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

Solution Manual forAdvanced Accounting, 14th Edition, Joe
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Ben Hoyle, Thomas Schaefer, Timothy Doupnik, ISBN10:
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1260247821, ISBN13: 9781260247824
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1-1
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,Chapter Outline
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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 company’s
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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
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reported at cost.c c c



B. Cost Method: applied to investments without a readily determinable fair value. When the
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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. c


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 c c c c c c c c c c c c


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 influence
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over operating and financial policies of the investee.
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3. 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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4. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
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outstanding voting stock of the investee is held by the investor.
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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 apply.
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However, the option, once taken, is irrevocable. The investor recognizes both investee
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dividends and changes in fair value over time as income.
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II. Accounting for an investment: the equity method c c c c c c


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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1-2

,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 value
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at the date significant influence is attained is compared to the investee’s book value
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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 comprehensive income
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(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
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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 c


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 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
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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
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1. The investor applies the equity method until the disposal date to establish a proper
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book value.
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2. Following the sale, the equity method continues to be appropriate if enough shares
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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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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 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
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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.
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1-3
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, V. Deferral of intra-entity gross profit in inventory c c c c c c


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 c c c


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


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


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


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


2. Under the equity method, the deferral process for intra-entity gross profits is identical
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for upstream and downstream transfers. The procedures are separately identified
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in Chapter One because the handling does vary within the consolidation process.
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Answers to Discussion Questions c c c



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 case.
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Next, authoritative accounting literature (FASB ASC) or other relevant literature can be consulted
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as a 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 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 past
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so 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.
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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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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
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figures. With a large block of the investee’s voting shares, an investor could influence the amount
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and timing of the investee’s dividend declarations. Thus, when enjoying a good earnings year, an
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investor might influence the investee to withhold declaring a dividend until needed in a subsequent
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year. Alternatively, if the investor judged that its current year earnings ―needed a boost,‖ it might
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influence the investee to declare a current year dividend. The equity method effectively removes
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managers’ ability to increase current income (or defer income to future periods) through their
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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
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paid
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1-4