KPMG Professor of Accountancy, Mendoza College of Business, University of Notre Dame, Timothy S. Doupnik, Associate Professor of Accounting, School of Business, College of Charleston. Description: Thirteenth Edition. | New York, NY : McGraw-Hill Education, 2016. | Revised edition of the authors’ Advanced accounting, 2015. Identifiers: LCCN 2016040833 | ISBN 9781259444951 (hardback) Subjects: LCSH: Accounting. | BISAC: BUSINESS & ECONOMICS / Accounting / General. Classification: LCC HF5636 .H69 2016 | DDC 657/.046—dc23 LC record available at https://lccn.loc.gov/2016040833 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.
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About the Authors Joe B. Hoyle, University of Richmond
Joe B. Hoyle is associate professor of accounting at the Robins School of Business at the University of Richmond, where he teaches intermediate accounting, financial accounting, and advanced accounting. In 2015, he was the first recipient of the J. Michael and Mary Anne Cook Prize for undergraduate teaching. The Cook Prize is awarded by the American Accounting Association and “is the foremost recognition of an individual who consistently demonstrates the attributes of a superior teacher in the discipline of accounting.” Professor Hoyle has also been named (in 2007) as the Virginia Professor of the Year by the Carnegie Foundation for the Advancement of Teaching and the Center for Advancement and Support of Education. He has been selected as a Distinguished Educator five times at the University of Richmond and Professor of the Year on two occasions. He has authored a book of essays titled Tips and Thoughts on Improving the Teaching Process in College, which is available at http://oncampus.richmond.edu/∼ jhoyle/. His blog, Teaching—Getting the Most from Your Students, at http://joehoyle-teaching.blogspot.com/ was named the Accounting Education Innovation of the Year for 2013 by the American Accounting Association.
Thomas F. Schaefer, University of Notre Dame
Thomas F. Schaefer is the KPMG Professor of Accounting at the University of Notre Dame. He has written a number of articles for scholarly journals such as The Accounting Review, Journal of Accounting Research, Journal of Accounting & Economics, Accounting Horizons, and others. His primary teaching and research interests are in financial accounting and reporting. Tom is a past president of the American Accounting Association’s Accounting Program Leadership Group. He received the 2007 Joseph A. Silvoso Faculty Merit Award from the Federation of Schools of Accountancy and the 2013 Notre Dame Master of Science in Accountancy Dincolo Outstanding Professor Award.
Timothy S. Doupnik, College of Charleston
Timothy S. Doupnik is distinguished professor emeritus of accounting at the University of South Carolina. He is a current member of the accounting faculty at the College of Charleston, where he teaches advanced and international accounting. Tim has published extensively in the area of international accounting in journals such as The Accounting Review; Accounting, Organizations, and Society; Abacus; International Journal of Accounting; and Journal of International Business Studies. Tim is a past president of the American Accounting Association’s International Accounting Section and a recipient of the section’s Outstanding International Accounting Educator Award.
Advanced Accounting 13e Stays Current Overall—this edition of the text provides relevant and up-to-date accounting standards references to the Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC). Chapter Changes for Advanced Accounting, 13th Edition:
Chapter 1 ∙ Updated the chapter to reflect Accounting Standards Update (ASU) No. 2016-07 to ASC Topic 323, Investments—Equity Method and Joint Ventures, entitled “Simplifying the Transition to the Equity Method of Accounting.” The ASU is effective for fiscal years beginning after December 15, 2016. The ASU eliminates the requirement to retrospectively apply the equity method to previously held ownership interests in an investee when an increase in ownership results in significant influence and thus qualifies for use of the equity method. ∙ Updated coverage for Accounting Standards Update (ASU) No. 2016-01, Financial Instruments—Overall, which requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, unless fair values are not readily determinable. Thus, the previously available-forsale category with fair value changes recorded in other comprehensive income will no longer be available. The ASU is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. ∙ Eliminate coverage of investee extraordinary items to align the text coverage with Accounting Standards Update No. 2015-01 which eliminates the concept of extraordinary items. ∙ Updated terminology in discussion of intra-entity gross profits to reflect the new revenue recognition standards (ASC 606). ∙ Updated real-world references. ∙ Added and revised several end-of-chapter problems. vi
Chapter 2 ∙ Added new descriptive coverage of three recent realworld business combinations—Facebook and WhatsApp, AT&T and DirecTV, and MeadwestVaco and Rock-Tenn. ∙ Revised chapter learning objectives to focus on combinations when the acquired firm is dissolved vs. continued existence. The chapter also newly recognizes a learning objective on the related costs that typically accompany business combinations. ∙ Added an updated appendix on pushdown accounting based on Accounting Standards Update (ASU) No.2014-17, Business Combinations: Pushdown Accounting. The ASU allows companies an option to apply pushdown accounting for newly acquired subsidiaries. ∙ Updated real-world references. ∙ In addition to several new and revised end-of-chapter problems, replaced/added new research cases that provide students with real-world applications of financial reporting for business combinations.
