Advanced Accounting 14th Edition by Joe Ben Hoyle, Thomas Schaefer, Timothy Doupnik | A+ Solution Manual

Solution Manual For All Chapters
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SOLUTION MANUAL FOR .xi . xi




ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS .xi .xi .xi .xi .xi .xi .xi .xi




SCHAEFER AND TIMOTHY DOUPNIK
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CHAPTER 1-19 .xi




CHAPTER1 i
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THEEQUITYMETHODOFACCOUNTING FORINVESTMENTS
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Chapter Outline .xi




I. Four methods are principally used to account for an investment in equity securities along
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with a fair value option.
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A. Fair value method: applied by an investor when only a small percentage of a
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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 is .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




reported at cost. .xi .xi .xi




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 the
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investment provides neither significant influence nor control, the investment may be
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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 same
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issuer. .xi




The investor typically recognizes its share of investee dividends declared as dividend
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income.
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C. Consolidation: when one firm controls another (e.g., when a parent has a majority .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




interest in the voting stock of a subsidiary or control through variable interests, their
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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 significant
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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 .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




2-1
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, outstanding voting stock of the investee is held by the investor. .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




Current financial reporting standards allow firms to elect to use fair value for any new
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investment in equity shares including those where the equity method would otherwise
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apply. However, the option, once taken, is irrevocable. The investor recognizes both
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investee dividends and changes in fair value over time as income.
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II. Accounting for an investment: the equity method .xi .xi .xi .xi .xi .xi




A. The investor adjusts the investment account to reflect all changes in the equity of the
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investee company.
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B. The investor accrues investee income when it is reported in the investee‘s financial
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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 paid
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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 an
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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 at
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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 stock
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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
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book value to determine future excess fair value amortizations.
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B. Investee income from other than continuing operations .xi .xi .xi .xi .xi .xi




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 .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




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 .xi




1. Losses reported by the investee create corresponding losses for the investor. .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




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 .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




to a zero balance. At that point, the equity method ceases to be applicable and the
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fair-value method is subsequently used.
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D. Reporting the sale of an equity investment .xi .xi .xi .xi .xi .xi




1. The investor applies the equity method until the disposal date to establish a proper
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book value. .xi .xi




2. Following the sale, the equity method continues to be appropriate if enough shares .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




are still held to maintain the investor‘s ability to significantly influence the investee.
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If that ability has been lost, the fair-value method is subsequently used.
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2-24
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,Solution Manual For All Chapters .xi .xi .xi .xi




IV. Excess investment cost over book value acquired .xi .xi .xi .xi .xi .xi




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 .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




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
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expected to be derived from the investment. In accounting, these amounts are
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presumed to reflect an intangible asset referred to as goodwill. Goodwill is calculated
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as any excess payment that is not attributable to specific identifiable assets and
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liabilities of the investee. Because goodwill is an indefinite-lived asset, it is not
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amortized. .xi




V. Deferral of intra-entity gross profit in inventory .xi .xi .xi .xi .xi .xi




A. The investor‘s share of intra-entity profits in ending inventory are not recognized until
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the transferred goods are either consumed or until they are resold to unrelated parties.
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B. Downstream sales of inventory .xi .xi .xi




1. ―Downstream‖ refers to transfers made by the investor to the investee. .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




2. Intra-entity gross profits from sales are initially deferred under the equity method .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




and 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 .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




multiplied by the markup on the merchandise remaining at the end of the year.
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C. Upstream sales of inventory .xi .xi .xi




1. ―Upstream‖ refers to transfers made by the investee to the investor. .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




2. Under the equity method, the deferral process for intra-entity gross profits is .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi .xi




identical for upstream and downstream transfers. The procedures are separately
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identified in Chapter One because the handling does vary within the consolidation
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process. .xi




Answers to Discussion Questions .xi .xi .xi




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
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student discussion. Students should be encouraged to begin by defining the issue(s) in each
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case. Next, authoritative accounting literature (FASB ASC) or other relevant literature can be
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consulted as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting
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Standards 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
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past so that accounting education is only a matter of learning to apply historically prescribed
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procedures. However, in actual practice, the only real answer is often the one that provides the
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fairest representation of the firm‘s transactions. If an authoritative solution is not available,
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students should be directed to list all of the issues involved and the consequences of possible
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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
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in addressing issues that go beyond the purely mechanical elements of accounting.
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2-3
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, 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
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income figures. With a large block of the investee‘s voting shares, an investor could influence the
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amount 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
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boost,‖ it might influence the investee to declare a current year dividend. The equity method
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effectively removes managers‘ ability to increase current income (or defer income to future
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periods) through 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
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because investee dividends are recorded as income by the investor. However, dividends paid
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typically are accompanied by a decrease in fair value (also recognized in income), thus leaving
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reported net income unaffected.
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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
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significant influence over operating and financial policies appears to be a rather vague criterion,
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ASC 323 "Investments—Equity Method and Joint Ventures," clearly specifies actual events that
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indicate 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
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board of directors, participation in policy-making processes, material intra-entity transactions,
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interchange of managerial personnel, or technological dependency. Another important
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consideration is the extent of ownership by an investor in relation to the concentration of other
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shareholdings, but substantial or majority ownership of the voting stock of an investee company
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by another investor does not necessarily preclude the ability to exercise significant influence by
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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
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Abraham, Inc. If any individual from Highland's organization is on Abraham‘s board of directors or
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is participating 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
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Highland 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
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Highland, the equity method should not be applied. This possibility seems especially likely in this
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case since one stockholder, James Abraham, continues to hold a majority (2/3) of the voting
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.stock. Thus, evidence of the ability to apply significant influence must be present before the equity
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method 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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