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