Chapter 3 ∙ Added coverage of post-acquisition procedures for excess fair value attributable to subsidiary long-term debt. Moved coverage of pushdown accounting to Chapter 2. ∙ Added a Discussion Question that addresses worksheet adjustments to the parent’s beginning-of-theyear retained earnings. ∙ Updated real-world references. ∙ Added an appendix covering Accounting Standards Update (ASU 2014-02) to Topic 350, “Intangibles—Goodwill and Other, on Accounting for Goodwill. The ASU provides an external reporting option (i.e., amortization) for private company goodwill accounting. The appendix also covers ASU 2014-18, Accounting for Identifiable Intangible Assets in a Business Combination, an amendment of Business Combinations (Topic 805). The new standards allow private companies an option to simplify their accounting by recognizing fewer intangible assets in future business combinations. ∙ Added new equity method end-of-chapter problems requiring the preparation of consolidated financial statements subsequent to acquisition. In addition,
as the Accounting Profession Changes changed the facts and requirements in several endof-chapter problems. ∙ Added a new research and analysis case on Microsoft’s 2015 goodwill impairment loss.
Chapter 4 ∙ Updated real-world references. ∙ Added two new equity method end-of-chapter problems. ∙ Added new end-of-chapter cases using the financial reports of Starbucks (step-acquisition example) and Costco (various noncontrolling interest figures and interpretations). ∙ Revised the end-of-chapter comprehensive FASB ASC and IFRS research case. The new case, entitled Bardeen Electric, continues to focus on valuation issues accompanying a business combination including alternative goodwill measurement under IFRS. In addition, several other end-of-chapter problems have been revised.
Chapter 5 ∙ Updated terminology in discussion of intra-entity gross profits to reflect the new revenue recognition standards (ASC 606). ∙ Revised and expanded coverage of the deferral and subsequent recognition of intra-entity gains on longterm assets transfers across affiliates. The revised exposition emphasizes the nature of reallocating intra-entity gains across time increasing consistency with the chapter’s coverage of intra-entity gross profits in inventory. ∙ Updated real-world references. ∙ Changed the facts and requirements in several endof-chapter problems.
Chapter 6 ∙ Updated real-world references. ∙ Expanded coverage of post-control period reporting for primary beneficiaries and variable interest entities including an example of consolidated statement preparation. ∙ Added and revised several end-of-chapter problems.
Chapter 7 ∙ Updated real-world references. ∙ Added coverage of the FASB 2015 Proposed Accounting Standards Update on Income Taxes
(Topic 740), entitled Intra-Entity Asset Transfers. The proposed accounting would converge the IFRS and U.S. GAAP treatment. ∙ Updated terminology in discussion of intra-entity gross profits to reflect the new revenue recognition standards (ASC 606). ∙ Changed the facts and requirements in several endof-chapter problems.
Chapter 8 ∙ Deleted the section within Interim Reporting related to extraordinary items. ∙ Added a real-world example of a company with seasonal items. ∙ Added the name of the relevant international standard to the title of sections on IFRS. ∙ Removed reference to IFRS from the learning objectives. ∙ Updated references to actual company practices and excerpts from annual reports. ∙ Changed the facts in several end-of-chapter problems.
