Advanced Accounting (Hoyle, Schaefer & Doupnik) — 15th
Edition | Test Bank & Complete Solutions (2025 Verified)
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
,CHAPTER 1-19
CHAPTER1
THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
Chapter Outline
I. Four methods are principally used to account for an investment in equity securities
along with a fair value option.
A. Fair value method: applied by an investor when only a small percentage of
a company‘svotingstock is held.
1. The investor recognizes income when the investee declares a dividend.
2. Portfolios are reported at fair value. If fair values are unavailable, investment
is reported at cost.
B. Cost Method: applied to investments without a readily determinable fair value. When
the fair value of an investment in equity securities is not readily determinable, and
the I investment provides neither significant influence nor control, the investment
may be m measured at cost. The investment remains at cost unless
1. A demonstrable impairment occurs for the investment, or
2. An observable price change occurs for identical or similar investments of the same
I issuer.
The investor typically recognizes its share of investee dividends declared a dividend
I come.
C. Consolidation: when one firm controls another (e.g., when a parent has a majority
in tersest in the voting stock of a subsidiary or control through variable interests,
their fi facial statements are consolidated and reported for the combined entity.
D. Equity method: applied when the investor has the ability to exercise
significant influence over operating and financial policies of the investee.
1. Ability to significantly influence investee is indicated by several factors including
representation on the board of directors, participation in policy-making, etc.
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
, Outstanding voting stock of the investee is held by the investor.
Current financial reporting standards allow firms to elect to use fair value for any new
invest tent in equity shares including those where the equity method would otherwise
apply. Ho waver, the option, once taken, is irrevocable. The investor recognizes both
investee divide nods and changes in fair value over time as income.
II. Accounting for an investment: the equity method
A. The investor adjusts the investment account to reflect all changes in the equity of the
I Investee Company.
B. The investor accrues investee income when it is reported in the investee’s financial
statements.
C. Dividends declared by the investee create a reduction in the carrying amount of the
Investment account. This book assumes all investee dividends are declared and
paid in the same reporting period.
III. Special accounting procedures used in the application of the equity method
A. Reporting a change to the equity method when the ability to significantly influence an
I investee is achieved through a series of acquisitions.
1. Initial purchase(s) will be accounted for by means of the fair value method (or
at cost) until the ability to significantly influence is attained.
2. When the ability to exercise significant influence occurs following a series of stock
purchases, the investor applies the equity method prospectively. The total fair value e
at the date significant influence is attained is compared to the investee‘sbookva lee to
determine future excess fair value amortizations.
B. Investee income from other than continuing operations
1. The investor recognizes its share of investee reported other comprehensive
income (OCI) through the investment account and the investor‘sownOCI.
2. Income items such as discontinued operations that are reported separately by the
I investee should be shown in the same manner by the investor. The materiality of
the see other investee income elements (as it affects the investor) continues to be
a cri pterion for separate disclosure.
C. Investee losses
1. Losses reported by the investee create corresponding losses for the investor.
2. A permanent decline in the fair value of an investee‘sstockshould be recognized I
immediately by the investor as an impairment loss.
3. Investee losses can possibly reduce the carrying value of the investment account
t o a zero balance. At that point, the equity method ceases to be applicable and
the f air-value method is subsequently used.
D. Reporting the sale of an equity investment
1. The investor applies the equity method until the disposal date to establish a
proper book value.
2. Following the sale, the equity method continues to be appropriate if enough shares
are still held to maintain the investor‘sabilitysignificantly influence the investee. I f
that ability has been lost, the fair-value method is subsequently used.
2-24
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
, Solution Manual for All Chapters
IV. Excess investment cost over book value acquired
A. The price an investor pays for equity securities often differs significantly from the
I nvestee‘sunderlying book value primarily because the historical cost based ace
uniting model does not keep track of changes in a firm‘sfairvalue.
B. Payments made in excess of underlying book value can sometimes be identified
with specific investee accounts such as inventory or equipment.
C. An extra acquisition price can also be assigned to anticipate benefits that are expect end
to be derived from the investment. In accounting, these amounts are presumed to reflect
an intangible asset referred to as goodwill. Goodwill is calculated as any excess s
payment that is not attributable to specific identifiable assets and liabilities of the in
esteem. Because goodwill is an indefinite-lived asset, it is not amortized.
