2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
,ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEFER
yx yx yx yx yx yx yx yx yx y
AND TIMOTHY DOUPNIK
x yx yx
CHAPTER 1-19 yx
CHAPTER 1 TH yx yx
E EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
yx yx yx yx yx yx
Chapter Outline yx
I. Four methods are principally used to account for an investment in equity securities along
yx yx yx yx yx yx yx yx yx yx yx yx yx y
with a fair value option.
x yx yx yx yx
A. Fair value method: applied by an investor when only a small percentage of a
yx yx yx yx yx yx yx yx yx yx yx yx yx y
company‘s voting stock is held.
x yx yx yx yx
1. The investor recognizes income when the investee declares a dividend.
yx yx yx yx yx yx yx yx yx
2. Portfolios are reported at fair value. If fair values are unavailable, investment is
yx yx yx yx yx yx yx yx yx yx yx yx y
reported at cost. x yx yx
B. Cost Method: applied to investments without a readily determinable fair value. When
yx yx yx yx yx yx yx yx yx yx yx yx
the fair value of an investment in equity securities is not readily determinable, and the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx y
investment provides neither significant influence nor control, the investment may be
x yx yx yx yx yx yx yx yx yx yx yx
measured at cost. The investment remains at cost unless yx yx yx yx yx yx yx yx
1. A demonstrable impairment occurs for the investment, or
yx yx yx yx yx yx yx
2. An observable price change occurs for identical or similar investments of the same
yx yx yx yx yx yx yx yx yx yx yx yx y
issuer. x
The investor typically recognizes its share of investee dividends declared as dividend i
yx yx yx yx yx yx yx yx yx yx yx yx
ncome.
C. Consolidation: when one firm controls another (e.g., when a parent has a majority i yx yx yx yx yx yx yx yx yx yx yx yx yx
nterest in the voting stock of a subsidiary or control through variable interests, their
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
financial statements are consolidated and reported for the combined entity.
yx yx yx yx yx yx yx yx yx
D. Equity method: applied when the investor has the ability to exercise significant
yx yx yx yx yx yx yx yx yx yx yx y
influence over operating and financial policies of the investee.
x yx yx yx yx yx yx yx yx
1. Ability to significantly influence investee is indicated by several factors including
yx yx yx yx yx yx yx yx yx yx yx
representation on the board of directors, participation in policy-making, etc. yx yx yx yx yx yx yx yx yx
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, outstanding voting stock of the investee is held by the investor. yx yx yx yx yx yx yx yx yx yx
Current financial reporting standards allow firms to elect to use fair value for any new inve
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
stment in equity shares including those where the equity method would otherwise apply. H
yx yx yx yx yx yx yx yx yx yx yx yx yx
owever, the option, once taken, is irrevocable. The investor recognizes both investee divi
yx yx yx yx yx yx yx yx yx yx yx yx
dends and changes in fair value over time as income.
yx yx yx yx yx yx yx yx yx
II. Accounting for an investment: the equity method
yx yx yx yx yx yx
A. The investor adjusts the investment account to reflect all changes in the equity of the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx y
investee company.
x yx
B. The investor accrues investee income when it is reported in the investee‘s financial
yx yx yx yx yx yx yx yx yx yx yx yx y
statements.
x
C. Dividends declared by the investee create a reduction in the carrying amount of the I
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
nvestment account. This book assumes all investee dividends are declared and paid i
yx yx yx yx yx yx yx yx yx yx yx yx
n the same reporting period.
yx yx yx yx
III. Special accounting procedures used in the application of the equity method
yx yx yx yx yx yx yx yx yx yx
A. Reporting a change to the equity method when the ability to significantly influence an
yx yx yx yx yx yx yx yx yx yx yx yx yx y
investee is achieved through a series of acquisitions.
x yx yx yx yx yx yx yx
1. Initial purchase(s) will be accounted for by means of the fair value method (or at
yx yx yx yx yx yx yx yx yx yx yx yx yx yx y
cost) until the ability to significantly influence is attained.
x yx yx yx yx yx yx yx yx
2. When the ability to exercise significant influence occurs following a series of stock
yx yx yx yx yx yx yx yx yx yx yx yx yx
purchases, the investor applies the equity method prospectively. The total fair val yx yx yx yx yx yx yx yx yx yx yx
ue at the date significant influence is attained is compared to the investee‘s book
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
value to determine future excess fair value amortizations.