Chapter 9 ∙ Reduced the size of Exhibit 9.1 containing exchange rates for selected countries. ∙ Rewrote the section now titled Forward Contracts that was previously titled Spot and Forward Rates. ∙ Moved the section on foreign currency borrowing from the end of the chapter to immediately follow the section on foreign currency transactions. ∙ Moved the portion of the IFRS section at the end of the chapter that deals with foreign currency transactions to immediately follow the section on foreign currency borrowing. ∙ Expanded the learning objective related to how forward contracts and foreign currency options can be used to hedge foreign exchange risk to include understanding what types of foreign exchange risk can be hedged. ∙ Added new learning objectives on the accounting guidelines for derivatives and the basics of hedge accounting. ∙ Updated real-world references including examples of company practices, excerpts from annual reports, and foreign exchange rates. vii
∙ Added language to more clearly explain the impact that the accounting for a derivative financial instrument used to hedge a foreign exchange risk has on financial statements within the examples demonstrating the accounting for various types of foreign currency hedges. ∙ Updated the section at the end of the chapter that summarizes the accounting for derivative financial instruments under IFRS. ∙ Changed the facts in several end-of-chapter problems. ∙ Updated the develop your skills assignments based on actual exchange rates.
∙ Deleted the section “A Principles-Based Approach to Standard Setting.” ∙ Revised the Comprehensive Illustration to show the process for determining conversion worksheet entries necessary to convert from IFRS to U.S. GAAP for nine differences between the two sets of standards. ∙ Added several new questions related to material added to the chapter. ∙ Added several new problems focusing on the conversion of IFRS to U.S. GAAP. ∙ Deleted the end-of-chapter case related to “Voluntary Adoption of IFRS” and added a new case related to “IFRS Website.”
∙ Updated references to actual company practice and related excerpts from annual reports. ∙ In the section on Exchange Rates Used in Translation, added instruction to first read the related Discussion Question before continuing. ∙ Removed reference to the theoretical possibility of translating income statement items at the current exchange rate. ∙ Removed reference to a research study published in 1988 that investigated the weighting of functional currency indicators. ∙ Moved the section on IFRS from the end of the chapter to immediately after the section describing U.S. authoritative literature. ∙ Changed facts in several end-of-chapter problems.
Chapter 11 ∙ Updated real-world references. ∙ Removed the discussion of culture as a reason for accounting diversity and the section “A General Model of the Reasons for International Differences in Financial Reporting.” ∙ Expanded discussion of results from the FASBIASB convergence process to include a new exhibit summarizing successful convergence projects. ∙ Added a section on “IFRS for SMEs.” ∙ Added a section on the “Relevance of IFRS for U.S. Accountants.” ∙ Removed the section “U.S. GAAP Reconciliations.” ∙ Added a major new section focusing on the “Conversion of IFRS Financial Statements to U.S. GAAP.” viii
∙ Updated SEC data and Registration Statement exemptions. ∙ Updated SEC division information. ∙ Updated web link references as necessary. ∙ Revised end-of-chapter material.
Chapter 13 ∙ Added discussion of reporting issues that companies face as the possibility of bankruptcy grows, such as the need to test goodwill and other assets for impairment and the possibility that a valuation allowance is required to offset any deferred income tax assets. ∙ Presented coverage of new FASB pronouncement: Accounting Standards Update 2014-15 (“Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”) which provides accounting and reporting guidance if the possibility arises that substantial doubt exists as to whether a company will be able to remain a going concern. ∙ Included additional discussion about the liquidation basis of accounting, including examples of the necessary financial statements. ∙ Revised references to include companies that have recently experienced bankruptcy and liquidation such as RadioShack.
Chapter 14 ∙ Revised tables showing the allocation of partnership income/loss across partners to provide additional
emphasis on the step-by-step nature of the income distribution across partners. ∙ Changed the facts and requirements in several endof-chapter problems.
