Solution Manual For Advanced Accounting 15th Edition By Joe Ben Hoyle, Thomas Schaefer And Timothy Doupnik Chapter 1-19

Solution Manual For Advanced Accounting 15th Edition By Joe
Ben Hoyle, Thomas Schaefer And Timothy Doupnik Chapter
1-19

Chapter 1 The Equity Method Of Accounting For Investments

Chapter Outline

I. Four Methods Are Principally Used To Account For An Investment In Equity Securities
Along With a Fair Value Option.

A. Fair Value Method: Applied By An Investor When Only a Small Percentage
Of a Company‘s Voting Stock Is Held.

1. The Investor Recognizes Income When The Investee Declares a Dividend.

2. Portfolios Are Reported At Fair Value. If Fair Values Are Unavailable,
Investment Is Reported At Cost.

B. Cost Method: Applied To Investments Without a Readily Determinable Fair Value.
When The Fair Value Of An Investment In Equity Securities Is Not Readily
Determinable, And The Investment Provides Neither Significant Influence Nor
Control, The Investment May Be Measured At Cost. The Investment Remains At
Cost Unless

1. A Demonstrable Impairment Occurs For The Investment, Or

2. An Observable Price Change Occurs For Identical Or Similar Investments Of The
Same Issuer.
The Investor Typically Recognizes Its Share Of Investee Dividends Declared As
Dividend Income.

C. Consolidation: When One Firm Controls Another (e.g., When a Parent Has a
Majority Interest In The Voting Stock Of a Subsidiary Or Control Through Variable
Interests, Their Financial Statements Are Consolidated And Reported For The
Combined Entity.

D. Equity Method: Applied When The Investor Has The Ability To Exercise
Significant Influence Over Operating And Financial Policies Of The Investee.

1. Ability To Significantly Influence Investee Is Indicated By Several Factors
Including Representation On The Board Of Directors, Participation In Policy-
Making, Etc.

2. GAAP Guidelines Presume The Equity Method Is Applicable If 20 To 50 Percent Of The

, Outstanding Voting Stock Of The Investee Is Held By The Investor.

Current Financial Reporting Standards Allow Firms To Elect To Use Fair Value For Any
New Investment In Equity Shares Including Those Where The Equity Method Would
Otherwise Apply. However, The Option, Once Taken, Is Irrevocable. The Investor
Recognizes Both Investee Dividends And Changes In Fair Value Over Time As Income.



II. Accounting For An Investment: The Equity Method

A. The Investor Adjusts The Investment Account To Reflect All Changes In The Equity
Of The Investee Company.

B. The Investor Accrues Investee Income When It Is Reported In The Investee‘s
Financial Statements.

C. Dividends Declared By The Investee Create a Reduction In The Carrying Amount Of
The Investment Account. This Book Assumes All Investee Dividends Are Declared
And Paid In The Same Reporting Period.

III. Special Accounting Procedures Used In The Application Of The Equity Method
A. Reporting a Change To The Equity Method When The Ability To Significantly
Influence An Investee Is Achieved Through a Series Of Acquisitions.
1. Initial Purchase(s) Will Be Accounted For By Means Of The Fair Value Method
(Or At Cost) Until The Ability To Significantly Influence Is Attained.
2. When The Ability To Exercise Significant Influence Occurs Following a Series Of
Stock Purchases, The Investor Applies The Equity Method Prospectively. The
Total Fair Value At The Date Significant Influence Is Attained Is Compared To
The Investee‘s Book Value To Determine Future Excess Fair Value
Amortizations.
B. Investee Income From Other Than Continuing Operations
1. The Investor Recognizes Its Share Of Investee Reported Other
Comprehensive Income (OCI) Through The Investment Account And The
Investor‘s Own OCI.
2. Income Items Such As Discontinued Operations That Are Reported Separately By
The Investee Should Be Shown In The Same Manner By The Investor. The
Materiality Of These Other Investee Income Elements (As It Affects The Investor)
Continues To Be a Criterion For Separate Disclosure.
C. Investee Losses
1. Losses Reported By The Investee Create Corresponding Losses For The Investor.
2. A Permanent Decline In The Fair Value Of An Investee‘s Stock Should Be
Recognized Immediately By The Investor As An Impairment Loss.
3. Investee Losses Can Possibly Reduce The Carrying Value Of The Investment
Account To a Zero Balance. At That Point, The Equity Method Ceases To Be
Applicable And The Fair-Value Method Is Subsequently Used.
D. Reporting The Sale Of An Equity Investment
1. The Investor Applies The Equity Method Until The Disposal Date To Establish a
Proper Book Value.
2. Following The Sale, The Equity Method Continues To Be Appropriate If Enough
Shares Are Still Held To Maintain The Investor‘s Ability To Significantly Influence
The Investee. If That Ability Has Been Lost, The Fair-Value Method Is
Subsequently Used.

,IV. Excess Investment Cost Over Book Value Acquired
A. The Price An Investor Pays For Equity Securities Often Differs Significantly
From The Investee‘s Underlying Book Value Primarily Because The Historical
Cost Based Accounting Model Does Not Keep Track Of Changes In a Firm‘s
Fair Value.
B. Payments Made In Excess Of Underlying Book Value Can Sometimes Be Identified
With Specific Investee Accounts Such As Inventory Or Equipment.
C. An Extra Acquisition Price Can Also Be Assigned To Anticipated Benefits That Are
Expected To Be Derived From The Investment. In Accounting, These Amounts Are
Presumed To Reflect An Intangible Asset Referred To As Goodwill. Goodwill Is
Calculated As Any Excess Payment That Is Not Attributable To Specific Identifiable
Assets And Liabilities Of The Investee. Because Goodwill Is An Indefinite-Lived
Asset, It Is Not Amortized.