yx yx yx yx yx yx yx
B. Investee income from other than continuing operations
yx yx yx yx yx yx
1. The investor recognizes its share of investee reported other comprehensive
yx yx yx yx yx yx yx yx yx y
income (OCI) through the investment account and the investor‘s own OCI.
x yx yx yx yx yx yx yx yx yx yx
2. Income items such as discontinued operations that are reported separately by the
yx yx yx yx yx yx yx yx yx yx yx y
investee should be shown in the same manner by the investor. The materiality of
x yx yx yx yx yx yx yx yx yx yx yx yx yx yx
these other investee income elements (as it affects the investor) continues to be a
yx yx yx yx yx yx yx yx yx yx yx yx yx y
criterion for separate disclosure.
x yx yx yx
C. Investee losses yx
1. Losses reported by the investee create corresponding losses for the investor.
yx yx yx yx yx yx yx yx yx yx
2. A permanent decline in the fair value of an investee‘s stock should be recognized
yx yx yx yx yx yx yx yx yx yx yx yx yx y
immediately by the investor as an impairment loss.
x yx yx yx yx yx yx yx
3. Investee losses can possibly reduce the carrying value of the investment account t
yx yx yx yx yx yx yx yx yx yx yx yx
o a zero balance. At that point, the equity method ceases to be applicable and the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
fair-value method is subsequently used. yx yx yx yx
D. Reporting the sale of an equity investment yx yx yx yx yx yx
1. The investor applies the equity method until the disposal date to establish a proper
yx yx yx yx yx yx yx yx yx yx yx yx yx y
book value. x yx
2. Following the sale, the equity method continues to be appropriate if enough shares
yx yx yx yx yx yx yx yx yx yx yx yx y
are still held to maintain the investor‘s ability to significantly influence the investee.
x yx yx yx yx yx yx yx yx yx yx yx yx
If that ability has been lost, the fair-value method is subsequently used.
yx yx yx yx yx yx yx yx yx yx yx yx
2-24
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, Solution Manual For All Chapters yx yx yx yx
IV. Excess investment cost over book value acquired
yx yx yx yx yx yx
A. The price an investor pays for equity securities often differs significantly from the
yx yx yx yx yx yx yx yx yx yx yx yx y
investee‘s underlying book value primarily because the historical cost based ac
x yx yx yx yx yx yx yx yx yx yx
counting model does not keep track of changes in a firm‘s fair value. yx yx yx yx yx yx yx yx yx yx yx yx
B. Payments made in excess of underlying book value can sometimes be identified with yx yx yx yx yx yx yx yx yx yx yx yx y
specific investee accounts such as inventory or equipment.
x yx yx yx yx yx yx yx
C. An extra acquisition price can also be assigned to anticipated benefits that are expec
yx yx yx yx yx yx yx yx yx yx yx yx yx
ted to be derived from the investment. In accounting, these amounts are presumed t
yx yx yx yx yx yx yx yx yx yx yx yx yx
o reflect an intangible asset referred to as goodwill. Goodwill is calculated as any exc
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
ess payment that is not attributable to specific identifiable assets and liabilities of the
yx yx yx yx yx yx yx yx yx yx yx yx yx y
investee. Because goodwill is an indefinite-lived asset, it is not amortized.
x yx yx yx yx yx yx yx yx yx yx
V. Deferral of intra-entity gross profit in inventoryyx yx yx yx yx yx
A. The investor‘s share of intra- yx yx yx yx
entity profits in ending inventory are not recognized until the transferred goods are eith
yx yx yx yx yx yx yx yx yx yx yx yx yx
er consumed or until they are resold to unrelated parties.
yx yx yx yx yx yx yx yx yx
B. Downstream sales of inventory yx yx yx
1. ―Downstream‖ refers to transfers made by the investor to the investee. yx yx yx yx yx yx yx yx yx yx
2. Intra-
entity gross profits from sales are initially deferred under the equity method and t
yx yx yx yx yx yx yx yx yx yx yx yx yx
hen recognized as income at the time of the inventory‘s eventual disposal.