Chapter 15 ∙ Split an existing end-of-chapter problem with two unrelated parts into two separate problems. ∙ Added a new end-of-chapter problem related to learning objectives LO 15-2 and LO 15-5. ∙ Changed the facts and requirements in several endof-chapter problems.
Chapter 16 ∙ Updated numerous references to the financial statements of a wide variety of state and local governments such as the City of Baltimore, the City of Houston, the City of Charlotte, and the City of Dallas.
Chapter 17 ∙ Provided coverage of new pronouncement: GASB Statement No. 76, “The Hierarchy of Generally Accepted Accounting Principles for State and Local Governments.”
∙ Provided coverage of new pronouncement: GASB Statement No. 77, “Tax Abatement Disclosures.” ∙ Updated references to the financial statements of state and local governments such as the City of Los Angeles, the City of Chicago, the City of Orlando, and the City of Boston.
Chapter 18 ∙ Discussed the potential implications of FASB’s current projects on the presentation and disclosure of financial statements by not-for-profit entities ∙ Updated numerous references to the financial statements of a wide variety of private not-for-profit entities such as ChildFund International, Girl Scouts of the United States of America, American Heart Association, and Georgetown University.
Chapter 19 ∙ Updated tax code references, numbers, and statistics. ∙ Included coverage of the American Taxpayer Relief Act of 2012. ∙ Revised web links in footnote references as appropriate. ∙ Revised end-of-chapter material reflecting changes from the chapter.
Students Solve the Accounting Puzzle The approach used by Hoyle, Schaefer, and Doupnik allows students to think critically about accounting, just as they will in their careers and as they prepare for the CPA exam. Read on to understand how students will succeed as accounting majors and as future CPAs by using Advanced Accounting, 13e.
Thinking Critically With this text, students gain a well-balanced appreciation of the accounting profession. As Hoyle 13e introduces them to the field’s many aspects, it often focuses on past controversies and present resolutions. The text shows the development of financial reporting as a product of intense and considered debate that continues today and will in the future.
Readability The writing style of the 12 previous editions has been highly praised. Students easily comprehend chapter concepts because of theConfirming conversational tone used throughout Pages the book. The authors have made every effort to ensure that the writing style remains engaging, lively, and consistent. Consolidation of Financial Information 41
EXHIBIT 2.1 Recent Notable Business Combinations
Acquirer AT&T Berkshire Hathaway, Inc. Visa, Inc. Facebook, Inc. MeadWestvaco Intel Corporation CVS Health Corporation Marriott Merck Weyerhaeuser Celgene Corporation Cox Automotive FedEx Expedia Microsemi Corporation Constellation Brands
Real-World Examples Deal Value
$47.4B Students are better able to relate what $32.0B they learn $23.3B to what they will encounter in the $17.2B business world $16.0B after reading these frequent examples.$15.0B Quotations, articles, and illustra$12.9B $12.2B tions from$ Forbes, The Wall Street Journal, 9.5B 8.4B Time, and $Bloomberg BusinessWeek are $ 7.2B incorporated throughout the text. Data have $ 4.0B $ 4.8B First Pages been pulled from business, not-for-profit, and $ 3.9B $ 2.5B government financial statements as well as $ 1.0B official pronouncements.
