVANCED ACCOUNTING 15TH EDITION BYJOE BEN HOYLE, THOMAS SCHAEFER f f f f f f f f f
AND TIMOTHY DOUPNIK
f f f
CHAPTER1-19 f
CHAPTER1 f
THEEQUITYMETHODOFACCOUNTINGFORINVESTMENTS
f f f f f f f
Chapter Outline f
I. Four methods are principally used to account for an investment in equity securities along with
f f f f f f f f f f f f f f
a fair value option.
f f f f
A. Fair value method: applied by an investor when only a small percentage of a
f f f f f f f f f f f f f
company‘s voting stock is held.
f f f f f
1. The investor recognizes income when the investee declares a dividend.
f f f f f f f f f
2. Portfolios are reported at fair value. If fair values are unavailable, investment is f f f f f f f f f f f f
reported at cost. f f f
B. Cost Method: applied to investments without a readily determinable fair value. When the
f f f f f f f f f f f f
fair value of an investment in equity securities is not readily determinable, and the
f f f f f f f f f f f f f f
investment provides neither significant influence nor control, the investment may be
f f f f f f f f f f f
measured at cost. The investment remains at cost unless
f f f f f f f f f
1. A demonstrable impairment occurs for the investment, or
f f f f f f f
2. An observable price change occurs for identical or similar investments of the same
f f f f f f f f f f f f
issuer. f
The investor typically recognizes its share of investee dividends declared as dividend
f f f f f f f f f f f
income.
f
C. Consolidation: when one firm controls another (e.g., when a parent has a majority f f f f f f f f f f f f
interest in the voting stock of a subsidiary or control through variable interests, their
f f f f f f f f f f f f f f
financial statements are consolidated and reported for the combined entity.
f f f f f f f f f f
D. Equity method: applied when the investor has the ability to exercise significant
f f f f f f f f f f f
influence over operating and financial policies of the investee.
f f f f f f f f f
1. Ability to significantly influence investee is indicated by several factors includingf f f f f f f f f f
representation on the board of directors, participation in policy-making, etc.
f f f f f f f f f f
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the f f f f f f f f f f f f f f
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
, outstanding voting stock of the investee is held by the investor. f f f f f f f f f f
Current financial reporting standards allow firms to elect to use fair value for any new
f f f f f f f f f f f f f f
investment in equity shares including those where the equity method would otherwise apply.
f f f f f f f f f f f f f
However, the option, once taken, is irrevocable. The investor recognizes both investee
f f f f f f f f f f f f
dividends and changes in fair value over time as income.
f f f f f f f f f f
II. Accounting for an investment: the equity method f f f f f f
A. The investor adjusts the investment account to reflect all changes in the equity of the
f f f f f f f f f f f f f f
investee company.
f f
B. The investor accrues investee income when it is reported in the investee‘s financial
f f f f f f f f f f f f
statements.
f
C. Dividends declared by the investee create a reduction in the carrying amount of the f f f f f f f f f f f f f
Investment account. This book assumes all investee dividends are declared and paid in
f f f f f f f f f f f f f
the same reporting period.
f f f f
III. Special accounting procedures used in the application of the equity method
f f f f f f f f f f
A. Reporting a change to the equity method when the ability to significantly influence an
f f f f f f f f f f f f f
investee is achieved through a series of acquisitions.
f f f f f f f f
1. Initial purchase(s) will be accounted for by means of the fair value method (or at cost)
f f f f f f f f f f f f f f f
until the ability to significantly influence is attained.
f f f f f f f f
2. When the ability to exercise significant influence occurs following a series of stock
f f f f f f f f f f f f
purchases, the investor applies the equity method prospectively. The total fair value at
f f f f f f f f f f f f f
the date significant influence is attained is compared to the investee‘s book value to
f f f f f f f f f f f f f f
determine future excess fair value amortizations.
f f f f f f
B. Investee income from other than continuing operations f f f f f f
1. The investor recognizes its share of investee reported other comprehensive
f f f f f f f f f
income (OCI) through the investment account and the investor‘s own OCI.
f f f f f f f f f f f
2. Income items such as discontinued operations that are reported separately by the f f f f f f f f f f f
investee should be shown in the same manner by the investor. The materiality of these
f f f f f f f f f f f f f f f
other investee income elements (as it affects the investor) continues to be a criterion for
f f f f f f f f f f f f f f f
separate disclosure.