yx yx yx yx yx yx yx yx yx yx yx
3. The amount of gross profit to be deferred is the investor‘s ownership percentage
yx yx yx yx yx yx yx yx yx yx yx yx y
multiplied by the markup on the merchandise remaining at the end of the year.
x yx yx yx yx yx yx yx yx yx yx yx yx yx
C. Upstream sales of inventory yx yx yx
1. ―Upstream‖ refers to transfers made by the investee to the investor. yx yx yx yx yx yx yx yx yx yx
2. Under the equity method, the deferral process for intra- yx yx yx yx yx yx yx yx
entity gross profits is identical for upstream and downstream transfers. The proce
yx yx yx yx yx yx yx yx yx yx yx
dures are separately identified in Chapter One because the handling does vary wi
yx yx yx yx yx yx yx yx yx yx yx yx
thin the consolidation process. yx yx yx
Answers to Discussion Questions yx yx yx
The textbook includes discussion questions to stimulate student thought and discussion. These q
yx yx yx yx yx yx yx yx yx yx yx yx
uestions are also designed to allow students to consider relevant issues that might otherwise be
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
overlooked. Some of these questions may be addressed by the instructor in class to motivate stu
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
dent discussion. Students should be encouraged to begin by defining the issue(s) in each case.
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
Next, authoritative accounting literature (FASB ASC) or other relevant literature can be consulted
yx yx yx yx yx yx yx yx yx yx yx yx y
as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting Standards C
x yx yx yx yx yx yx yx yx yx yx yx yx yx yx
odification will provide the necessary support. yx yx yx yx yx
Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
yx yx yx yx yx yx yx yx yx yx yx yx
available. Students often seem to believe that all accounting issues have been resolved in the pa
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
st so that accounting education is only a matter of learning to apply historically prescribed proced
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
ures. However, in actual practice, the only real answer is often the one that provides the fairest re
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
presentation of the firm‘s transactions. If an authoritative solution is not available, students shoul
yx yx yx yx yx yx yx yx yx yx yx yx yx
d be directed to list all of the issues involved and the consequences of possible alternative action
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
s. The various factors presented can be weighed to produce a viable solution.
yx yx yx yx yx yx yx yx yx yx yx yx
The discussion questions are designed to help students develop research and critical thinking skil
yx yx yx yx yx yx yx yx yx yx yx yx yx
ls in addressing issues that go beyond the purely mechanical elements of accounting.
yx yx yx yx yx yx yx yx yx yx yx yx
2-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
,ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEFER
yx yx yx yx yx yx yx yx yx y
AND TIMOTHY DOUPNIK
x yx yx
CHAPTER 1-19 yx
CHAPTER 1 TH yx yx
E EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
yx yx yx yx yx yx
Chapter Outline yx
I. Four methods are principally used to account for an investment in equity securities along
yx yx yx yx yx yx yx yx yx yx yx yx yx y
with a fair value option.
x yx yx yx yx
A. Fair value method: applied by an investor when only a small percentage of a
yx yx yx yx yx yx yx yx yx yx yx yx yx y
company‘s voting stock is held.
x yx yx yx yx
1. The investor recognizes income when the investee declares a dividend.
yx yx yx yx yx yx yx yx yx
2. Portfolios are reported at fair value. If fair values are unavailable, investment is
yx yx yx yx yx yx yx yx yx yx yx yx y
reported at cost. x yx yx
B. Cost Method: applied to investments without a readily determinable fair value. When
yx yx yx yx yx yx yx yx yx yx yx yx
the fair value of an investment in equity securities is not readily determinable, and the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx y
investment provides neither significant influence nor control, the investment may be
x yx yx yx yx yx yx yx yx yx yx yx
measured at cost. The investment remains at cost unless yx yx yx yx yx yx yx yx
1. A demonstrable impairment occurs for the investment, or
yx yx yx yx yx yx yx
2. An observable price change occurs for identical or similar investments of the same
yx yx yx yx yx yx yx yx yx yx yx yx y
issuer. x
The investor typically recognizes its share of investee dividends declared as dividend i
yx yx yx yx yx yx yx yx yx yx yx yx
ncome.