DirecTV Precision Castparts Visa Europe Ltd WhatsApp RockTenn Altera Corporation Omnicare, Inc. Starwood Hotels Intl Cubist Plum Creek Timber Receptos, Inc. Dealertrack Technologies TNT Express HomeAway PMC-Sierra, Inc. Ballast Point Brewing & Spirits
and delivery, substantial savings can result. As an example, Oracle’s acquisiChapter manufacturing, 4
tion of Sun Microsystems creates synergies by enabling Oracle to integrate its software product lines with Sun’s hardware specifications. The acquisition further allows Oracle to offer complete systems made of chips, computers, storage devices, and software with an aim toward increased efficiency and quality.2 Other cost savings resulting from elimination of duplicate efforts, such as data processing and marketing, can make a single entity more profitable than the separate parent and subsidiary had been in the past. Such synergies often accompany business combinations. Although no two business combinations are exactly alike, many share one or more of the DOES GAAP UNDERVALUE POST-CONTROL STOCK ACQUISITIONS? following characteristics that potentially enhance profitability:
This feature facilitates student understanding of the underlying accounting principles at Berkshire Hathaway’s 2012 annual report, in in discussing company’s ∙ In Vertical integration of one firm’s output and Warren another Buffett, firm’s or the further workdistribution particular reporting situations. Simipost-control step acquisitions of Marmon Holdings, Inc., observed the following: processing. lar to minicases, these questions help explain ∙ Cost savings through elimination of duplicate facilities and staff. Marmon provides an example of a clear and substantial gap existing between book ∙ value Quick and entryintrinsic for newvalue. and existing products into domestic and foreign markets.at hand in practical terms. Many the Let me explain the odd origin of thisissues differential. ∙ Economies ofI scale allowing andadditional negotiatingshares power.in Marmon, raising our Last year told you that greater we hadefficiency purchased times,increases, thesenegotiating cases are designed to demon∙ ownership The ability to financing at more rates. As firm sizeI also toaccess 80% (up from the 64%attractive we acquired in 2008). told you that GAAP power with financial institutions can increase also. strate to students accounting required us to immediately record the 2011 purchase on our books at farwhy less a topic is problematic ∙ than Diversification of business risk. what we paid. I’ve now had a year to think about this weird accounting rule, but I’ve and worth considering.
yet to find an explanation thatbecause makesmany any sense—nor can Charlie or Marc Hamburg, Business combinations also occur firms seek the continuous expansion of their our CFO, comeoften up with My confusion increasescontrol when Iover am told that if we hadn’t already organizations, intoone. diversified areas. Acquiring a vast network of differentowned businesses has been strategy utilized in by2011 a number companies (sometimes as at 64%, the 16%a we purchased wouldofhave been entered on known our books conglomerates) for decades. Entry into new industries is immediately available to the parent our cost. without to construct facilities, develop to products, train management, or an create market 10% In having 2012 (and in early 2013, retroactive year end 2012) we acquired additional recognition. Many have successfully to produce huge, of Marmon and corporations the same bizarre accounting employed treatmentthis wasstrategy required. The $700 million highly profitable organizations. Unfortunately, others discovered that the task of managing a write-off we immediately incurred had no effect on earnings but did reduce book value
with 13th Edition Features CPA Simulations Hoyle 13e provides instructors and students access to CPA Simulations that correspond to several key topics and chapters throughout the text. Students can complete these simulations online, allowing them to practice advanced accounting concepts in a web-based interface that mimics the actual CPA exam. There will be no hesitation or confusion when students sit for the real exam; they will know exactly how to maneuver through the computerized test.
38. On May 1, Burns Corporation acquired 100 percent of the outstanding ow Corporation in exchange for $710,000 cash. At the acquisition date, Quig were as follows:
As in previous editions, the end-of-chapter material remains a strength of the text. The sheer numConfirmingCash Pages .......................................... $ 95,0 Receivables . . . . .the . . . . . . students’ ......................... 200,0 ber of questions, problems, and Internet assignments test and, therefore,Inventory. expand ...................................... 210,0 Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130,0 knowledge of chapter concepts. Building and equipment (net) . . . . . . . . . . . . . . . . . . . . . 270,0 Excel Spreadsheet Assignments extend specific problems and are located on the 13th Patented technology . . . . . . edition ......................