V. Deferral Of Intra-Entity Gross Profit In Inventory
A. The Investor‘s Share Of Intra-Entity Profits In Ending Inventory Are Not Recognized
Until The Transferred Goods Are Either Consumed Or Until They Are Resold To
Unrelated Parties.
B. Downstream Sales Of Inventory
1. ―Downstream‖ Refers To Transfers Made By The Investor To The Investee.
2. Intra-Entity Gross Profits From Sales Are Initially Deferred Under The Equity
Method And Then Recognized As Income At The Time Of The Inventory‘s
Eventual Disposal.
3. The Amount Of Gross Profit To Be Deferred Is The Investor‘s Ownership
Percentage Multiplied By The Markup On The Merchandise Remaining At The
End Of The Year.
C. Upstream Sales Of Inventory
1. ―Upstream‖ Refers To Transfers Made By The Investee To The Investor.
2. Under The Equity Method, The Deferral Process For Intra-Entity Gross Profits Is
Identical For Upstream And Downstream Transfers. The Procedures Are
Separately Identified In Chapter One Because The Handling Does Vary Within
The Consolidation Process.


Answers To Discussion Questions
The Textbook Includes Discussion Questions To Stimulate Student Thought And Discussion.
These Questions Are Also Designed To Allow Students To Consider Relevant Issues That Might
Otherwise Be Overlooked. Some Of These Questions May Be Addressed By The Instructor In
Class To Motivate Student Discussion. Students Should Be Encouraged To Begin By Defining
The Issue(s) In Each Case. Next, Authoritative Accounting Literature (FASB ASC) Or Other
Relevant Literature Can Be Consulted As a Preliminary Step In Arriving At Logical Actions.
Frequently, The Fasb Accounting Standards Codification Will Provide The Necessary Support.

Unfortunately, In Accounting, Definitive Resolutions To Financial Reporting Questions Are Not
Always Available. Students Often Seem To Believe That All Accounting Issues Have Been
Resolved In The Past So That Accounting Education Is Only a Matter Of Learning To Apply
Historically Prescribed Procedures. However, In Actual Practice, The Only Real Answer Is Often
The One That Provides The Fairest Representation Of The Firm‘s Transactions. If An
Authoritative Solution Is Not Available, Students Should Be Directed To List All Of The Issues
Involved And The Consequences Of Possible Alternative 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 Skills In Addressing Issues That Go Beyond The Purely Mechanical Elements Of
Accounting.
Did The Cost Method Invite Manipulation?
The Cost Method Of Accounting For Investments Often Caused a Lack Of Objectivity In Reported
Income Figures. With a Large Block Of The Investee‘s Voting Shares, An Investor Could
Influence The Amount And Timing Of The Investee‘s Dividend Declarations. Thus, When
Enjoying a Good Earnings Year, An Investor Might Influence The Investee To Withhold Declaring
a Dividend Until Needed In a Subsequent Year. Alternatively, If The Investor Judged That Its
Current Year Earnings ―Needed a Boost,‖ It Might Influence The Investee To Declare a Current
Year Dividend. The Equity Method Effectively Removes Managers‘ Ability To Increase Current
Income (Or Defer Income To Future Periods) Through Their Influence Over The Timing And
Amounts Of Investee Dividend Declarations.
At First Glance It May Seem That The Fair Value Method Allows Managers To Manipulate
Income Because Investee Dividends Are Recorded As Income By The Investor. However,
Dividends Paid Typically Are Accompanied By a Decrease In Fair Value (Also Recognized In
Income), Thus Leaving Reported Net Income Unaffected.

Does The Equity Method Really Apply Here?
The Discussion In The Case Between The Two Accountants Is Limited To The Reason For The
Investment Acquisition And The Current Percentage Of Ownership. Instead, They Should Be
Examining The Actual Interaction That Currently Exists Between The Two Companies. Although
The Ability To Exercise Significant Influence Over Operating And Financial Policies Appears To
Be a Rather Vague Criterion, Asc 323 "Investments—Equity Method And Joint Ventures," Clearly
Specifies Actual Events That Indicate This Level Of Authority (Paragraph 323-10-15-6):

Ability To Exercise That Influence May Be Indicated In Several Ways, Such As Representation
On The Board Of Directors, Participation In Policy-Making Processes, Material Intra-Entity
Transactions, Interchange Of Managerial Personnel, Or Technological Dependency. Another
Important Consideration Is The Extent Of Ownership By An Investor In Relation To The
Concentration Of Other Shareholdings, But Substantial Or Majority Ownership Of The Voting
Stock Of An Investee Company By Another Investor Does Not Necessarily Preclude The Ability
To Exercise Significant Influence By The Investor.

In This Case, The Accountants Would Be Wise To Determine Whether Dennis Bostitch Or Any
Other Member Of The Highland Laboratories Administration Is Participating In The Management
Of Abraham, Inc. If Any Individual From Highland's Organization Is On Abraham‘s Board Of
Directors Or Is Participating In Management Decisions, The Equity Method Would Seem To Be
Appropriate.
Likewise, If Significant Transactions Have Occurred Between The Companies (Such As Loans By
Highland To Abraham), The Ability To Apply Significant Influence Becomes Much More Evident.

However, If James Abraham Continues To Operate Abraham, Inc., With Little Or No Regard For
Highland, The Equity Method Should Not Be Applied. This Possibility Seems Especially Likely In
This Case Since One Stockholder, James Abraham, Continues To Hold a Majority (2/3) Of The
Voting Stock. Thus, Evidence Of The Ability To Apply Significant Influence Must Be Present
Before The Equity Method Is Viewed As Applicable. The Mere Holding Of 1/3 Of The Stock Is Not
Conclusive.




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