Solution Manual For All Chapters
5t 5t 5t 5t
SOLUTION MANUAL FOR 5t 5t
ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEF
5t 5t 5t 5t 5t 5t 5t 5t 5t
ER AND TIMOTHY DOUPNIK
5t 5t 5t
CHAPTER 1-19 5t
CHAPTER 1 TH 5t 5t
E EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
5t 5t 5t 5t 5t 5t
Chapter Outline 5t
I. Four methods are principally used to account for an investment in equity securities alon
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g with a fair value option.
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A. Fair value method: applied by an investor when only a small percentage of
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a 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 i
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s reported at cost. 5t 5t 5t
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 th
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e investment provides neither significant influence nor control, the investment may b
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e 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 sam
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e issuer. 5t
The investor typically recognizes its share of investee dividends declared as dividend
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income.
C. Consolidation: when one firm controls another (e.g., when a parent has a majority 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
interest in the voting stock of a subsidiary or control through variable interests, thei
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r 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 significan
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t 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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2-1
©5tMcGraw5tHill5tLLC.5tAll5trights5treserved.5tNo5treproduction5tor5tdistribution5twithout5tthe5tprior5twritten5tconsent5tof5tMcGraw5tHill5t
LLC.
, outstanding voting stock of the investee is held by the investor.5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
Current financial reporting standards allow firms to elect to use fair value for any new inv
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
estment 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 d
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ividends 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 th
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e investee company.
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B. The investor accrues investee income when it is reported in the investee‘s financia
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l 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 pai
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d in 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 a
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n 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 a
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t 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 stoc
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k purchases, the investor applies the equity method prospectively. The total fair
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value at the date significant influence is attained is compared to the investee‘s b
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ook value 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 comprehensiv
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e income (OCI) through the investment account and the investor‘s own OC
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I.
2. Income items such as discontinued operations that are reported separately by th
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e investee should be shown in the same manner by the investor. The materiality
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of these other investee income elements (as it affects the investor) continues to b
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e a criterion for separate disclosure.
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C. Investee losses 5t
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 recognize
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d 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
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to a zero balance. At that point, the equity method ceases to be applicable and th
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e fair-value method is subsequently used.
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D. Reporting the sale of an equity investment 5t 5t 5t 5t 5t 5t
1. The investor applies the equity method until the disposal date to establish a prope
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r book value. 5t 5t
2. Following the sale, the equity method continues to be appropriate if enough share
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s are still held to maintain the investor‘s ability to significantly influence the invest
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ee. If that ability has been lost, the fair-value method is subsequently used.
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2-24
©5tMcGraw5tHill5tLLC.5tAll5trights5treserved.5tNo5treproduction5tor5tdistribution5twithout5tthe5tprior5twritten5tconsent5tof5tMcGraw5tHill5t
LLC.
,Solution Manual For All Chapters
5t 5t 5t 5t
IV. Excess investment cost over book value acquired
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A. The price an investor pays for equity securities often differs significantly from th
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e 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. 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
B. Payments made in excess of underlying book value can sometimes be identified wit
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h 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 expe
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cted to be derived from the investment. In accounting, these amounts are presumed
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to reflect an intangible asset referred to as goodwill. Goodwill is calculated as any e
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xcess payment that is not attributable to specific identifiable assets and liabilities of
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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
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A. The investor‘s share of intra- 5t 5t 5t 5t
entity profits in ending inventory are not recognized until the transferred goods are eit
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her consumed or until they are resold to unrelated parties.
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B. Downstream sales of inventory 5t 5t 5t
1. ―Downstream‖ refers to transfers made by the investor to the investee. 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
2. Intra-
entity gross profits from sales are initially deferred under the equity method and
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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 percentag
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e multiplied by the markup on the merchandise remaining at the end of the yea
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r.