64 Chapter 2 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $905,0 Instructor Resources page, with templated versions that can be provided to students for Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $120,0 3. Ificon the consideration transferred for an firmproblems exceeds the total fair valuehave of the acquired firm’s assignments. An Excel appears next toacquired those that corresponding Long-term liabilities. . . spreadsheet ........................... 510,0 net assets, the residual amount is recognized in the consolidated financial statements as goodwill, an Common stock ($5 par value). . . . . . . . . . . . . . . . . . . . . 210,0 assignments. intangible asset. When a bargain purchase occurs, individual assets and liabilities acquired continue Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . 90,0 to be recorded at their fair values and a gain on bargain purchase is recognized. Retained earnings. .to . . . .master . . . . . . . . . . . to . . . . .pass ......... (25,0 “Develop Your Skills” asks questions that address the four skills students need 4. Particular attention should be given to the recognition of intangible assets in business combinations. Total liabilities and stockholders equity . . . . . . . . . . . . $905,0 An intangible asset must be recognized in an acquiring firm’s financial statements if the assetAn arisesicon indicates when the CPA exam: Research, Analysis, Spreadsheet, and Communication. from a legal or contractual right (e.g., trademarks, copyrights, artistic materials, royalty agreements). recogdirects Quigley to seek additional financing for expansion throu these skills are tested. If the intangible asset does not represent a legal or contractual right, the intangible will still beBurns Confirming Pages
74 Chapter 2
EXHIBIT 2.10 Pushdown Accounting— Date of Acquisition
firm (e.g., customer lists, noncontractual customer issue. Consequently, Quigley will issue a set of financial statements sep parent to support its request for debt and accompanying regulatory filing pushdown accounting in order to show recent fair valuations for its assets Prepare a separate acquisition-date balance sheet for Quigley Corp Example: Pushdown Accounting accounting. (Estimated Time: 45 to the Exhibit 65 Minutes) Following are the account balances of Miller Company and RichTo illustrate an application of pushdown accounting, we use 2.3 BigNet and Smallport ComComprehensive pany example presented previously in this chapter. Smallport Company 31. applies pushdown mond Company asIfof December The fair accountvalues of Richmond Company’s assets and liabilities are its acquisition-date separately reported balance sheet would appear as presented in Exhibit 2.10: Illustration ing,Note listed. that the valuesalso for each asset and liability in Smallport’s separate balance sheet above are iden-
Develop Your Skills
tical to those reported in BigNet’s consolidated acquisition-date balance sheet.
Richmond Richmond FASB ASC RESEARCH AND ANALYSIS CASE—CONSIDERATION OR Company Company COMPENSATION? Fair Values Book Values
Pushdown accounting has several advantages for internal reporting. For example, it simplifies the con- Miller solidation process. If the subsidiary enters the acquisition-date fair value allocations into its records, Company worksheet Entry A (to recognize the allocations originating from the fair-value adjustments) is not Values needed. Amortizations of the excess fair value allocation (see Chapter 3) would be incorporated Book in subsequent periods as well. 12/31 Despite some simplifications to the consolidation process, pushdown accounting does not address the many issues in preparing consolidated financial statements that appear in subsequent chapters of Cashto .be. seen . . .how . . .many . . .acquired . . . . .companies . . . . . .will . . choose . . . . to. elect . . . pushdown . $ 600,000 this text. Therefore, it remains skills accounting. For newly acquired subsidiaries that expect to issue new debt or eventually undergo an Receivables . .investors . . . . .with . . .a .better . . .understanding . . . . . . . .of. the . . company. .. 900,000 initial public offering, fair values may provide In summary, pushdown accounting provides its 1,100,000 Inventory. . . . . . a. newly . . . .acquired . . . . .subsidiary . . . . . .the. .option . . . .to. revalue . assets and liabilities to acquisition-date fair values in its separately reported financial statements. This Buildings and (net) . . . shares . . . .to. the . . public . fol- 9,000,000 valuation option may be useful when the parentequipment expects to offer the subsidiary lowing a period of planned improvements. Other benefits from pushdown accounting may arise when Unpatented technology . . . . . . . . . . . . . . . . . –0– the subsidiary plans to issue debt and needs its separate financial statements to incorporate acquisitiondate fair values and previously unrecognized intangibles in their standalone financial reports. In-process research and development .... –0–
What is a business combination? Notes payable (3,400,000) Describe the different types of legal arrangements that can take place to create a business combination. What does the term consolidated financial statements mean? Totals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,800,000 Within the consolidation process, what is the purpose of a worksheet? Jones Company obtains all of the common stock of Hudson, by issuing Common stock—$20 parInc.,value . .50,000 . . . .shares . . . of . its own $ (2,000,000) stock. Under these circumstances, why might the determination of a fair value for the consideration transferred be difficult? Common stock—$5 par value . . . . . . . . . . . What is the accounting valuation basis for consolidating assets and liabilities in a business Additional paid-in capital . . . . . . . . . . . . . . . . (900,000) combination? Retained 1/1.and . .expenses? ............... (2,300,000) How should a parent consolidate itsearnings, subsidiary’s revenues Morgan Company acquires all of the outstanding shares of Jennings, Inc., for cash. Morgan transRevenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,000,000) fers consideration more than the fair value of the company’s net assets. How should the payment in . .the. .consolidation . . . . . . . process? . . . . . . . . . . . . . . . . . . 3,400,000 excess of fair valueExpenses be accounted for in Catron Corporation is having liquidity problems, and as a result, it sells all of its outstanding stock to Totals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (7,800,000) Lambert, Inc., for cash. Because of Catron’s problems, Lambert is able to acquire this stock at less than the fair value of the company’s net assets. How is this reduction in price accounted for within the consolidation process? Note: Parentheses indicate a credit balance.