C. Consolidation: when one firm controls another (e.g., when a parent has a majority i yx yx yx yx yx yx yx yx yx yx yx yx yx
nterest in the voting stock of a subsidiary or control through variable interests, their
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
financial statements are consolidated and reported for the combined entity.
yx yx yx yx yx yx yx yx yx
D. Equity method: applied when the investor has the ability to exercise significant
yx yx yx yx yx yx yx yx yx yx yx y
influence over operating and financial policies of the investee.
x yx yx yx yx yx yx yx yx
1. Ability to significantly influence investee is indicated by several factors including
yx yx yx yx yx yx yx yx yx yx yx
representation on the board of directors, participation in policy-making, etc. yx yx yx yx yx yx yx yx yx
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, outstanding voting stock of the investee is held by the investor. yx yx yx yx yx yx yx yx yx yx
Current financial reporting standards allow firms to elect to use fair value for any new inve
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
stment in equity shares including those where the equity method would otherwise apply. H
yx yx yx yx yx yx yx yx yx yx yx yx yx
owever, the option, once taken, is irrevocable. The investor recognizes both investee divi
yx yx yx yx yx yx yx yx yx yx yx yx
dends and changes in fair value over time as income.
yx yx yx yx yx yx yx yx yx
II. Accounting for an investment: the equity method
yx yx yx yx yx yx
A. The investor adjusts the investment account to reflect all changes in the equity of the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx y
investee company.
x yx
B. The investor accrues investee income when it is reported in the investee‘s financial
yx yx yx yx yx yx yx yx yx yx yx yx y
statements.
x
C. Dividends declared by the investee create a reduction in the carrying amount of the I
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
nvestment account. This book assumes all investee dividends are declared and paid i
yx yx yx yx yx yx yx yx yx yx yx yx
n the same reporting period.
yx yx yx yx
III. Special accounting procedures used in the application of the equity method
yx yx yx yx yx yx yx yx yx yx
A. Reporting a change to the equity method when the ability to significantly influence an
yx yx yx yx yx yx yx yx yx yx yx yx yx y
investee is achieved through a series of acquisitions.
x yx yx yx yx yx yx yx
1. Initial purchase(s) will be accounted for by means of the fair value method (or at
yx yx yx yx yx yx yx yx yx yx yx yx yx yx y
cost) until the ability to significantly influence is attained.
x yx yx yx yx yx yx yx yx
2. When the ability to exercise significant influence occurs following a series of stock
yx yx yx yx yx yx yx yx yx yx yx yx yx
purchases, the investor applies the equity method prospectively. The total fair val yx yx yx yx yx yx yx yx yx yx yx
ue at the date significant influence is attained is compared to the investee‘s book
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
value to determine future excess fair value amortizations.
yx yx yx yx yx yx yx
B. Investee income from other than continuing operations
yx yx yx yx yx yx
1. The investor recognizes its share of investee reported other comprehensive
yx yx yx yx yx yx yx yx yx y
income (OCI) through the investment account and the investor‘s own OCI.
x yx yx yx yx yx yx yx yx yx yx
2. Income items such as discontinued operations that are reported separately by the
yx yx yx yx yx yx yx yx yx yx yx y
investee should be shown in the same manner by the investor. The materiality of
x yx yx yx yx yx yx yx yx yx yx yx yx yx yx
these other investee income elements (as it affects the investor) continues to be a
yx yx yx yx yx yx yx yx yx yx yx yx yx y
criterion for separate disclosure.
x yx yx yx
C. Investee losses yx
1. Losses reported by the investee create corresponding losses for the investor.
yx yx yx yx yx yx yx yx yx yx
2. A permanent decline in the fair value of an investee‘s stock should be recognized
yx yx yx yx yx yx yx yx yx yx yx yx yx y
immediately by the investor as an impairment loss.
x yx yx yx yx yx yx yx
3. Investee losses can possibly reduce the carrying value of the investment account t
yx yx yx yx yx yx yx yx yx yx yx yx
o a zero balance. At that point, the equity method ceases to be applicable and the
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
fair-value method is subsequently used. yx yx yx yx
D. Reporting the sale of an equity investment yx yx yx yx yx yx
1. The investor applies the equity method until the disposal date to establish a proper
yx yx yx yx yx yx yx yx yx yx yx yx yx y
book value. x yx
2. Following the sale, the equity method continues to be appropriate if enough shares
yx yx yx yx yx yx yx yx yx yx yx yx y
are still held to maintain the investor‘s ability to significantly influence the investee.
