Solution Manual forAdvanced Accounting, 14th Edition, Joe
c c c c c c c
Ben Hoyle, Thomas Schaefer, Timothy Doupnik, ISBN10:
c c c c c c c
1260247821, ISBN13: 9781260247824
c c c
1-1
.
,Chapter Outline
c
I. Four methods are principally used to account for an investment in equity securities along
c c c c c c c c c c c c c
with a fair value option.
c c c c c
A. Fair value method: applied by an investor when only a small percentage of a company’s
c c c c c c c c c c c c c c
voting stock is held.
c c c c
1. The investor recognizes income when the investee declares a dividend.
c c c c c c c c c
2. Portfolios are reported at fair value. If fair values are unavailable, investment is
c c c c c c c c c c c c
reported at cost.c c c
B. Cost Method: applied to investments without a readily determinable fair value. When the
c c c c c c c c c c c c
fair value of an investment in equity securities is not readily determinable, and the
c c c c c c c c c c c c c c
investment provides neither significant influence nor control, the investment may be
c c c c c c c c c c c
measured at cost. The investment remains at cost unless
c c c c c c c c c
1. A demonstrable impairment occurs for the investment, or
c c c c c c c
2. An observable price change occurs for identical or similar investments of the same
c c c c c c c c c c c c
issuer. c
The investor typically recognizes its share of investee dividends declared as dividend
c c c c c c c c c c c
income.
c
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
c c c c c c c c c c c c c c
financial statements are consolidated and reported for the combined entity.
c c c c c c c c c c
D. Equity method: applied when the investor has the ability to exercise significant influence
c c c c c c c c c c c c
over operating and financial policies of the investee.
c c c c c c c c
3. Ability to significantly influence investee is indicated by several factors including
c c c c c c c c c c
representation on the board of directors, participation in policy-making, etc.
c c c c c c c c c c
4. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
c c c c c c c c c c c c c c
outstanding voting stock of the investee is held by the investor.
c c c c c c c c c c c
Current financial reporting standards allow firms to elect to use fair value for any new
c c c c c c c c c c c c c c
investment in equity shares including those where the equity method would otherwise apply.
c c c c c c c c c c c c c
However, the option, once taken, is irrevocable. The investor recognizes both investee
c c c c c c c c c c c c
dividends and changes in fair value over time as income.
c c c c c c c c c c
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
c c c c c c c c c c c c c c
investee company.
c c
B. The investor accrues investee income when it is reported in the investee’s financial
c c c c c c c c c c c c
statements.
c
C. Dividends declared by the investee create a reduction in the carrying amount of the
c c c c c c c c c c c c c
Investment account. This book assumes all investee dividends are declared and paid
c c c c c c c c c c c c
in the same reporting period.
c c c c c
1-2
,III. Special accounting procedures used in the application of the equity method
c c c c c c c c c c
A. Reporting a change to the equity method when the ability to significantly influence an
c c c c c c c c c c c c c
investee is achieved through a series of acquisitions.
c c c c c c c c
1. Initial purchase(s) will be accounted for by means of the fair value method (or at
c c c c c c c c c c c c c c
cost) until the ability to significantly influence is attained.
c c c c c c c c c
2. When the ability to exercise significant influence occurs following a series of stock
c c c c c c c c c c c c
purchases, the investor applies the equity method prospectively. The total fair value
c c c c c c c c c c c c
at the date significant influence is attained is compared to the investee’s book value
c c c c c c c c c c c c c c
to determine future excess fair value amortizations.
c c c c c c c
B. Investee income from other than continuing operations
c c c c c c
1. The investor recognizes its share of investee reported other comprehensive income
c c c c c c c c c c
(OCI) through the investment account and the investor’s own OCI.
c c c c c c c c c c
2. Income items such as discontinued operations that are reported separately by the
c c c c c c c c c c c
investee should be shown in the same manner by the investor. The materiality of
c c c c c c c c c c c c c c
these other investee income elements (as it affects the investor) continues to be a
c c c c c c c c c c c c c c
criterion for separate disclosure.
c c c c
C. Investee losses c
1. Losses reported by the investee create corresponding losses for the investor.
c c c c c c c c c c
2. A permanent decline in the fair value of an investee’s stock should be recognized
c c c c c c c c c c c c c
immediately by the investor as an impairment loss.
c c c c c c c c
3. Investee losses can possibly reduce the carrying value of the investment account to
c c c c c c c c c c c c
a zero balance. At that point, the equity method ceases to be applicable and the
c c c c c c c c c c c c c c c
fair-value method is subsequently used.
c c c c c
D. Reporting the sale of an equity investment
c c c c c c
1. The investor applies the equity method until the disposal date to establish a proper
c c c c c c c c c c c c c
book value.