V. Deferral of intra-entity gross profit in inventory
A. The investor‘sshareofintra-
Entity profits in ending inventory are not recognized until the transferred goods are
eighth err consumed or until they are resold to unrelated parties.
B. Downstream sales of inventory
1. ―Downstream‖referstotransfers made by the investor to the investee.
2. Intra-
Entity gross profits from sales are initially deferred under the equity method and
t hen recognized as income at the time of the inventory‘seventualdisposal.
3. The amount of gross profit to be deferred is the investor‘sownershippercentage
multiplied by the markup on the merchandise remaining at the end of the year.
C. Upstream sales of inventory
1. ―Upstream‖referstotransfers made by the investee to the investor.
2. Under the equity method, the deferral process for intra-
Entity gross profits is identical for upstream and downstream transfers. The
proceed rues are separately identified in Chapter One because the handling does
vary with in the consolidation process.
Answers to Discussion Questions
The textbook includes discussion questions to stimulate student thought and discussion. These q
questions are also designed to allow students to consider relevant issues that might otherwise be
o overlooked. Some of these questions may be addressed by the instructor in class to motivate
stud not discussion. Students should be encouraged to begin by defining the issue(s) in each
case. Next, authoritative accounting literature (FASB ASC) or other relevant literature can be
consulted as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting
Standards Codify action will provide the necessary support.
Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
an available. Students often seem to believe that all accounting issues have been resolved in the
past so that accounting education is only a matter of learning to apply historically prescribed
procedure s. However, in actual practice, the only real answer is often the one that provides the
fairest repress enation of the firm’s transactions. If an authoritative solution is not available,
students should be d erected to list all of the issues involved and the consequences of possible
alternative actions. The various factors presented can be weighed to produce a viable solution.
The discussion questions are designed to help students develop research and critical thinking
skill s in addressing issues that go beyond the purely mechanical elements of accounting.
2-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
Edition | Test Bank & Complete Solutions (2025 Verified)
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
,CHAPTER 1-19
CHAPTER1
THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
Chapter Outline
I. Four methods are principally used to account for an investment in equity securities
along with a fair value option.
A. Fair value method: applied by an investor when only a small percentage of
a company‘svotingstock is held.
1. The investor recognizes income when the investee declares a dividend.
2. Portfolios are reported at fair value. If fair values are unavailable, investment
is reported at cost.
B. Cost Method: applied to investments without a readily determinable fair value. When
the fair value of an investment in equity securities is not readily determinable, and
the I investment provides neither significant influence nor control, the investment
may be m measured at cost. The investment remains at cost unless
1. A demonstrable impairment occurs for the investment, or
2. An observable price change occurs for identical or similar investments of the same
I issuer.
The investor typically recognizes its share of investee dividends declared a dividend
I come.
C. Consolidation: when one firm controls another (e.g., when a parent has a majority
in tersest in the voting stock of a subsidiary or control through variable interests,
their fi facial statements are consolidated and reported for the combined entity.
D. Equity method: applied when the investor has the ability to exercise
significant influence over operating and financial policies of the investee.
1. Ability to significantly influence investee is indicated by several factors including
representation on the board of directors, participation in policy-making, etc.
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of the
2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
, Outstanding voting stock of the investee is held by the investor.
Current financial reporting standards allow firms to elect to use fair value for any new
invest tent in equity shares including those where the equity method would otherwise
apply. Ho waver, the option, once taken, is irrevocable. The investor recognizes both
investee divide nods and changes in fair value over time as income.
II. Accounting for an investment: the equity method
A. The investor adjusts the investment account to reflect all changes in the equity of the
I Investee Company.
B. The investor accrues investee income when it is reported in the investee’s financial
statements.
C. Dividends declared by the investee create a reduction in the carrying amount of the
Investment account. This book assumes all investee dividends are declared and
paid in the same reporting period.
III. Special accounting procedures used in the application of the equity method
A. Reporting a change to the equity method when the ability to significantly influence an
I investee is achieved through a series of acquisitions.