f f
C. Investee losses f
1. Losses reported by the investee create corresponding losses for the investor. f f f f f f f f f f
2. A permanent decline in the fair value of an investee‘s stock should be recognized
f f f f f f f f f f f f f
immediately by the investor as an impairment loss.
f f f f f f f f
3. Investee losses can possibly reduce the carrying value of the investment account to a f f f f f f f f f f f f f
zero balance. At that point, the equity method ceases to be applicable and the fair-value
f f f f f f f f f f f f f f f
method is subsequently used.
f f f f
D. Reporting the sale of an equity investment f f f f f f
1. The investor applies the equity method until the disposal date to establish a proper book
f f f f f f f f f f f f f f
value. f
2. Following the sale, the equity method continues to be appropriate if enough shares are f f f f f f f f f f f f f
still held to maintain the investor‘s ability to significantly influence the investee. If that
f f f f f f f f f f f f f f
ability has been lost, the fair-value method is subsequently used.
f f f f f f f f f f
2-24
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
,Solution Manual For All Chapters
f f f f
IV. Excess investment cost over book value acquired f f f f f f
A. The price an investor pays for equity securities often differs significantly from thef f f f f f f f f f f f
investee‘s underlying book value primarily because the historical cost based
f f f f f f f f f f
accounting model does not keep track of changes in a firm‘s fair value.
f f f f f f f f f f f f f
B. Payments made in excess of underlying book value can sometimes be identified with f f f f f f f f f f f f
specific investee accounts such as inventory or equipment.
f f f f f f f f
C. An extra acquisition price can also be assigned to anticipated benefits that are expected
f f f f f f f f f f f f f
to be derived from the investment. In accounting, these amounts are presumed to reflect
f f f f f f f f f f f f f f
an intangible asset referred to as goodwill. Goodwill is calculated as any excess payment
f f f f f f f f f f f f f f
that is not attributable to specific identifiable assets and liabilities of the investee.
f f f f f f f f f f f f f
Because goodwill is an indefinite-lived asset, it is not amortized.
f f f f f f f f f f
V. Deferral of intra-entity gross profit in inventory f f f f f f
A. The investor‘s share of intra-entity profits in ending inventory are not recognized until the
f f f f f f f f f f f f f
transferred goods are either consumed or until they are resold to unrelated parties.
f f f f f f f f f f f f f
B. Downstream sales of inventory f f f
1. ―Downstream‖ refers to transfers made by the investor to the investee. f f f f f f f f f f
2. Intra-entity gross profits from sales are initially deferred under the equity method and f f f f f f f f f f f f
then recognized as income at the time of the inventory‘s eventual disposal. f f f f f f f f f f f f
3. The amount of gross profit to be deferred is the investor‘s ownership percentage f f f f f f f f f f f f
multiplied by the markup on the merchandise remaining at the end of the year.f f f f f f f f f f f f f f
C. Upstream sales of inventory f f f
1. ―Upstream‖ refers to transfers made by the investee to the investor. f f f f f f f f f f
2. Under the equity method, the deferral process for intra-entity gross profits is identical f f f f f f f f f f f f
for upstream and downstream transfers. The procedures are separately identified in
f f f f f f f f f f f
Chapter One because the handling does vary within the consolidation process. f f f f f f f f f f f
Answers to Discussion Questions
f f f
The textbook includes discussion questions to stimulate student thought and discussion. These
f f f f f f f f f f f
questions are also designed to allow students to consider relevant issues that might otherwise be
f f f f f f f f f f f f f f f
overlooked. Some of these questions may be addressed by the instructor in class to motivate student
f f f f f f f f f f f f f f f f
discussion. Students should be encouraged to begin by defining the issue(s) in each case. Next,
f f f f f f f f f f f f f f f
authoritative accounting literature (FASB ASC) or other relevant literature can be consulted as a
f f f f f f f f f f f f f f
preliminary step in arriving at logical actions. Frequently, the FASB Accounting Standards
f f f f f f f f f f f f
Codification will provide the necessary support.
f f f f f f
Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
f f f f f f f f f f f
available. Students often seem to believe that all accounting issues have been resolved in the past so
f f f f f f f f f f f f f f f f f
that accounting education is only a matter of learning to apply historically prescribed procedures.
