SOLUTIONS MANUAL for Advanced Accounting, 15th Edition by Joe Ben Hoyle, Schaefer and Doupnik | Complete 19 Chapters

h Solution Manual For All Chapters
h h h h




SOLUTION MANUAL FOR h h




ADVANCED ACCOUNTING 15TH EDITION BY JOE BEN HOYLE, THOMAS
h h h h h h h h


SCHAEFER AND TIMOTHY DOUPNIK
h h h h




CHAPTER 1-19 h




CHAPTER 1 h




hTHE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
h h h h h h




Chapter Outline h




I. Four methods are principally used to account for an investment in equity securities
h h h h h h h h h h h h


along with a fair value option.
h h h h h h




A. Fair value method: applied by an investor when only a small percentage of
h h h h h h h h h h h h


a company‘s voting stock is held.
h h h h h h




1. The investor recognizes income when the investee declares a dividend.
h h h h h h h h h




2. Portfolios are reported at fair value. If fair values are unavailable, investment
h h h h h h h h h h h


is reported at cost.
h h h h




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


the fair value of an investment in equity securities is not readily determinable, and
h h h h h h h h h h h h h h


the investment provides neither significant influence nor control, the investment may
h h h h h h h h h h h


be measured at cost. The investment remains at cost unless
h h h h h h h h h h




1. A demonstrable impairment occurs for the investment, or
h h h h h h h




2. An observable price change occurs for identical or similar investments of the
h h h h h h h h h h h


same issuer. h h




The investor typically recognizes its share of investee dividends declared as dividend
h h h h h h h h h h h


income.
h




C. Consolidation: when one firm controls another (e.g., when a parent has a majority h h h h h h h h h h h h


interest in the voting stock of a subsidiary or control through variable interests,
h h h h h h h h h h h h h


their financial statements are consolidated and reported for the combined entity.
h h h h h h h h h h h




D. Equity method: applied when the investor has the ability to exercise
h h h h h h h h h h


significant influence over operating and financial policies of the investee.
h h h h h h h h h h




1. Ability to significantly influence investee is indicated by several factors including
h h h h h h h h h h


representation on the board of directors, participation in policy-making, etc.
h h h h h h h h h h




2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
h h h h h h h h h h h h h h




2-1
© hMcGraw hHill hLLC. hAll hrights hreserved. hNo hreproduction hor hdistribution hwithout hthe hprior hwritten hconsent hof hMcGraw hHill
LLC.

, outstanding voting stock of the investee is held by the investor. h h h h h h h h h h




Current financial reporting standards allow firms to elect to use fair value for any new
h h h h h h h h h h h h h h


investment in equity shares including those where the equity method would otherwise
h h h h h h h h h h h h


apply. However, the option, once taken, is irrevocable. The investor recognizes both
h h h h h h h h h h h h


investee dividends and changes in fair value over time as income.
h h h h h h h h h h h




II. Accounting for an investment: the equity method
h h h h h h




A. The investor adjusts the investment account to reflect all changes in the equity of
h h h h h h h h h h h h h


the investee company.
h h h




B. The investor accrues investee income when it is reported in the investee‘s
h h h h h h h h h h h


financial statements.
h h




C. Dividends declared by the investee create a reduction in the carrying amount of the
h h h h h h h h h h h h h


Investment account. This book assumes all investee dividends are declared and
h h h h h h h h h h h


paid in the same reporting period.
h h h h h h




III. Special accounting procedures used in the application of the equity method
h h h h h h h h h h


A. Reporting a change to the equity method when the ability to significantly influence
h h h h h h h h h h h h


an investee is achieved through a series of acquisitions.
h h h h h h h h h


1. Initial purchase(s) will be accounted for by means of the fair value method (or
h h h h h h h h h h h h h


at cost) until the ability to significantly influence is attained.
h h h h h h h h h h


2. When the ability to exercise significant influence occurs following a series of
h h h h h h h h h h h


stock purchases, the investor applies the equity method prospectively. The total
h h h h h h h h h h h


fair value at the date significant influence is attained is compared to the
h h h h h h h h h h h h h


investee‘s book value to determine future excess fair value amortizations.
h h h h h h h h h h


B. Investee income from other than continuing operations
h h h h h h


1. The investor recognizes its share of investee reported other comprehensive
h h h h h h h h h


income (OCI) through the investment account and the investor‘s own OCI.
h h h h h h h h h h h


