Solution Manual For Advanced Accounting, 14th Edition

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Chapter 01-The Equity Method of Accounting for Investments–Hoyle, Schaefer, Doupnik,Advanced Accounting,14e1-1CHAPTER 1THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTSChapter OutlineI.Four methods are principally used to account for an investment in equity securities alongwith a fair value option.A.Fair value method: applied by an investor when only a small percentage of a company’svoting stock is held.1.The investor recognizes incomewhen the investee declares a dividend.2.Portfolios are reported at fair value. If fair values are unavailable, investment isreported at cost.B.Cost Method: applied to investments without a readily determinable fair value.When thefair value of an investment in equity securities is not readily determinable, and theinvestment provides neither significant influence nor control, the investment may bemeasured at cost.The investment remains at cost unless1.Ademonstrable impairmentoccurs for the investment, or2.Anobservable price change occursfor identical or similar investments of the sameissuer.The investor typically recognizesits share of investee dividends declaredas dividendincome.C.Consolidation: when one firm controls another (e.g., when a parent has a majorityinterest in the voting stock of a subsidiary or control through variable interests, theirfinancial statements are consolidated and reported for the combined entity.D.Equity method: applied when the investor has theability to exercise significantinfluenceover operating and financial policies of the investee.3.Ability to significantly influence investee is indicated by several factors includingrepresentation on the board of directors, participation in policy-making, etc.4.GAAP guidelines presume the equity method is applicable if 20 to 50 percent of theoutstanding voting stock of the investee is held by the investor.Current financial reporting standards allow firms to elect to use fair value for any newinvestment in equity shares including those where the equity method would otherwise apply.However, the option, once taken, is irrevocable.The investor recognizes both investeedividends and changes in fair value over time as income.II.Accounting for an investment: the equity methodA.Theinvestor adjusts the investment accountto reflect all changes in the equity of theinvestee company.B.The investor accrues investee incomewhen it is reported in the investee’s financialstatements.C.Dividends declared by the investee create a reduction in the carrying amount of theInvestment account.This book assumes all investee dividends are declared and paidin the same reporting period.

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