SolutioncManualcForcAllcChapters
SOLUTION MANUAL FOR c c
ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEF
c c c c c c c c c
ER AND TIMOTHY DOUPNIK
c c c
CHAPTER 1-19 c
CHAPTER 1 TH c c
E EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
c c c c c c
ChaptercOutline
I. Fourcmethodscarecprincipallycusedctocaccountcforcancinvestmentcincequitycsecuritiescalongc
c
withcacfaircvaluecoption.
A. Faircvaluecmethod:cappliedcbycancinvestorcwhenconlycacsmallcpercentagecofcac
company‘scvotingcstockcischeld.
1. Thecinvestorcrecognizescincomecwhencthecinvesteecdeclarescacdividend.
2. Portfolioscarecreportedcatcfaircvalue.cIfcfaircvaluescarecunavailable,cinvestmentciscr
eportedcatccost.
B. CostcMethod:cappliedctocinvestmentscwithoutcacreadilycdeterminablecfaircvalue.cWhenct
hecfaircvaluecofcancinvestmentcincequitycsecuritiesciscnotcreadilycdeterminable,candcthecin
vestmentcprovidescneithercsignificantcinfluencecnorccontrol,cthecinvestmentcmaycbecme
asuredcatccost.cThecinvestmentcremainscatccostcunless
1. Acdemonstrablecimpairmentcoccurscforcthecinvestment,cor
2. Ancobservablecpricecchangecoccurscforcidenticalcorcsimilarcinvestmentscofcthecsameci
ssuer.
Thecinvestorctypicallycrecognizescitscsharecofcinvesteecdividendscdeclaredcascdividendcin
come.
C. Consolidation:cwhenconecfirmccontrolscanotherc(e.g.,cwhencacparentchascacmajoritycint
erestcincthecvotingcstockcofcacsubsidiarycorccontrolcthroughcvariablecinterests,ctheircfin
ancialcstatementscarecconsolidatedcandcreportedcforctheccombinedcentity.
D. Equitycmethod:cappliedcwhencthecinvestorchascthecabilityctocexercisecsignificantci
nfluencecovercoperatingcandcfinancialcpoliciescofcthecinvestee.
1. Abilityctocsignificantlycinfluencecinvesteeciscindicatedcbycseveralcfactorscincludingcr
epresentationconcthecboardcofcdirectors,cparticipationcincpolicy-making,cetc.
2. GAAPcguidelinescpresumecthecequitycmethodciscapplicablecifc20ctoc50cpercentcofcthe
2-1
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
, outstandingcvotingcstockcofcthecinvesteecischeldcbycthecinvestor.
Currentcfinancialcreportingcstandardscallowcfirmsctocelectctocusecfaircvaluecforcanycnewcinvest
mentcincequitycsharescincludingcthosecwherecthecequitycmethodcwouldcotherwisecapply.cHow
ever,cthecoption,concectaken,ciscirrevocable.cThecinvestorcrecognizescbothcinvesteecdividend
scandcchangescincfaircvaluecoverctimecascincome.
II. Accountingcforcancinvestment:cthecequitycmethod
A. Thecinvestorcadjustscthecinvestmentcaccountctocreflectcallcchangescincthecequitycofctheci
nvesteeccompany.
B. Thecinvestorcaccruescinvesteecincomecwhencitciscreportedcincthecinvestee‘scfinancialc
statements.
C. DividendscdeclaredcbycthecinvesteeccreatecacreductioncinctheccarryingcamountcofcthecIn
vestmentcaccount.cThiscbookcassumescallcinvesteecdividendscarecdeclaredcandcpaidcinc
thecsamecreportingcperiod.
III. Specialcaccountingcprocedurescusedcincthecapplicationcofcthecequitycmethod
A. Reportingcacchangectocthecequitycmethodcwhencthecabilityctocsignificantlycinfluencecanci
nvesteeciscachievedcthroughcacseriescofcacquisitions.
1. Initialcpurchase(s)cwillcbecaccountedcforcbycmeanscofcthecfaircvaluecmethodc(orcatcc
ost)cuntilcthecabilityctocsignificantlycinfluenceciscattained.
2. Whencthecabilityctocexercisecsignificantcinfluencecoccurscfollowingcacseriescofcstockc
purchases,cthecinvestorcappliescthecequitycmethodcprospectively.cThectotalcfaircvalu
ecatcthecdatecsignificantcinfluenceciscattainedcisccomparedctocthecinvestee‘scbookcval
uectocdeterminecfuturecexcesscfaircvaluecamortizations.
