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