c c
2. Following the sale, the equity method continues to be appropriate if enough shares
c c c c c c c c c c c c
are still held to maintain the investor’s ability to significantly influence the investee.
c c c c c c c c c c c c c
If that ability has been lost, the fair-value method is subsequently used.
c c c c c c c c c c c c
IV. Excess investment cost over book value acquired
c c c c c c
A. The price an investor pays for equity securities often differs significantly from the
c c c c c c c c c c c c
investee’s underlying book value primarily because the historical cost based
c c c c c c c c c c
accounting model does not keep track of changes in a firm’s fair value.
c c c c c c c c c c c c c
B. Payments made in excess of underlying book value can sometimes be identified with
c c c c c c c c c c c c
specific investee accounts such as inventory or equipment.
c c c c c c c c
C. An extra acquisition price can also be assigned to anticipated benefits that are
c c c c c c c c c c c c
expected to be derived from the investment. In accounting, these amounts are
c c c c c c c c c c c c
presumed to reflect an intangible asset referred to as goodwill. Goodwill is calculated
c c c c c c c c c c c c c
as any excess payment that is not attributable to specific identifiable assets and
c c c c c c c c c c c c c
liabilities of the investee. Because goodwill is an indefinite-lived asset, it is not
c c c c c c c c c c c c c
amortized.
c
1-3
.
, 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
c c c c c c c c c c c c
the transferred goods are either consumed or until they are resold to unrelated parties.
c c c c c c c c c c c c c c
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.
c c c c c c c c c c c c
3. The amount of gross profit to be deferred is the investor’s ownership percentage
c c c c c c c c c c c c
multiplied by the markup on the merchandise remaining at the end of the year.
c c c c c c c c c c c c c c
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
c c c c c c c c c c c c
for upstream and downstream transfers. The procedures are separately identified
c c c c c c c c c c
in Chapter One because the handling does vary within the consolidation process.
c c c c c c c c c c c c
Answers to Discussion Questions c c c
The textbook includes discussion questions to stimulate student thought and discussion. These
c c c c c c c c c c c
questions are also designed to allow students to consider relevant issues that might otherwise be
c c c c c c c c c c c c c c c
overlooked. Some of these questions may be addressed by the instructor in class to motivate
c c c c c c c c c c c c c c c
student discussion. Students should be encouraged to begin by defining the issue(s) in each case.
c c c c c c c c c c c c c c c
Next, authoritative accounting literature (FASB ASC) or other relevant literature can be consulted
c c c c c c c c c c c c c
as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting Standards
c c c c c c c c c c c c c c
Codification will provide the necessary support.
c c c c c c
Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
c c c c c c c c c c c
available. Students often seem to believe that all accounting issues have been resolved in the past
c c c c c c c c c c c c c c c c
so that accounting education is only a matter of learning to apply historically prescribed procedures.
c c c c c c c c c c c c c c c
However, in actual practice, the only real answer is often the one that provides the fairest
c c c c c c c c c c c c c c c c
representation of the firm’s transactions. If an authoritative solution is not available, students should
c c c c c c c c c c c c c c
be directed to list all of the issues involved and the consequences of possible alternative actions.
c c c c c c c c c c c c c c c c
The various factors presented can be weighed to produce a viable solution.
c c c c c c c c c c c c
The discussion questions are designed to help students develop research and critical thinking skills
c c c c c c c c c c c c c
in addressing issues that go beyond the purely mechanical elements of accounting.
c c c c c c c c c c c c
Did the Cost Method Invite Manipulation?
c c c c c
The cost method of accounting for investments often caused a lack of objectivity in reported income
c c c c c c c c c c c c c c c
figures. With a large block of the investee’s voting shares, an investor could influence the amount
c c c c c c c c c c c c c c c c
and timing of the investee’s dividend declarations. Thus, when enjoying a good earnings year, an
c c c c c c c c c c c c c c c
investor might influence the investee to withhold declaring a dividend until needed in a subsequent
c c c c c c c c c c c c c c c
year. Alternatively, if the investor judged that its current year earnings ―needed a boost,‖ it might
c c c c c c c c c c c c c c c c
influence the investee to declare a current year dividend. The equity method effectively removes
c c c c c c c c c c c c c c
managers’ ability to increase current income (or defer income to future periods) through their
c c c c c c c c c c c c c c
influence over the timing and amounts of investee dividend declarations.
c c c c c c c c c c
At first glance it may seem that the fair value method allows managers to manipulate income
c c c c c c c c c c c c c c c
because investee dividends are recorded as income by the investor. However, dividends
c c c c c c c c c c c c
paid
c
1-4
c c c c c c c
Ben Hoyle, Thomas Schaefer, Timothy Doupnik, ISBN10:
c c c c c c c
1260247821, ISBN13: 9781260247824
c c c
1-1
.