x yx yx yx yx yx yx yx yx yx yx yx yx
If that ability has been lost, the fair-value method is subsequently used.
yx yx yx yx yx yx yx yx yx yx yx yx
2-24
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, Solution Manual For All Chapters yx yx yx yx
IV. Excess investment cost over book value acquired
yx yx yx yx yx yx
A. The price an investor pays for equity securities often differs significantly from the
yx yx yx yx yx yx yx yx yx yx yx yx y
investee‘s underlying book value primarily because the historical cost based ac
x yx yx yx yx yx yx yx yx yx yx
counting model does not keep track of changes in a firm‘s fair value. yx yx yx yx yx yx yx yx yx yx yx yx
B. Payments made in excess of underlying book value can sometimes be identified with yx yx yx yx yx yx yx yx yx yx yx yx y
specific investee accounts such as inventory or equipment.
x yx yx yx yx yx yx yx
C. An extra acquisition price can also be assigned to anticipated benefits that are expec
yx yx yx yx yx yx yx yx yx yx yx yx yx
ted to be derived from the investment. In accounting, these amounts are presumed t
yx yx yx yx yx yx yx yx yx yx yx yx yx
o reflect an intangible asset referred to as goodwill. Goodwill is calculated as any exc
yx yx yx yx yx yx yx yx yx yx yx yx yx yx
ess payment that is not attributable to specific identifiable assets and liabilities of the
yx yx yx yx yx yx yx yx yx yx yx yx yx y
investee. Because goodwill is an indefinite-lived asset, it is not amortized.
x yx yx yx yx yx yx yx yx yx yx
V. Deferral of intra-entity gross profit in inventoryyx yx yx yx yx yx
A. The investor‘s share of intra- yx yx yx yx
entity profits in ending inventory are not recognized until the transferred goods are eith
yx yx yx yx yx yx yx yx yx yx yx yx yx
er consumed or until they are resold to unrelated parties.
yx yx yx yx yx yx yx yx yx
B. Downstream sales of inventory yx yx yx
1. ―Downstream‖ refers to transfers made by the investor to the investee. yx yx yx yx yx yx yx yx yx yx
2. Intra-
entity gross profits from sales are initially deferred under the equity method and t
yx yx yx yx yx yx yx yx yx yx yx yx yx
hen recognized as income at the time of the inventory‘s eventual disposal.
yx yx yx yx yx yx yx yx yx yx yx
3. The amount of gross profit to be deferred is the investor‘s ownership percentage
yx yx yx yx yx yx yx yx yx yx yx yx y
multiplied by the markup on the merchandise remaining at the end of the year.
x yx yx yx yx yx yx yx yx yx yx yx yx yx
C. Upstream sales of inventory yx yx yx
1. ―Upstream‖ refers to transfers made by the investee to the investor. yx yx yx yx yx yx yx yx yx yx
2. Under the equity method, the deferral process for intra- yx yx yx yx yx yx yx yx
entity gross profits is identical for upstream and downstream transfers. The proce
yx yx yx yx yx yx yx yx yx yx yx
dures are separately identified in Chapter One because the handling does vary wi
yx yx yx yx yx yx yx yx yx yx yx yx
thin the consolidation process. yx yx yx
Answers to Discussion Questions yx yx yx
The textbook includes discussion questions to stimulate student thought and discussion. These q
yx yx yx yx yx yx yx yx yx yx yx yx
uestions are also designed to allow students to consider relevant issues that might otherwise be
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
overlooked. Some of these questions may be addressed by the instructor in class to motivate stu
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
dent discussion. Students should be encouraged to begin by defining the issue(s) in each case.
yx yx yx yx yx yx yx yx yx yx yx yx yx yx yx
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 C
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odification will provide the necessary support. yx yx yx yx yx
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 pa
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st so that accounting education is only a matter of learning to apply historically prescribed proced
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ures. However, in actual practice, the only real answer is often the one that provides the fairest re
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presentation of the firm‘s transactions. If an authoritative solution is not available, students shoul
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d be directed to list all of the issues involved and the consequences of possible alternative action
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s. 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 skil
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ls in addressing issues that go beyond the purely mechanical elements of accounting.
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