B. Investeecincomecfromcothercthanccontinuingcoperations
1. Thecinvestorcrecognizescitscsharecofcinvesteecreportedcotherccomprehensiveci
ncomec(OCI)cthroughcthecinvestmentcaccountcandcthecinvestor‘scowncOCI.
2. Incomecitemscsuchcascdiscontinuedcoperationscthatcarecreportedcseparatelycbyctheci
nvesteecshouldcbecshowncincthecsamecmannercbycthecinvestor.cThecmaterialitycofcth
esecothercinvesteecincomecelementsc(ascitcaffectscthecinvestor)ccontinuesctocbecaccri
terioncforcseparatecdisclosure.
C. Investeeclosses
1. Lossescreportedcbycthecinvesteeccreateccorrespondingclossescforcthecinvestor.
2. Acpermanentcdeclinecincthecfaircvaluecofcancinvestee‘scstockcshouldcbecrecognizedci
mmediatelycbycthecinvestorcascancimpairmentcloss.
3. Investeeclossesccancpossiblycreducectheccarryingcvaluecofcthecinvestmentcaccountcto
caczerocbalance.cAtcthatcpoint,cthecequitycmethodcceasesctocbecapplicablecandcthecfai
r-valuecmethodciscsubsequentlycused.
D. Reportingcthecsalecofcancequitycinvestment
1. Thecinvestorcappliescthecequitycmethodcuntilcthecdisposalcdatectocestablishcacproperc
bookcvalue.
2. Followingcthecsale,cthecequitycmethodccontinuesctocbecappropriatecifcenoughcsharesc
arecstillcheldctocmaintaincthecinvestor‘scabilityctocsignificantlycinfluencecthecinvestee.cIf
cthatcabilitychascbeenclost,cthecfair-valuecmethodciscsubsequentlycused.
2-24
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
,SolutioncManualcForcAllcChapters
IV. Excesscinvestmentccostcovercbookcvaluecacquired
A. Thecpricecancinvestorcpayscforcequitycsecuritiescoftencdifferscsignificantlycfromctheci
nvestee‘scunderlyingcbookcvaluecprimarilycbecausecthechistoricalccostcbasedcacco
untingcmodelcdoescnotckeepctrackcofcchangescincacfirm‘scfaircvalue.
B. Paymentscmadecincexcesscofcunderlyingcbookcvalueccancsometimescbecidentifiedcwithc
specificcinvesteecaccountscsuchcascinventorycorcequipment.
C. Ancextracacquisitioncpriceccancalsocbecassignedctocanticipatedcbenefitscthatcarecexpect
edctocbecderivedcfromcthecinvestment.cIncaccounting,cthesecamountscarecpresumedctocr
eflectcancintangiblecassetcreferredctocascgoodwill.cGoodwillcisccalculatedcascanycexcessc
paymentcthatciscnotcattributablectocspecificcidentifiablecassetscandcliabilitiescofcthecinves
tee.cBecausecgoodwillciscancindefinite-livedcasset,citciscnotcamortized.
V. Deferralcofcintra-entitycgrosscprofitcincinventory
A. Thecinvestor‘scsharecofcintra-
entitycprofitscincendingcinventorycarecnotcrecognizedcuntilcthectransferredcgoodscareceithe
rcconsumedcorcuntilctheycarecresoldctocunrelatedcparties.
B. Downstreamcsalescofcinventory
1. ―Downstream‖crefersctoctransferscmadecbycthecinvestorctocthecinvestee.
2. Intra-
entitycgrosscprofitscfromcsalescarecinitiallycdeferredcundercthecequitycmethodcandcth
encrecognizedcascincomecatcthectimecofcthecinventory‘sceventualcdisposal.
3. Thecamountcofcgrosscprofitctocbecdeferredciscthecinvestor‘scownershipcpercentagec
multipliedcbycthecmarkupconcthecmerchandisecremainingcatcthecendcofcthecyear.
C. Upstreamcsalescofcinventory
1. ―Upstream‖crefersctoctransferscmadecbycthecinvesteectocthecinvestor.
2. Undercthecequitycmethod,cthecdeferralcprocesscforcintra-
entitycgrosscprofitsciscidenticalcforcupstreamcandcdownstreamctransfers.cThecproced
urescarecseparatelycidentifiedcincChaptercOnecbecausecthechandlingcdoescvarycwithi
ncthecconsolidationcprocess.