2. Income items such as discontinued operations that are reported separately by
h h h h h h h h h h


the investee should be shown in the same manner by the investor. The
h h h h h h h h h h h h h


materiality of these other investee income elements (as it affects the investor)
h h h h h h h h h h h h


continues to be a criterion for separate disclosure.
h h h h h h h h


C. Investee losses h


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


2. A permanent decline in the fair value of an investee‘s stock should be
h h h h h h h h h h h h


recognized immediately by the investor as an impairment loss.
h h h h h h h h h


3. Investee losses can possibly reduce the carrying value of the investment account
h h h h h h h h h h h


to a zero balance. At that point, the equity method ceases to be applicable and
h h h h h h h h h h h h h h h


the fair-value method is subsequently used.
h h h h h h


D. Reporting the sale of an equity investment h h h h h h


1. The investor applies the equity method until the disposal date to establish a
h h h h h h h h h h h h


proper book value.
h h h


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


shares are still held to maintain the investor‘s ability to significantly influence the
h h h h h h h h h h h h h


investee. If that ability has been lost, the fair-value method is subsequently used.
h h h h h h h h h h h h h




2-24
© hMcGraw hHill hLLC. hAll hrights hreserved. hNo hreproduction hor hdistribution hwithout hthe hprior hwritten hconsent hof hMcGraw hHill
LLC.

,Solution Manual For All Chapters
h h h h




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


A. The price an investor pays for equity securities often differs significantly from
h h h h h h h h h h h


the investee‘s underlying book value primarily because the historical cost
h h h h h h h h h h


based accounting model does not keep track of changes in a firm‘s fair value.
h h h h h h h h h h h h h h


B. Payments made in excess of underlying book value can sometimes be identified
h h h h h h h h h h h


with specific investee accounts such as inventory or equipment.
h h h h h h h h h


C. An extra acquisition price can also be assigned to anticipated benefits that are
h h h h h h h h h h h h


expected to be derived from the investment. In accounting, these amounts are
h h h h h h h h h h h h


presumed to reflect an intangible asset referred to as goodwill. Goodwill is
h h h h h h h h h h h h


calculated as any excess payment that is not attributable to specific identifiable
h h h h h h h h h h h h


assets and liabilities of the investee. Because goodwill is an indefinite-lived asset, it
h h h h h h h h h h h h h


is not amortized.
h h h




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


A. The investor‘s share of intra-entity profits in ending inventory are not recognized until
h h h h h h h h h h h h


the transferred goods are either consumed or until they are resold to unrelated
h h h h h h h h h h h h h


parties. h


B. Downstream sales of inventory h h h


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


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


method and then recognized as income at the time of the inventory‘s eventual
h h h h h h h h h h h h h


disposal. h


3. The amount of gross profit to be deferred is the investor‘s ownership
h h h h h h h h h h h


percentage multiplied by the markup on the merchandise remaining at the end
h h h h h h h h h h h h


of the year. h h h


C. Upstream sales of inventory h h h


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


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


identical for upstream and downstream transfers. The procedures are separately
h h h h h h h h h h


identified in Chapter One because the handling does vary within the
h h h h h h h h h h h


consolidation process. h h




Answers to Discussion Questions
h h h




The textbook includes discussion questions to stimulate student thought and discussion. These
h h h h h h h h h h h


questions are also designed to allow students to consider relevant issues that might otherwise
h h h h h h h h h h h h h h


be overlooked. Some of these questions may be addressed by the instructor in class to
h h h h h h h h h h h h h h h


motivate student discussion. Students should be encouraged to begin by defining the issue(s) in
h h h h h h h h h h h h h h


each case. Next, authoritative accounting literature (FASB ASC) or other relevant literature can
h h h h h h h h h h h h h


be consulted as a preliminary step in arriving at logical actions. Frequently, the FASB
h h h h h h h h h h h h h h


Accounting Standards Codification will provide the necessary support.
h h h h h h h h




Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
h h h h h h h h h h h


available. Students often seem to believe that all accounting issues have been resolved in the
h h h h h h h h h h h h h h h


past so that accounting education is only a matter of learning to apply historically prescribed
h h h h h h h h h h h h h h h


procedures. However, in actual practice, the only real answer is often the one that provides the
h h h h h h h h h h h h h h h h


fairest representation of the firm‘s transactions. If an authoritative solution is not available,
h h h h h h h h h h h h h


students should be directed to list all of the issues involved and the consequences of possible
h h h h h h h h h h h h h h h h


alternative actions. The various factors presented can be weighed to produce a viable solution.
h h h h h h h h h h h h h h




The discussion questions are designed to help students develop research and critical thinking
h h h h h h h h h h h h


skills in addressing issues that go beyond the purely mechanical elements of accounting.
h h h h h h h h h h h h h




2-3
© hMcGraw hHill hLLC. hAll hrights hreserved. hNo hreproduction hor hdistribution hwithout hthe hprior hwritten hconsent hof hMcGraw hHill
LLC.