,Chapter Outline
c
I. Four methods are principally used to account for an investment in equity securities along
c c c c c c c c c c c c c
with a fair value option.
c c c c c
A. Fair value method: applied by an investor when only a small percentage of a company’s
c c c c c c c c c c c c c c
voting stock is held.
c c c c
1. The investor recognizes income when the investee declares a dividend.
c c c c c c c c c
2. Portfolios are reported at fair value. If fair values are unavailable, investment is
c c c c c c c c c c c c
reported at cost.c c c
B. Cost Method: applied to investments without a readily determinable fair value. When the
c c c c c c c c c c c c
fair value of an investment in equity securities is not readily determinable, and the
c c c c c c c c c c c c c c
investment provides neither significant influence nor control, the investment may be
c c c c c c c c c c c
measured at cost. The investment remains at cost unless
c c c c c c c c c
1. A demonstrable impairment occurs for the investment, or
c c c c c c c
2. An observable price change occurs for identical or similar investments of the same
c c c c c c c c c c c c
issuer. c
The investor typically recognizes its share of investee dividends declared as dividend
c c c c c c c c c c c
income.
c
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
c c c c c c c c c c c c c c
financial statements are consolidated and reported for the combined entity.
c c c c c c c c c c
D. Equity method: applied when the investor has the ability to exercise significant influence
c c c c c c c c c c c c
over operating and financial policies of the investee.
c c c c c c c c
3. Ability to significantly influence investee is indicated by several factors including
c c c c c c c c c c
representation on the board of directors, participation in policy-making, etc.
c c c c c c c c c c
4. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
c c c c c c c c c c c c c c
outstanding voting stock of the investee is held by the investor.
c c c c c c c c c c c
Current financial reporting standards allow firms to elect to use fair value for any new
c c c c c c c c c c c c c c
investment in equity shares including those where the equity method would otherwise apply.
c c c c c c c c c c c c c
However, the option, once taken, is irrevocable. The investor recognizes both investee
c c c c c c c c c c c c
dividends and changes in fair value over time as income.
c c c c c c c c c c
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
c c c c c c c c c c c c c c
investee company.
c c
B. The investor accrues investee income when it is reported in the investee’s financial
c c c c c c c c c c c c
statements.
c
C. Dividends declared by the investee create a reduction in the carrying amount of the
c c c c c c c c c c c c c
Investment account. This book assumes all investee dividends are declared and paid
c c c c c c c c c c c c
in the same reporting period.
c c c c c
1-2
,III. Special accounting procedures used in the application of the equity method
c c c c c c c c c c
A. Reporting a change to the equity method when the ability to significantly influence an
c c c c c c c c c c c c c
investee is achieved through a series of acquisitions.
c c c c c c c c
1. Initial purchase(s) will be accounted for by means of the fair value method (or at
c c c c c c c c c c c c c c
cost) until the ability to significantly influence is attained.
c c c c c c c c c
2. When the ability to exercise significant influence occurs following a series of stock
c c c c c c c c c c c c
purchases, the investor applies the equity method prospectively. The total fair value
c c c c c c c c c c c c
at the date significant influence is attained is compared to the investee’s book value
c c c c c c c c c c c c c c
to determine future excess fair value amortizations.
c c c c c c c
B. Investee income from other than continuing operations
c c c c c c
1. The investor recognizes its share of investee reported other comprehensive income
c c c c c c c c c c
(OCI) through the investment account and the investor’s own OCI.
c c c c c c c c c c
2. Income items such as discontinued operations that are reported separately by the
c c c c c c c c c c c
investee should be shown in the same manner by the investor. The materiality of
c c c c c c c c c c c c c c
these other investee income elements (as it affects the investor) continues to be a
c c c c c c c c c c c c c c
criterion for separate disclosure.
c c c c
C. Investee losses c
1. Losses reported by the investee create corresponding losses for the investor.
c c c c c c c c c c
2. A permanent decline in the fair value of an investee’s stock should be recognized
c c c c c c c c c c c c c
immediately by the investor as an impairment loss.
c c c c c c c c
3. Investee losses can possibly reduce the carrying value of the investment account to
c c c c c c c c c c c c
a zero balance. At that point, the equity method ceases to be applicable and the
c c c c c c c c c c c c c c c
fair-value method is subsequently used.
c c c c c
D. Reporting the sale of an equity investment
c c c c c c
1. The investor applies the equity method until the disposal date to establish a proper
c c c c c c c c c c c c c
book value.