AnswersctocDiscussioncQuestions
Thectextbookcincludescdiscussioncquestionsctocstimulatecstudentcthoughtcandcdiscussion.cThesecqu
estionscarecalsocdesignedctocallowcstudentsctocconsidercrelevantcissuescthatcmightcotherwisecbecove
rlooked.cSomecofcthesecquestionscmaycbecaddressedcbycthecinstructorcincclassctocmotivatecstudentc
discussion.cStudentscshouldcbecencouragedctocbegincbycdefiningcthecissue(s)cinceachccase.cNext,ca
uthoritativecaccountingcliteraturec(FASBcASC)corcothercrelevantcliteratureccancbecconsultedcascacpre
liminarycstepcincarrivingcatclogicalcactions.cFrequently,cthecFASBcAccountingcStandardscCodificatio
ncwillcprovidecthecnecessarycsupport.
Unfortunately,cincaccounting,cdefinitivecresolutionsctocfinancialcreportingcquestionscarecnotcalwaysca
vailable.cStudentscoftencseemctocbelievecthatcallcaccountingcissueschavecbeencresolvedcincthecpastc
socthatcaccountingceducationcisconlycacmattercofclearningctocapplychistoricallycprescribedcprocedure
s.cHowever,cincactualcpractice,ctheconlycrealcanswerciscoftenctheconecthatcprovidescthecfairestcrepres
entationcofcthecfirm‘sctransactions.cIfcancauthoritativecsolutionciscnotcavailable,cstudentscshouldcbecdi
rectedctoclistcallcofcthecissuescinvolvedcandcthecconsequencescofcpossiblecalternativecactions.cThecv
ariouscfactorscpresentedccancbecweighedctocproducecacviablecsolution.
Thecdiscussioncquestionscarecdesignedctochelpcstudentscdevelopcresearchcandccriticalcthinkingcskill
scincaddressingcissuescthatcgocbeyondcthecpurelycmechanicalcelementscofcaccounting.
2-3
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
, DidcthecCostcMethodcInvitecManipulation?
Theccostcmethodcofcaccountingcforcinvestmentscoftenccausedcaclackcofcobjectivitycincreportedcincom
ecfigures.cWithcaclargecblockcofcthecinvestee‘scvotingcshares,cancinvestorccouldcinfluencecthecamount
candctimingcofcthecinvestee‘scdividendcdeclarations.cThus,cwhencenjoyingcacgoodcearningscyear,canci
nvestorcmightcinfluencecthecinvesteectocwithholdcdeclaringcacdividendcuntilcneededcincacsubsequentc
year.cAlternatively,cifcthecinvestorcjudgedcthatcitsccurrentcyearcearningsc―neededcacboost,‖citcmightcin
fluencecthecinvesteectocdeclarecaccurrentcyearcdividend.cThecequitycmethodceffectivelycremovescma
nagers‘cabilityctocincreaseccurrentcincomec(orcdefercincomectocfuturecperiods)cthroughctheircinfluenc
ecovercthectimingcandcamountscofcinvesteecdividendcdeclarations.
Atcfirstcglancecitcmaycseemcthatcthecfaircvaluecmethodcallowscmanagersctocmanipulatecincomecbeca
usecinvesteecdividendscarecrecordedcascincomecbycthecinvestor.cHowever,cdividendscpaidctypicallyc
arecaccompaniedcbycacdecreasecincfaircvaluec(alsocrecognizedcincincome),cthuscleavingcreportedcnet
cincomecunaffected.
DoescthecEquitycMethodcReallycApplycHere?
Thecdiscussioncinctheccasecbetweencthectwocaccountantscisclimitedctocthecreasoncforcthecinvestment
cacquisitioncandctheccurrentcpercentagecofcownership.cInstead,ctheycshouldcbecexaminingcthecactual
cinteractioncthatccurrentlycexistscbetweencthectwoccompanies.cAlthoughcthecabilityctocexercisecsignifi
cantcinfluencecovercoperatingcandcfinancialcpoliciescappearsctocbecacrathercvagueccriterion,cASCc32
3c"Investments—
EquitycMethodcandcJointcVentures,"cclearlycspecifiescactualceventscthatcindicatecthisclevelcofcauthori
tyc(paragraphc323-10-15-6):
Abilityctocexercisecthatcinfluencecmaycbecindicatedcincseveralcways,csuchcascrepresentationconcthecb
oardcofcdirectors,cparticipationcincpolicy-makingcprocesses,cmaterialcintra-
entityctransactions,cinterchangecofcmanagerialcpersonnel,corctechnologicalcdependency.cAnotherci
mportantcconsiderationciscthecextentcofcownershipcbycancinvestorcincrelationctocthecconcentrationcofc
othercshareholdings,cbutcsubstantialcorcmajoritycownershipcofcthecvotingcstockcofcancinvesteeccomp
anycbycanothercinvestorcdoescnotcnecessarilycprecludecthecabilityctocexercisecsignificantcinfluencecb
ycthecinvestor.