C. Upstream sales of inventory 5t 5t 5t
1. ―Upstream‖ refers to transfers made by the investee to the investor. 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
2. Under the equity method, the deferral process for intra- 5t 5t 5t 5t 5t 5t 5t 5t
entity gross profits is identical for upstream and downstream transfers. The proc
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edures are separately identified in Chapter One because the handling does vary
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within the consolidation process. 5t 5t 5t
Answers to Discussion Questions 5t 5t 5t
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 b
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e 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 ca
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se. Next, authoritative accounting literature (FASB ASC) or other relevant literature can be cons
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ulted as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting Stand
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ards 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 p
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ast so that accounting education is only a matter of learning to apply historically prescribed proc
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edures. However, in actual practice, the only real answer is often the one that provides the faire
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st representation of the firm‘s transactions. If an authoritative solution is not available, students s
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hould be directed to list all of the issues involved and the consequences of possible alternative
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actions. 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 sk
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ills in addressing issues that go beyond the purely mechanical elements of accounting.
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2-3
©5tMcGraw5tHill5tLLC.5tAll5trights5treserved.5tNo5treproduction5tor5tdistribution5twithout5tthe5tprior5twritten5tconsent5tof5tMcGraw5tHill5t
LLC.
, 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 inc
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ome figures. With a large block of the investee‘s voting shares, an investor could influence the a
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mount and timing of the investee‘s dividend declarations. Thus, when enjoying a good earnings
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year, an investor might influence the investee to withhold declaring a dividend until needed in a
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subsequent year. Alternatively, if the investor judged that its current year earnings ―needed a bo
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ost,‖ it might influence the investee to declare a current year dividend. The equity method effecti
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vely removes managers‘ ability to increase current income (or defer income to future periods) thr
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ough their 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 be
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cause investee dividends are recorded as income by the investor. However, dividends paid typic
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ally are accompanied by a decrease in fair value (also recognized in income), thus leaving report
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
ed net income unaffected.
5t 5t 5t
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 investm
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ent acquisition and the current percentage of ownership. Instead, they should be examining the
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actual interaction that currently exists between the two companies. Although the ability to exerci
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se significant influence over operating and financial policies appears to be a rather vague criterio
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n, ASC 323 "Investments—
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Equity Method and Joint Ventures," clearly specifies actual events that indicate this level of auth
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ority (paragraph 323-10-15-6):
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Ability to exercise that influence may be indicated in several ways, such as representation on th
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e board of directors, participation in policy-making processes, material intra-
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entity transactions, interchange of managerial personnel, or technological dependency. Another
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important consideration is the extent of ownership by an investor in relation to the concentration
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of other shareholdings, but substantial or majority ownership of the voting stock of an investee c
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ompany by another investor does not necessarily preclude the ability to exercise significant influ
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ence by the investor. 5t 5t 5t
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 Abrah
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am, Inc. If any individual from Highland's organization is on Abraham‘s board of directors or is pa
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rticipating 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 Hig
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hland 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 Highl
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and, the equity method should not be applied. This possibility seems especially likely in this case
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since one stockholder, James Abraham, continues to hold a majority (2/3) of the voting stock. T
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hus, evidence of the ability to apply significant influence must be present before the equity metho
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d is viewed as applicable. The mere holding of 1/3 of the stock is not conclusive.
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2-44
©5tMcGraw5tHill5tLLC.5tAll5trights5treserved.5tNo5treproduction5tor5tdistribution5twithout5tthe5tprior5twritten5tconsent5tof5tMcGraw5tHill5t
LLC.
5t 5t 5t 5t
SOLUTION MANUAL FOR 5t 5t
ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS SCHAEF
5t 5t 5t 5t 5t 5t 5t 5t 5t
ER AND TIMOTHY DOUPNIK
5t 5t 5t
CHAPTER 1-19 5t
CHAPTER 1 TH 5t 5t
E EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
5t 5t 5t 5t 5t 5t
Chapter Outline 5t
I. Four methods are principally used to account for an investment in equity securities alon
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
g with a fair value option.
5t 5t 5t 5t 5t
A. Fair value method: applied by an investor when only a small percentage of
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
a company‘s voting stock is held.