c c
2. Following the sale, the equity method continues to be appropriate if enough shares
c c c c c c c c c c c c
are still held to maintain the investor’s ability to significantly influence the investee.
c c c c c c c c c c c c c
If that ability has been lost, the fair-value method is subsequently used.
c c c c c c c c c c c c
IV. Excess investment cost over book value acquired
c c c c c c
A. The price an investor pays for equity securities often differs significantly from the
c c c c c c c c c c c c
investee’s underlying book value primarily because the historical cost based
c c c c c c c c c c
accounting model does not keep track of changes in a firm’s fair value.
c c c c c c c c c c c c c
B. Payments made in excess of underlying book value can sometimes be identified with
c c c c c c c c c c c c
specific investee accounts such as inventory or equipment.
c c c c c c c c
C. An extra acquisition price can also be assigned to anticipated benefits that are
c c c c c c c c c c c c
expected to be derived from the investment. In accounting, these amounts are
c c c c c c c c c c c c
presumed to reflect an intangible asset referred to as goodwill. Goodwill is calculated
c c c c c c c c c c c c c
as any excess payment that is not attributable to specific identifiable assets and
c c c c c c c c c c c c c
liabilities of the investee. Because goodwill is an indefinite-lived asset, it is not
c c c c c c c c c c c c c
amortized.
c
1-3
.
, 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
c c c c c c c c c c c c
the transferred goods are either consumed or until they are resold to unrelated parties.
c c c c c c c c c c c c c c
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.
c c c c c c c c c c c c
3. The amount of gross profit to be deferred is the investor’s ownership percentage
c c c c c c c c c c c c
multiplied by the markup on the merchandise remaining at the end of the year.
c c c c c c c c c c c c c c
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
c c c c c c c c c c c c
for upstream and downstream transfers. The procedures are separately identified
c c c c c c c c c c
in Chapter One because the handling does vary within the consolidation process.
c c c c c c c c c c c c
Answers to Discussion Questions c c c
The textbook includes discussion questions to stimulate student thought and discussion. These
c c c c c c c c c c c
questions are also designed to allow students to consider relevant issues that might otherwise be
c c c c c c c c c c c c c c c
overlooked. Some of these questions may be addressed by the instructor in class to motivate
c c c c c c c c c c c c c c c
student discussion. Students should be encouraged to begin by defining the issue(s) in each case.
c c c c c c c c c c c c c c c
Next, authoritative accounting literature (FASB ASC) or other relevant literature can be consulted
c c c c c c c c c c c c c
as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting Standards
c c c c c c c c c c c c c c
Codification will provide the necessary support.
c c c c c c
Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
c c c c c c c c c c c
available. Students often seem to believe that all accounting issues have been resolved in the past
c c c c c c c c c c c c c c c c
so that accounting education is only a matter of learning to apply historically prescribed procedures.
c c c c c c c c c c c c c c c
However, in actual practice, the only real answer is often the one that provides the fairest
c c c c c c c c c c c c c c c c
representation of the firm’s transactions. If an authoritative solution is not available, students should
c c c c c c c c c c c c c c
be directed to list all of the issues involved and the consequences of possible alternative actions.
c c c c c c c c c c c c c c c c
The various factors presented can be weighed to produce a viable solution.
c c c c c c c c c c c c
The discussion questions are designed to help students develop research and critical thinking skills
c c c c c c c c c c c c c
in addressing issues that go beyond the purely mechanical elements of accounting.
c c c c c c c c c c c c
Did the Cost Method Invite Manipulation?
c c c c c
The cost method of accounting for investments often caused a lack of objectivity in reported income
c c c c c c c c c c c c c c c
figures. With a large block of the investee’s voting shares, an investor could influence the amount
c c c c c c c c c c c c c c c c
and timing of the investee’s dividend declarations. Thus, when enjoying a good earnings year, an
c c c c c c c c c c c c c c c
investor might influence the investee to withhold declaring a dividend until needed in a subsequent
c c c c c c c c c c c c c c c
year. Alternatively, if the investor judged that its current year earnings ―needed a boost,‖ it might
c c c c c c c c c c c c c c c c
influence the investee to declare a current year dividend. The equity method effectively removes
c c c c c c c c c c c c c c
managers’ ability to increase current income (or defer income to future periods) through their
c c c c c c c c c c c c c c
influence over the timing and amounts of investee dividend declarations.
c c c c c c c c c c
At first glance it may seem that the fair value method allows managers to manipulate income
c c c c c c c c c c c c c c c
because investee dividends are recorded as income by the investor. However, dividends
c c c c c c c c c c c c
paid
c
1-4