Incthisccase,cthecaccountantscwouldcbecwisectocdeterminecwhethercDenniscBostitchcorcanycothercme
mbercofcthecHighlandcLaboratoriescadministrationciscparticipatingcincthecmanagementcofcAbraham,cI
nc.cIfcanycindividualcfromcHighland'scorganizationcisconcAbraham‘scboardcofcdirectorscorciscparticipati
ngcincmanagementcdecisions,cthecequitycmethodcwouldcseemctocbecappropriate.
Likewise,cifcsignificantctransactionschavecoccurredcbetweenctheccompaniesc(suchcascloanscbycHighl
andctocAbraham),cthecabilityctocapplycsignificantcinfluencecbecomescmuchcmorecevident.
However,cifcJamescAbrahamccontinuesctocoperatecAbraham,cInc.,cwithclittlecorcnocregardcforcHighlan
d,cthecequitycmethodcshouldcnotcbecapplied.cThiscpossibilitycseemscespeciallyclikelycincthisccasecsinc
econecstockholder,cJamescAbraham,ccontinuesctocholdcacmajorityc(2/3)cofcthecvotingc stock.cThus,cevi
dencecofcthecabilityctocapplycsignificantcinfluencecmustcbecpresentcbeforecthecequitycmethodciscviewe
dcascapplicable.cThecmerecholdingcofc1/3cofcthecstockciscnotcconclusive.
2-44
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
SOLUTION MANUAL FOR c c
ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEF
c c c c c c c c c
ER AND TIMOTHY DOUPNIK
c c c
CHAPTER 1-19 c
CHAPTER 1 TH c c
E EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
c c c c c c
ChaptercOutline
I. Fourcmethodscarecprincipallycusedctocaccountcforcancinvestmentcincequitycsecuritiescalongc
c
withcacfaircvaluecoption.
A. Faircvaluecmethod:cappliedcbycancinvestorcwhenconlycacsmallcpercentagecofcac
company‘scvotingcstockcischeld.
1. Thecinvestorcrecognizescincomecwhencthecinvesteecdeclarescacdividend.
2. Portfolioscarecreportedcatcfaircvalue.cIfcfaircvaluescarecunavailable,cinvestmentciscr
eportedcatccost.
B. CostcMethod:cappliedctocinvestmentscwithoutcacreadilycdeterminablecfaircvalue.cWhenct
hecfaircvaluecofcancinvestmentcincequitycsecuritiesciscnotcreadilycdeterminable,candcthecin
vestmentcprovidescneithercsignificantcinfluencecnorccontrol,cthecinvestmentcmaycbecme
asuredcatccost.cThecinvestmentcremainscatccostcunless
1. Acdemonstrablecimpairmentcoccurscforcthecinvestment,cor
2. Ancobservablecpricecchangecoccurscforcidenticalcorcsimilarcinvestmentscofcthecsameci
ssuer.
Thecinvestorctypicallycrecognizescitscsharecofcinvesteecdividendscdeclaredcascdividendcin
come.
C. Consolidation:cwhenconecfirmccontrolscanotherc(e.g.,cwhencacparentchascacmajoritycint
erestcincthecvotingcstockcofcacsubsidiarycorccontrolcthroughcvariablecinterests,ctheircfin
ancialcstatementscarecconsolidatedcandcreportedcforctheccombinedcentity.
D. Equitycmethod:cappliedcwhencthecinvestorchascthecabilityctocexercisecsignificantci
nfluencecovercoperatingcandcfinancialcpoliciescofcthecinvestee.
1. Abilityctocsignificantlycinfluencecinvesteeciscindicatedcbycseveralcfactorscincludingcr
epresentationconcthecboardcofcdirectors,cparticipationcincpolicy-making,cetc.