f f f f f f f f f f f f f f
However, in actual practice, the only real answer is often the one that provides the fairest
f f f f f f f f f f f f f f f f
representation of the firm‘s transactions. If an authoritative solution is not available, students should be
f f f f f f f f f f f f f f f
directed to list all of the issues involved and the consequences of possible alternative actions. The
f f f f f f f f f f f f f f f f
various factors presented can be weighed to produce a viable solution.
f f f f f f f f f f f
The discussion questions are designed to help students develop research and critical thinking skills in
f f f f f f f f f f f f f f
addressing issues that go beyond the purely mechanical elements of accounting.
f f f f f f f f f f f
2-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
, Did the Cost Method Invite Manipulation?
f f f f f
The cost method of accounting for investments often caused a lack of objectivity in reported income
f f f f f f f f f f f f f f f
figures. With a large block of the investee‘s voting shares, an investor could influence the amount and
f f f f f f f f f f f f f f f f f
timing of the investee‘s dividend declarations. Thus, when enjoying a good earnings year, an investor
f f f f f f f f f f f f f f f
might influence the investee to withhold declaring a dividend until needed in a subsequent year.
f f f f f f f f f f f f f f f
Alternatively, if the investor judged that its current year earnings ―needed a boost,‖ it might influence
f f f f f f f f f f f f f f f f
the investee to declare a current year dividend. The equity method effectively removes managers‘
f f f f f f f f f f f f f f
ability to increase current income (or defer income to future periods) through their influence over the
f f f f f f f f f f f f f f f f
timing and amounts of investee dividend declarations.
f f f f f f f
At first glance it may seem that the fair value method allows managers to manipulate income because
f f f f f f f f f f f f f f f f
investee dividends are recorded as income by the investor. However, dividends paid typically are
f f f f f f f f f f f f f f
accompanied by a decrease in fair value (also recognized in income), thus leaving reported net income
f f f f f f f f f f f f f f f f
unaffected.
f
Does the Equity Method Really Apply Here?
f f f f f f
The discussion in the case between the two accountants is limited to the reason for the investment
f f f f f f f f f f f f f f f f
acquisition and the current percentage of ownership. Instead, they should be examining the actual
f f f f f f f f f f f f f f
interaction that currently exists between the two companies. Although the ability to exercise significant
f f f f f f f f f f f f f f
influence over operating and financial policies appears to be a rather vague criterion, ASC 323
f f f f f f f f f f f f f f f
"Investments—Equity Method and Joint Ventures," clearly specifies actual events that indicate this
f f f f f f f f f f f f
level of authority (paragraph 323-10-15-6):
f f f f f
Ability to exercise that influence may be indicated in several ways, such as representation on the board
f f f f f f f f f f f f f f f f
of directors, participation in policy-making processes, material intra-entity transactions, interchange
f f f f f f f f f f
of managerial personnel, or technological dependency. Another important consideration is the extent
f f f f f f f f f f f f
of ownership by an investor in relation to the concentration of other shareholdings, but substantial or
f f f f f f f f f f f f f f f f
majority ownership of the voting stock of an investee company by another investor does not
f f f f f f f f f f f f f f f
necessarily preclude the ability to exercise significant influence by the investor.
f f f f f f f f f f f
In this case, the accountants would be wise to determine whether Dennis Bostitch or any other member
f f f f f f f f f f f f f f f f
of the Highland Laboratories administration is participating in the management of Abraham, Inc. If any
f f f f f f f f f f f f f f f
individual from Highland's organization is on Abraham‘s board of directors or is participating in
f f f f f f f f f f f f f f
management decisions, the equity method would seem to be appropriate.
f f f f f f f f f f
Likewise, if significant transactions have occurred between the companies (such as loans by Highland
f f f f f f f f f f f f f
to Abraham), the ability to apply significant influence becomes much more evident.
f f f f f f f f f f f f
However, if James Abraham continues to operate Abraham, Inc., with little or no regard for Highland,
f f f f f f f f f f f f f f f
the equity method should not be applied. This possibility seems especially likely in this case since one
f f f f f f f f f f f f f f f f f
stockholder, James Abraham, continues to hold a majority (2/3) of the voting stock. Thus, evidence of
f f f f f f f f f f f f f f f f
the ability to apply significant influence must be present before the equity method is viewed as
f f f f f f f f f f f f f f f f
applicable. The mere holding of 1/3 of the stock is not conclusive.