5t 5t 5t 5t 5t
1. The investor recognizes income when the investee declares a dividend.
5t 5t 5t 5t 5t 5t 5t 5t 5t
2. Portfolios are reported at fair value. If fair values are unavailable, investment i
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
s reported at cost. 5t 5t 5t
B. Cost Method: applied to investments without a readily determinable fair value. When
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
the fair value of an investment in equity securities is not readily determinable, and th
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
e investment provides neither significant influence nor control, the investment may b
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
e measured at cost. The investment remains at cost unless
5t 5t 5t 5t 5t 5t 5t 5t 5t
1. A demonstrable impairment occurs for the investment, or
5t 5t 5t 5t 5t 5t 5t
2. An observable price change occurs for identical or similar investments of the sam
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
e issuer. 5t
The investor typically recognizes its share of investee dividends declared as dividend
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
income.
C. Consolidation: when one firm controls another (e.g., when a parent has a majority 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
interest in the voting stock of a subsidiary or control through variable interests, thei
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r financial statements are consolidated and reported for the combined entity.
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
D. Equity method: applied when the investor has the ability to exercise significan
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
t influence over operating and financial policies of the investee.
5t 5t 5t 5t 5t 5t 5t 5t 5t
1. Ability to significantly influence investee is indicated by several factors including
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
representation on the board of directors, participation in policy-making, etc.
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
2-1
©5tMcGraw5tHill5tLLC.5tAll5trights5treserved.5tNo5treproduction5tor5tdistribution5twithout5tthe5tprior5twritten5tconsent5tof5tMcGraw5tHill5t
LLC.
, outstanding voting stock of the investee is held by the investor.5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
Current financial reporting standards allow firms to elect to use fair value for any new inv
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
estment in equity shares including those where the equity method would otherwise apply.
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
However, the option, once taken, is irrevocable. The investor recognizes both investee d
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
ividends and changes in fair value over time as income.
5t 5t 5t 5t 5t 5t 5t 5t 5t
II. Accounting for an investment: the equity method
5t 5t 5t 5t 5t 5t
A. The investor adjusts the investment account to reflect all changes in the equity of th
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
e investee company.
5t 5t
B. The investor accrues investee income when it is reported in the investee‘s financia
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
l statements.
5t
C. Dividends declared by the investee create a reduction in the carrying amount of the
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
Investment account. This book assumes all investee dividends are declared and pai
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
d in the same reporting period.
5t 5t 5t 5t 5t
III. Special accounting procedures used in the application of the equity method
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
A. Reporting a change to the equity method when the ability to significantly influence a
5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
n investee is achieved through a series of acquisitions.
5t 5t 5t 5t 5t 5t 5t 5t
1. Initial purchase(s) will be accounted for by means of the fair value method (or a
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t 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 stoc
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k purchases, the investor applies the equity method prospectively. The total fair
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value at the date significant influence is attained is compared to the investee‘s b
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ook value 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 comprehensiv
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e income (OCI) through the investment account and the investor‘s own OC
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I.
2. Income items such as discontinued operations that are reported separately by th
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e investee should be shown in the same manner by the investor. The materiality
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of these other investee income elements (as it affects the investor) continues to b
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e a criterion for separate disclosure.
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C. Investee losses 5t
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 recognize
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d 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
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to a zero balance. At that point, the equity method ceases to be applicable and th
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e fair-value method is subsequently used.
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D. Reporting the sale of an equity investment 5t 5t 5t 5t 5t 5t
1. The investor applies the equity method until the disposal date to establish a prope
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r book value. 5t 5t
2. Following the sale, the equity method continues to be appropriate if enough share
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s are still held to maintain the investor‘s ability to significantly influence the invest
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ee. If that ability has been lost, the fair-value method is subsequently used.
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2-24
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LLC.