2. GAAPcguidelinescpresumecthecequitycmethodciscapplicablecifc20ctoc50cpercentcofcthe
2-1
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
, outstandingcvotingcstockcofcthecinvesteecischeldcbycthecinvestor.
Currentcfinancialcreportingcstandardscallowcfirmsctocelectctocusecfaircvaluecforcanycnewcinvest
mentcincequitycsharescincludingcthosecwherecthecequitycmethodcwouldcotherwisecapply.cHow
ever,cthecoption,concectaken,ciscirrevocable.cThecinvestorcrecognizescbothcinvesteecdividend
scandcchangescincfaircvaluecoverctimecascincome.
II. Accountingcforcancinvestment:cthecequitycmethod
A. Thecinvestorcadjustscthecinvestmentcaccountctocreflectcallcchangescincthecequitycofctheci
nvesteeccompany.
B. Thecinvestorcaccruescinvesteecincomecwhencitciscreportedcincthecinvestee‘scfinancialc
statements.
C. DividendscdeclaredcbycthecinvesteeccreatecacreductioncinctheccarryingcamountcofcthecIn
vestmentcaccount.cThiscbookcassumescallcinvesteecdividendscarecdeclaredcandcpaidcinc
thecsamecreportingcperiod.
III. Specialcaccountingcprocedurescusedcincthecapplicationcofcthecequitycmethod
A. Reportingcacchangectocthecequitycmethodcwhencthecabilityctocsignificantlycinfluencecanci
nvesteeciscachievedcthroughcacseriescofcacquisitions.
1. Initialcpurchase(s)cwillcbecaccountedcforcbycmeanscofcthecfaircvaluecmethodc(orcatcc
ost)cuntilcthecabilityctocsignificantlycinfluenceciscattained.
2. Whencthecabilityctocexercisecsignificantcinfluencecoccurscfollowingcacseriescofcstockc
purchases,cthecinvestorcappliescthecequitycmethodcprospectively.cThectotalcfaircvalu
ecatcthecdatecsignificantcinfluenceciscattainedcisccomparedctocthecinvestee‘scbookcval
uectocdeterminecfuturecexcesscfaircvaluecamortizations.
B. Investeecincomecfromcothercthanccontinuingcoperations
1. Thecinvestorcrecognizescitscsharecofcinvesteecreportedcotherccomprehensiveci
ncomec(OCI)cthroughcthecinvestmentcaccountcandcthecinvestor‘scowncOCI.
2. Incomecitemscsuchcascdiscontinuedcoperationscthatcarecreportedcseparatelycbyctheci
nvesteecshouldcbecshowncincthecsamecmannercbycthecinvestor.cThecmaterialitycofcth
esecothercinvesteecincomecelementsc(ascitcaffectscthecinvestor)ccontinuesctocbecaccri
terioncforcseparatecdisclosure.
C. Investeeclosses
1. Lossescreportedcbycthecinvesteeccreateccorrespondingclossescforcthecinvestor.
2. Acpermanentcdeclinecincthecfaircvaluecofcancinvestee‘scstockcshouldcbecrecognizedci
mmediatelycbycthecinvestorcascancimpairmentcloss.
3. Investeeclossesccancpossiblycreducectheccarryingcvaluecofcthecinvestmentcaccountcto
caczerocbalance.cAtcthatcpoint,cthecequitycmethodcceasesctocbecapplicablecandcthecfai
r-valuecmethodciscsubsequentlycused.
D. Reportingcthecsalecofcancequitycinvestment
1. Thecinvestorcappliescthecequitycmethodcuntilcthecdisposalcdatectocestablishcacproperc
bookcvalue.
2. Followingcthecsale,cthecequitycmethodccontinuesctocbecappropriatecifcenoughcsharesc
arecstillcheldctocmaintaincthecinvestor‘scabilityctocsignificantlycinfluencecthecinvestee.cIf
cthatcabilitychascbeenclost,cthecfair-valuecmethodciscsubsequentlycused.
2-24
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
,SolutioncManualcForcAllcChapters
IV. Excesscinvestmentccostcovercbookcvaluecacquired
A. Thecpricecancinvestorcpayscforcequitycsecuritiescoftencdifferscsignificantlycfromctheci
nvestee‘scunderlyingcbookcvaluecprimarilycbecausecthechistoricalccostcbasedcacco
untingcmodelcdoescnotckeepctrackcofcchangescincacfirm‘scfaircvalue.