, Did the Cost Method Invite Manipulation?
h h h h h


The cost method of accounting for investments often caused a lack of objectivity in reported
h h h h h h h h h h h h h h


income figures. With a large block of the investee‘s voting shares, an investor could influence
h h h h h h h h h h h h h h h


the amount and timing of the investee‘s dividend declarations. Thus, when enjoying a good
h h h h h h h h h h h h h h


earnings year, an investor might influence the investee to withhold declaring a dividend until
h h h h h h h h h h h h h h


needed in a subsequent year. Alternatively, if the investor judged that its current year earnings
h h h h h h h h h h h h h h h


―needed a boost,‖ it might influence the investee to declare a current year dividend. The equity
h h h h h h h h h h h h h h h h


method effectively removes managers‘ ability to increase current income (or defer income to
h h h h h h h h h h h h h


future periods) through their influence over the timing and amounts of investee dividend
h h h h h h h h h h h h h


declarations.
h


At first glance it may seem that the fair value method allows managers to manipulate income
h h h h h h h h h h h h h h h


because investee dividends are recorded as income by the investor. However, dividends paid
h h h h h h h h h h h h h


typically are accompanied by a decrease in fair value (also recognized in income), thus leaving
h h h h h h h h h h h h h h h


reported net income unaffected.
h h h h




Does the Equity Method Really Apply Here?
h h h h h h


The discussion in the case between the two accountants is limited to the reason for the
h h h h h h h h h h h h h h h


investment acquisition and the current percentage of ownership. Instead, they should be
h h h h h h h h h h h h


examining the actual interaction that currently exists between the two companies. Although the
h h h h h h h h h h h h h


ability to exercise significant influence over operating and financial policies appears to be a
h h h h h h h h h h h h h h


rather vague criterion, ASC 323 "Investments—Equity Method and Joint Ventures," clearly
h h h h h h h h h h h


specifies actual events that indicate this level of authority (paragraph 323-10-15-6):
h h h h h h h h h h h




Ability to exercise that influence may be indicated in several ways, such as representation on the
h h h h h h h h h h h h h h h


board of directors, participation in policy-making processes, material intra-entity transactions,
h h h h h h h h h h


interchange of managerial personnel, or technological dependency. Another important
h h h h h h h h h


consideration is the extent of ownership by an investor in relation to the concentration of other
h h h h h h h h h h h h h h h h


shareholdings, but substantial or majority ownership of the voting stock of an investee company
h h h h h h h h h h h h h h


by another investor does not necessarily preclude the ability to exercise significant influence by
h h h h h h h h h h h h h h


the investor.
h h




In this case, the accountants would be wise to determine whether Dennis Bostitch or any other
h h h h h h h h h h h h h h h


hmember of the Highland Laboratories administration is participating in the management of
h h h h h h h h h h h


hAbraham, Inc. If any individual from Highland's organization is on Abraham‘s board of directors
h h h h h h h h h h h h h


hor is participating in management decisions, the equity method would seem to be appropriate.
h h h h h h h h h h h h h


Likewise, if significant transactions have occurred between the companies (such as loans by
h h h h h h h h h h h h


hHighland to Abraham), the ability to apply significant influence becomes much more evident.
h h h h h h h h h h h h




However, if James Abraham continues to operate Abraham, Inc., with little or no regard for
h h h h h h h h h h h h h h


Highland, the equity method should not be applied. This possibility seems especially likely in this
h h h h h h h h h h h h h h h


case since one stockholder, James Abraham, continues to hold a majority (2/3) of the voting
h h h h h h h h h h h h h h h


hstock. Thus, evidence of the ability to apply significant influence must be present before the
h h h h h h h h h h h h h h


equity method is viewed as applicable. The mere holding of 1/3 of the stock is not conclusive.
h h h h h h h h h h h h h h h h h




2-44
© hMcGraw hHill hLLC. hAll hrights hreserved. hNo hreproduction hor hdistribution hwithout hthe hprior hwritten hconsent hof hMcGraw hHill
LLC.