1. Initial purchase(s) will be accounted for by means of the fair value method (or
at cost) until the ability to significantly influence is attained.
2. When the ability to exercise significant influence occurs following a series of stock
purchases, the investor applies the equity method prospectively. The total fair value e
at the date significant influence is attained is compared to the investee‘sbookva lee to
determine future excess fair value amortizations.
B. Investee income from other than continuing operations
1. The investor recognizes its share of investee reported other comprehensive
income (OCI) through the investment account and the investor‘sownOCI.
2. Income items such as discontinued operations that are reported separately by the
I investee should be shown in the same manner by the investor. The materiality of
the see other investee income elements (as it affects the investor) continues to be
a cri pterion for separate disclosure.
C. Investee losses
1. Losses reported by the investee create corresponding losses for the investor.
2. A permanent decline in the fair value of an investee‘sstockshould be recognized I
immediately by the investor as an impairment loss.
3. Investee losses can possibly reduce the carrying value of the investment account
t o a zero balance. At that point, the equity method ceases to be applicable and
the f air-value method is subsequently used.
D. Reporting the sale of an equity investment
1. The investor applies the equity method until the disposal date to establish a
proper book value.
2. Following the sale, the equity method continues to be appropriate if enough shares
are still held to maintain the investor‘sabilitysignificantly influence the investee. I f
that ability has been lost, the fair-value method is subsequently used.
2-24
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
, Solution Manual for All Chapters
IV. Excess investment cost over book value acquired
A. The price an investor pays for equity securities often differs significantly from the
I nvestee‘sunderlying book value primarily because the historical cost based ace
uniting model does not keep track of changes in a firm‘sfairvalue.
B. Payments made in excess of underlying book value can sometimes be identified
with specific investee accounts such as inventory or equipment.
C. An extra acquisition price can also be assigned to anticipate benefits that are expect end
to be derived from the investment. In accounting, these amounts are presumed to reflect
an intangible asset referred to as goodwill. Goodwill is calculated as any excess s
payment that is not attributable to specific identifiable assets and liabilities of the in
esteem. Because goodwill is an indefinite-lived asset, it is not amortized.
V. Deferral of intra-entity gross profit in inventory
A. The investor‘sshareofintra-
Entity profits in ending inventory are not recognized until the transferred goods are
eighth err consumed or until they are resold to unrelated parties.
B. Downstream sales of inventory
1. ―Downstream‖referstotransfers made by the investor to the investee.
2. Intra-
Entity gross profits from sales are initially deferred under the equity method and
t hen recognized as income at the time of the inventory‘seventualdisposal.
3. The amount of gross profit to be deferred is the investor‘sownershippercentage
multiplied by the markup on the merchandise remaining at the end of the year.
C. Upstream sales of inventory
1. ―Upstream‖referstotransfers made by the investee to the investor.
2. Under the equity method, the deferral process for intra-
Entity gross profits is identical for upstream and downstream transfers. The
proceed rues are separately identified in Chapter One because the handling does
vary with in the consolidation process.
Answers to Discussion Questions
The textbook includes discussion questions to stimulate student thought and discussion. These q
questions are also designed to allow students to consider relevant issues that might otherwise be
o overlooked. Some of these questions may be addressed by the instructor in class to motivate
stud not discussion. Students should be encouraged to begin by defining the issue(s) in each
case. Next, authoritative accounting literature (FASB ASC) or other relevant literature can be
consulted as a preliminary step in arriving at logical actions. Frequently, the FASB Accounting
Standards Codify action will provide the necessary support.
Unfortunately, in accounting, definitive resolutions to financial reporting questions are not always
an available. Students often seem to believe that all accounting issues have been resolved in the
past so that accounting education is only a matter of learning to apply historically prescribed
procedure s. However, in actual practice, the only real answer is often the one that provides the
fairest repress enation of the firm’s transactions. If an authoritative solution is not available,
students should be d erected to list all of the issues involved and the consequences of possible
alternative actions. The various factors presented can be weighed to produce a viable solution.
The discussion questions are designed to help students develop research and critical thinking
skill s in addressing issues that go beyond the purely mechanical elements of accounting.
2-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LL