B. Paymentscmadecincexcesscofcunderlyingcbookcvalueccancsometimescbecidentifiedcwithc
specificcinvesteecaccountscsuchcascinventorycorcequipment.
C. Ancextracacquisitioncpriceccancalsocbecassignedctocanticipatedcbenefitscthatcarecexpect
edctocbecderivedcfromcthecinvestment.cIncaccounting,cthesecamountscarecpresumedctocr
eflectcancintangiblecassetcreferredctocascgoodwill.cGoodwillcisccalculatedcascanycexcessc
paymentcthatciscnotcattributablectocspecificcidentifiablecassetscandcliabilitiescofcthecinves
tee.cBecausecgoodwillciscancindefinite-livedcasset,citciscnotcamortized.
V. Deferralcofcintra-entitycgrosscprofitcincinventory
A. Thecinvestor‘scsharecofcintra-
entitycprofitscincendingcinventorycarecnotcrecognizedcuntilcthectransferredcgoodscareceithe
rcconsumedcorcuntilctheycarecresoldctocunrelatedcparties.
B. Downstreamcsalescofcinventory
1. ―Downstream‖crefersctoctransferscmadecbycthecinvestorctocthecinvestee.
2. Intra-
entitycgrosscprofitscfromcsalescarecinitiallycdeferredcundercthecequitycmethodcandcth
encrecognizedcascincomecatcthectimecofcthecinventory‘sceventualcdisposal.
3. Thecamountcofcgrosscprofitctocbecdeferredciscthecinvestor‘scownershipcpercentagec
multipliedcbycthecmarkupconcthecmerchandisecremainingcatcthecendcofcthecyear.
C. Upstreamcsalescofcinventory
1. ―Upstream‖crefersctoctransferscmadecbycthecinvesteectocthecinvestor.
2. Undercthecequitycmethod,cthecdeferralcprocesscforcintra-
entitycgrosscprofitsciscidenticalcforcupstreamcandcdownstreamctransfers.cThecproced
urescarecseparatelycidentifiedcincChaptercOnecbecausecthechandlingcdoescvarycwithi
ncthecconsolidationcprocess.
AnswersctocDiscussioncQuestions
Thectextbookcincludescdiscussioncquestionsctocstimulatecstudentcthoughtcandcdiscussion.cThesecqu
estionscarecalsocdesignedctocallowcstudentsctocconsidercrelevantcissuescthatcmightcotherwisecbecove
rlooked.cSomecofcthesecquestionscmaycbecaddressedcbycthecinstructorcincclassctocmotivatecstudentc
discussion.cStudentscshouldcbecencouragedctocbegincbycdefiningcthecissue(s)cinceachccase.cNext,ca
uthoritativecaccountingcliteraturec(FASBcASC)corcothercrelevantcliteratureccancbecconsultedcascacpre
liminarycstepcincarrivingcatclogicalcactions.cFrequently,cthecFASBcAccountingcStandardscCodificatio
ncwillcprovidecthecnecessarycsupport.
Unfortunately,cincaccounting,cdefinitivecresolutionsctocfinancialcreportingcquestionscarecnotcalwaysca
vailable.cStudentscoftencseemctocbelievecthatcallcaccountingcissueschavecbeencresolvedcincthecpastc
socthatcaccountingceducationcisconlycacmattercofclearningctocapplychistoricallycprescribedcprocedure
s.cHowever,cincactualcpractice,ctheconlycrealcanswerciscoftenctheconecthatcprovidescthecfairestcrepres
entationcofcthecfirm‘sctransactions.cIfcancauthoritativecsolutionciscnotcavailable,cstudentscshouldcbecdi
rectedctoclistcallcofcthecissuescinvolvedcandcthecconsequencescofcpossiblecalternativecactions.cThecv
ariouscfactorscpresentedccancbecweighedctocproducecacviablecsolution.
Thecdiscussioncquestionscarecdesignedctochelpcstudentscdevelopcresearchcandccriticalcthinkingcskill
scincaddressingcissuescthatcgocbeyondcthecpurelycmechanicalcelementscofcaccounting.
2-3
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
, DidcthecCostcMethodcInvitecManipulation?