f f f f f f f f f f f f
2-44
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
f f f f
SOLUTION MANUAL FOR f f
ADVANCED ACCOUNTING 15TH EDITION BYJOE BEN HOYLE, THOMAS SCHAEFER f f f f f f f f f
AND TIMOTHY DOUPNIK
f f f
CHAPTER1-19 f
CHAPTER1 f
THEEQUITYMETHODOFACCOUNTINGFORINVESTMENTS
f f f f f f f
Chapter Outline f
I. Four methods are principally used to account for an investment in equity securities along with
f f f f f f f f f f f f f f
a fair value option.
f f f f
A. Fair value method: applied by an investor when only a small percentage of a
f f f f f f f f f f f f f
company‘s voting stock is held.
f f f f f
1. The investor recognizes income when the investee declares a dividend.
f f f f f f f f f
2. Portfolios are reported at fair value. If fair values are unavailable, investment is f f f f f f f f f f f f
reported at cost. f f f
B. Cost Method: applied to investments without a readily determinable fair value. When the
f f f f f f f f f f f f
fair value of an investment in equity securities is not readily determinable, and the
f f f f f f f f f f f f f f
investment provides neither significant influence nor control, the investment may be
f f f f f f f f f f f
measured at cost. The investment remains at cost unless
f f f f f f f f f
1. A demonstrable impairment occurs for the investment, or
f f f f f f f
2. An observable price change occurs for identical or similar investments of the same
f f f f f f f f f f f f
issuer. f
The investor typically recognizes its share of investee dividends declared as dividend
f f f f f f f f f f f
income.
f
C. Consolidation: when one firm controls another (e.g., when a parent has a majority f f f f f f f f f f f f
interest in the voting stock of a subsidiary or control through variable interests, their
f f f f f f f f f f f f f f
financial statements are consolidated and reported for the combined entity.
f f f f f f f f f f
D. Equity method: applied when the investor has the ability to exercise significant
f f f f f f f f f f f
influence over operating and financial policies of the investee.
f f f f f f f f f
1. Ability to significantly influence investee is indicated by several factors includingf f f f f f f f f f
representation on the board of directors, participation in policy-making, etc.
f f f f f f f f f f
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the f f f f f f f f f f f f f f
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
, outstanding voting stock of the investee is held by the investor. f f f f f f f f f f
Current financial reporting standards allow firms to elect to use fair value for any new
f f f f f f f f f f f f f f
investment in equity shares including those where the equity method would otherwise apply.
f f f f f f f f f f f f f
However, the option, once taken, is irrevocable. The investor recognizes both investee
f f f f f f f f f f f f
dividends and changes in fair value over time as income.
f f f f f f f f f f
II. Accounting for an investment: the equity method f f f f f f
A. The investor adjusts the investment account to reflect all changes in the equity of the
f f f f f f f f f f f f f f
investee company.
f f
B. The investor accrues investee income when it is reported in the investee‘s financial
f f f f f f f f f f f f
statements.
f
C. Dividends declared by the investee create a reduction in the carrying amount of the f f f f f f f f f f f f f
Investment account. This book assumes all investee dividends are declared and paid in
f f f f f f f f f f f f f
the same reporting period.
f f f f
III. Special accounting procedures used in the application of the equity method
f f f f f f f f f f
A. Reporting a change to the equity method when the ability to significantly influence an
f f f f f f f f f f f f f
investee is achieved through a series of acquisitions.
f f f f f f f f
1. Initial purchase(s) will be accounted for by means of the fair value method (or at cost)
f f f f f f f f f f f f f f f
until the ability to significantly influence is attained.
f f f f f f f f
2. When the ability to exercise significant influence occurs following a series of stock
f f f f f f f f f f f f
purchases, the investor applies the equity method prospectively. The total fair value at
f f f f f f f f f f f f f
the date significant influence is attained is compared to the investee‘s book value to
f f f f f f f f f f f f f f
determine future excess fair value amortizations.
f f f f f f
B. Investee income from other than continuing operations f f f f f f
1. The investor recognizes its share of investee reported other comprehensive
f f f f f f f f f
income (OCI) through the investment account and the investor‘s own OCI.
f f f f f f f f f f f
2. Income items such as discontinued operations that are reported separately by the f f f f f f f f f f f
investee should be shown in the same manner by the investor. The materiality of these
f f f f f f f f f f f f f f f
other investee income elements (as it affects the investor) continues to be a criterion for
f f f f f f f f f f f f f f f
separate disclosure.