,Solution Manual For All Chapters
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IV. Excess investment cost over book value acquired
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A. The price an investor pays for equity securities often differs significantly from th
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e 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. 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
B. Payments made in excess of underlying book value can sometimes be identified wit
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h 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 expe
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cted to be derived from the investment. In accounting, these amounts are presumed
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to reflect an intangible asset referred to as goodwill. Goodwill is calculated as any e
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xcess payment that is not attributable to specific identifiable assets and liabilities of
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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
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A. The investor‘s share of intra- 5t 5t 5t 5t
entity profits in ending inventory are not recognized until the transferred goods are eit
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her consumed or until they are resold to unrelated parties.
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B. Downstream sales of inventory 5t 5t 5t
1. ―Downstream‖ refers to transfers made by the investor to the investee. 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
2. Intra-
entity gross profits from sales are initially deferred under the equity method and
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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 percentag
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e multiplied by the markup on the merchandise remaining at the end of the yea
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r.
C. Upstream sales of inventory 5t 5t 5t
1. ―Upstream‖ refers to transfers made by the investee to the investor. 5t 5t 5t 5t 5t 5t 5t 5t 5t 5t
2. Under the equity method, the deferral process for intra- 5t 5t 5t 5t 5t 5t 5t 5t
entity gross profits is identical for upstream and downstream transfers. The proc
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edures are separately identified in Chapter One because the handling does vary
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within the consolidation process. 5t 5t 5t
Answers to Discussion Questions 5t 5t 5t
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 b
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e 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 ca
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se. Next, authoritative accounting literature (FASB ASC) or other relevant literature can be cons
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ulted as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting Stand
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ards 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 p
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ast so that accounting education is only a matter of learning to apply historically prescribed proc
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edures. However, in actual practice, the only real answer is often the one that provides the faire
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st representation of the firm‘s transactions. If an authoritative solution is not available, students s
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hould be directed to list all of the issues involved and the consequences of possible alternative
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actions. 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 sk
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ills in addressing issues that go beyond the purely mechanical elements of accounting.
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2-3
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LLC.
, 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 inc
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ome figures. With a large block of the investee‘s voting shares, an investor could influence the a
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mount and timing of the investee‘s dividend declarations. Thus, when enjoying a good earnings
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year, an investor might influence the investee to withhold declaring a dividend until needed in a
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subsequent year. Alternatively, if the investor judged that its current year earnings ―needed a bo
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ost,‖ it might influence the investee to declare a current year dividend. The equity method effecti
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vely removes managers‘ ability to increase current income (or defer income to future periods) thr
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ough their 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 be
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cause investee dividends are recorded as income by the investor. However, dividends paid typic
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ally are accompanied by a decrease in fair value (also recognized in income), thus leaving report
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ed net income unaffected.
5t 5t 5t
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 investm
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ent acquisition and the current percentage of ownership. Instead, they should be examining the
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actual interaction that currently exists between the two companies. Although the ability to exerci
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se significant influence over operating and financial policies appears to be a rather vague criterio
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n, ASC 323 "Investments—
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Equity Method and Joint Ventures," clearly specifies actual events that indicate this level of auth
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ority (paragraph 323-10-15-6):
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Ability to exercise that influence may be indicated in several ways, such as representation on th
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e board of directors, participation in policy-making processes, material intra-
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entity transactions, interchange of managerial personnel, or technological dependency. Another
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important consideration is the extent of ownership by an investor in relation to the concentration
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of other shareholdings, but substantial or majority ownership of the voting stock of an investee c
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ompany by another investor does not necessarily preclude the ability to exercise significant influ
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ence by the investor. 5t 5t 5t
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 Abrah
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am, Inc. If any individual from Highland's organization is on Abraham‘s board of directors or is pa
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rticipating 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 Hig
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hland 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 Highl
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and, the equity method should not be applied. This possibility seems especially likely in this case
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since one stockholder, James Abraham, continues to hold a majority (2/3) of the voting stock. T
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hus, evidence of the ability to apply significant influence must be present before the equity metho
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d is viewed as applicable. The mere holding of 1/3 of the stock is not conclusive.
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2-44
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LLC.