Theccostcmethodcofcaccountingcforcinvestmentscoftenccausedcaclackcofcobjectivitycincreportedcincom
ecfigures.cWithcaclargecblockcofcthecinvestee‘scvotingcshares,cancinvestorccouldcinfluencecthecamount
candctimingcofcthecinvestee‘scdividendcdeclarations.cThus,cwhencenjoyingcacgoodcearningscyear,canci
nvestorcmightcinfluencecthecinvesteectocwithholdcdeclaringcacdividendcuntilcneededcincacsubsequentc
year.cAlternatively,cifcthecinvestorcjudgedcthatcitsccurrentcyearcearningsc―neededcacboost,‖citcmightcin
fluencecthecinvesteectocdeclarecaccurrentcyearcdividend.cThecequitycmethodceffectivelycremovescma
nagers‘cabilityctocincreaseccurrentcincomec(orcdefercincomectocfuturecperiods)cthroughctheircinfluenc
ecovercthectimingcandcamountscofcinvesteecdividendcdeclarations.
Atcfirstcglancecitcmaycseemcthatcthecfaircvaluecmethodcallowscmanagersctocmanipulatecincomecbeca
usecinvesteecdividendscarecrecordedcascincomecbycthecinvestor.cHowever,cdividendscpaidctypicallyc
arecaccompaniedcbycacdecreasecincfaircvaluec(alsocrecognizedcincincome),cthuscleavingcreportedcnet
cincomecunaffected.
DoescthecEquitycMethodcReallycApplycHere?
Thecdiscussioncinctheccasecbetweencthectwocaccountantscisclimitedctocthecreasoncforcthecinvestment
cacquisitioncandctheccurrentcpercentagecofcownership.cInstead,ctheycshouldcbecexaminingcthecactual
cinteractioncthatccurrentlycexistscbetweencthectwoccompanies.cAlthoughcthecabilityctocexercisecsignifi
cantcinfluencecovercoperatingcandcfinancialcpoliciescappearsctocbecacrathercvagueccriterion,cASCc32
3c"Investments—
EquitycMethodcandcJointcVentures,"cclearlycspecifiescactualceventscthatcindicatecthisclevelcofcauthori
tyc(paragraphc323-10-15-6):
Abilityctocexercisecthatcinfluencecmaycbecindicatedcincseveralcways,csuchcascrepresentationconcthecb
oardcofcdirectors,cparticipationcincpolicy-makingcprocesses,cmaterialcintra-
entityctransactions,cinterchangecofcmanagerialcpersonnel,corctechnologicalcdependency.cAnotherci
mportantcconsiderationciscthecextentcofcownershipcbycancinvestorcincrelationctocthecconcentrationcofc
othercshareholdings,cbutcsubstantialcorcmajoritycownershipcofcthecvotingcstockcofcancinvesteeccomp
anycbycanothercinvestorcdoescnotcnecessarilycprecludecthecabilityctocexercisecsignificantcinfluencecb
ycthecinvestor.
Incthisccase,cthecaccountantscwouldcbecwisectocdeterminecwhethercDenniscBostitchcorcanycothercme
mbercofcthecHighlandcLaboratoriescadministrationciscparticipatingcincthecmanagementcofcAbraham,cI
nc.cIfcanycindividualcfromcHighland'scorganizationcisconcAbraham‘scboardcofcdirectorscorciscparticipati
ngcincmanagementcdecisions,cthecequitycmethodcwouldcseemctocbecappropriate.
Likewise,cifcsignificantctransactionschavecoccurredcbetweenctheccompaniesc(suchcascloanscbycHighl
andctocAbraham),cthecabilityctocapplycsignificantcinfluencecbecomescmuchcmorecevident.
However,cifcJamescAbrahamccontinuesctocoperatecAbraham,cInc.,cwithclittlecorcnocregardcforcHighlan
d,cthecequitycmethodcshouldcnotcbecapplied.cThiscpossibilitycseemscespeciallyclikelycincthisccasecsinc
econecstockholder,cJamescAbraham,ccontinuesctocholdcacmajorityc(2/3)cofcthecvotingc stock.cThus,cevi
dencecofcthecabilityctocapplycsignificantcinfluencecmustcbecpresentcbeforecthecequitycmethodciscviewe
dcascapplicable.cThecmerecholdingcofc1/3cofcthecstockciscnotcconclusive.
2-44
©cMcGrawcHillcLLC.cAllcrightscreserved.cNocreproductioncorcdistributioncwithoutcthecpriorcwrittencconsentcofcMcGrawcHillcLLC
.