f f
C. Investee losses f
1. Losses reported by the investee create corresponding losses for the investor. f f f f f f f f f f
2. A permanent decline in the fair value of an investee‘s stock should be recognized
f f f f f f f f f f f f f
immediately by the investor as an impairment loss.
f f f f f f f f
3. Investee losses can possibly reduce the carrying value of the investment account to a f f f f f f f f f f f f f
zero balance. At that point, the equity method ceases to be applicable and the fair-value
f f f f f f f f f f f f f f f
method is subsequently used.
f f f f
D. Reporting the sale of an equity investment f f f f f f
1. The investor applies the equity method until the disposal date to establish a proper book
f f f f f f f f f f f f f f
value. f
2. Following the sale, the equity method continues to be appropriate if enough shares are f f f f f f f f f f f f f
still held to maintain the investor‘s ability to significantly influence the investee. If that
f f f f f f f f f f f f f f
ability has been lost, the fair-value method is subsequently used.
f f f f f f f f f f
2-24
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
,Solution Manual For All Chapters
f f f f
IV. Excess investment cost over book value acquired f f f f f f
A. The price an investor pays for equity securities often differs significantly from thef f f f f f f f f f f f
investee‘s underlying book value primarily because the historical cost based
f f f f f f f f f f
accounting model does not keep track of changes in a firm‘s fair value.
f f f f f f f f f f f f f
B. Payments made in excess of underlying book value can sometimes be identified with f f f f f f f f f f f f
specific investee accounts such as inventory or equipment.
f f f f f f f f
C. An extra acquisition price can also be assigned to anticipated benefits that are expected
f f f f f f f f f f f f f
to be derived from the investment. In accounting, these amounts are presumed to reflect
f f f f f f f f f f f f f f
an intangible asset referred to as goodwill. Goodwill is calculated as any excess payment
f f f f f f f f f f f f f f
that is not attributable to specific identifiable assets and liabilities of the investee.
f f f f f f f f f f f f f
Because goodwill is an indefinite-lived asset, it is not amortized.
f f f f f f f f f f
V. Deferral of intra-entity gross profit in inventory f f f f f f
A. The investor‘s share of intra-entity profits in ending inventory are not recognized until the
f f f f f f f f f f f f f
transferred goods are either consumed or until they are resold to unrelated parties.
f f f f f f f f f f f f f
B. Downstream sales of inventory f f f
1. ―Downstream‖ refers to transfers made by the investor to the investee. f f f f f f f f f f
2. Intra-entity gross profits from sales are initially deferred under the equity method and f f f f f f f f f f f f
then recognized as income at the time of the inventory‘s eventual disposal. f f f f f f f f f f f f
3. The amount of gross profit to be deferred is the investor‘s ownership percentage f f f f f f f f f f f f
multiplied by the markup on the merchandise remaining at the end of the year.f f f f f f f f f f f f f f
C. Upstream sales of inventory f f f
1. ―Upstream‖ refers to transfers made by the investee to the investor. f f f f f f f f f f
2. Under the equity method, the deferral process for intra-entity gross profits is identical f f f f f f f f f f f f
for upstream and downstream transfers. The procedures are separately identified in
f f f f f f f f f f f
Chapter One because the handling does vary within the consolidation process. f f f f f f f f f f f
Answers to Discussion Questions
f f f
The textbook includes discussion questions to stimulate student thought and discussion. These
f f f f f f f f f f f
questions are also designed to allow students to consider relevant issues that might otherwise be
f f f f f f f f f f f f f f f
overlooked. Some of these questions may be addressed by the instructor in class to motivate student
f f f f f f f f f f f f f f f f
discussion. Students should be encouraged to begin by defining the issue(s) in each case. Next,
f f f f f f f f f f f f f f f
authoritative accounting literature (FASB ASC) or other relevant literature can be consulted as a
f f f f f f f f f f f f f f
preliminary step in arriving at logical actions. Frequently, the FASB Accounting Standards
f f f f f f f f f f f f
Codification will provide the necessary support.
f f f f f f
Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
f f f f f f f f f f f
available. Students often seem to believe that all accounting issues have been resolved in the past so
f f f f f f f f f f f f f f f f f
that accounting education is only a matter of learning to apply historically prescribed procedures.
f f f f f f f f f f f f f f
However, in actual practice, the only real answer is often the one that provides the fairest
f f f f f f f f f f f f f f f f
representation of the firm‘s transactions. If an authoritative solution is not available, students should be
f f f f f f f f f f f f f f f
directed to list all of the issues involved and the consequences of possible alternative actions. The
f f f f f f f f f f f f f f f f
various factors presented can be weighed to produce a viable solution.
f f f f f f f f f f f
The discussion questions are designed to help students develop research and critical thinking skills in
f f f f f f f f f f f f f f
addressing issues that go beyond the purely mechanical elements of accounting.
f f f f f f f f f f f
2-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
, Did the Cost Method Invite Manipulation?
f f f f f
The cost method of accounting for investments often caused a lack of objectivity in reported income
f f f f f f f f f f f f f f f
figures. With a large block of the investee‘s voting shares, an investor could influence the amount and
f f f f f f f f f f f f f f f f f
timing of the investee‘s dividend declarations. Thus, when enjoying a good earnings year, an investor
f f f f f f f f f f f f f f f
might influence the investee to withhold declaring a dividend until needed in a subsequent year.
f f f f f f f f f f f f f f f
Alternatively, if the investor judged that its current year earnings ―needed a boost,‖ it might influence
f f f f f f f f f f f f f f f f
the investee to declare a current year dividend. The equity method effectively removes managers‘
f f f f f f f f f f f f f f
ability to increase current income (or defer income to future periods) through their influence over the
f f f f f f f f f f f f f f f f
timing and amounts of investee dividend declarations.
f f f f f f f
At first glance it may seem that the fair value method allows managers to manipulate income because
f f f f f f f f f f f f f f f f
investee dividends are recorded as income by the investor. However, dividends paid typically are
f f f f f f f f f f f f f f
accompanied by a decrease in fair value (also recognized in income), thus leaving reported net income
f f f f f f f f f f f f f f f f
unaffected.
f
Does the Equity Method Really Apply Here?
f f f f f f
The discussion in the case between the two accountants is limited to the reason for the investment
f f f f f f f f f f f f f f f f
acquisition and the current percentage of ownership. Instead, they should be examining the actual
f f f f f f f f f f f f f f
interaction that currently exists between the two companies. Although the ability to exercise significant
f f f f f f f f f f f f f f
influence over operating and financial policies appears to be a rather vague criterion, ASC 323
f f f f f f f f f f f f f f f
"Investments—Equity Method and Joint Ventures," clearly specifies actual events that indicate this
f f f f f f f f f f f f
level of authority (paragraph 323-10-15-6):
f f f f f
Ability to exercise that influence may be indicated in several ways, such as representation on the board
f f f f f f f f f f f f f f f f
of directors, participation in policy-making processes, material intra-entity transactions, interchange
f f f f f f f f f f
of managerial personnel, or technological dependency. Another important consideration is the extent
f f f f f f f f f f f f
of ownership by an investor in relation to the concentration of other shareholdings, but substantial or
f f f f f f f f f f f f f f f f
majority ownership of the voting stock of an investee company by another investor does not
f f f f f f f f f f f f f f f
necessarily preclude the ability to exercise significant influence by the investor.
f f f f f f f f f f f
In this case, the accountants would be wise to determine whether Dennis Bostitch or any other member
f f f f f f f f f f f f f f f f
of the Highland Laboratories administration is participating in the management of Abraham, Inc. If any
f f f f f f f f f f f f f f f
individual from Highland's organization is on Abraham‘s board of directors or is participating in
f f f f f f f f f f f f f f
management decisions, the equity method would seem to be appropriate.
f f f f f f f f f f
Likewise, if significant transactions have occurred between the companies (such as loans by Highland
f f f f f f f f f f f f f
to Abraham), the ability to apply significant influence becomes much more evident.
f f f f f f f f f f f f
However, if James Abraham continues to operate Abraham, Inc., with little or no regard for Highland,
f f f f f f f f f f f f f f f
the equity method should not be applied. This possibility seems especially likely in this case since one
f f f f f f f f f f f f f f f f f
stockholder, James Abraham, continues to hold a majority (2/3) of the voting stock. Thus, evidence of
f f f f f f f f f f f f f f f f
the ability to apply significant influence must be present before the equity method is viewed as
f f f f f f f f f f f f f f f f
applicable. The mere holding of 1/3 of the stock is not conclusive.
f f f f f f f f f f f f
2-44
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
f f f f f f f f f f f f f f f f f f f