(100,000) (130,000) (900,000) 750,000 $ (600,000)
C 12/31 NaviNow Company agrees to pay $20 million in cash to the four former owne $ 200,000 its assets liabilities. ownersshares of TrafficEye developed and paten 10.and Sloane, Inc.,These issuesfour 25,000 of its own common stoc time290,000 monitoring of traffic patterns on the nation’s top 200 frequently shares of Benjamin Company. Benjamin will remain aconge sepa 820,000 plans to combine the new technology with its existing global positioning syst Sloane record the issuance of these shares? ing900,000 substantial revenue increase. 500,000 obtain all of contract, the stock of Molly, Corpora As11. partTo of the acquisition NaviNow alsoInc., agreesHarrison to pay additional a ers 100,000 upon achievement of pay certain financial NaviNow will pay $8and million to rison had to $98,000 togoals. lawyers, accountants, a stoc (200,000) TrafficEye if revenues from during the combined system exceed millioncombina over the vices rendered the creation of this$100 business (1,100,000) estimates this contingent payment to have probability adjusted present in costs associated with the astock issuance. How will value theseo The four former owners have also been offered employment contracts w $1,510,000 system integration and performance enhancement issues. The employment Whichhave of the following does not to represent primary employ motiv service1.periods, nominal salaries similar those of aequivalent sharing component over the next years (if the employees remain with the a. Combinations arethree often a vehicle to accelerate growth a estimates to have a current fair value of $2 million. The four former owners o b. Cost savings can be achieved through elimination of du stay on as employees of NaviNow for at least three years to help achieve the d Synergies mayfor bethe available through quick entrytoforthenew Shouldc.NaviNow account contingent payments promised for as consideration transferred acquisition as compensation expense to d. Larger firms in aretheless likely toorfail.
2. Which of the following is the best theoretical justification f a. In form the companies are one entity; in substance they ASC RESEARCH CASE—DEFENSIVE INTANGIBLE ASSET b. In form the companies are separate; in substance they ar Additional Information (not reflected in the preceding figures) c. In form and substance thetransponders companies for aresatellite one entity. Ahorita Company manufactures wireless applicati ∙ On December 31, Miller issues 50,000 shares of its $20 par value common stock for all of the outskills acquired Zelltech Company, which is primarily known for software(AIC com d. In form and substance the companies are its separate. standing shares of Richmond Company. but $250,000 also a specialty transponder under the trade name “Z-Tech ∙ As part of the acquisition agreement, Miller agrees to payLO the2-3 former owners of Richmond 3. manufactures What is a statutory merger? if certain profit projections are realized over the next three years. Miller calculates the acquisitiona. A merger approved by the Securities and Exchange Com date fair value of this contingency at $100,000. b. An acquisition involving the purchase of both stock and ∙ In creating this combination, Miller pays $10,000 in stock issue costs and $20,000 in accounting and c. A takeover completed within one year of the initial tend legal fees. d. A business combination in which only one company con xi Required 4. FASB ASC 805, “Business Combinations,” provides prin LO 2-4 hoy44953_ch02_039-088.indd 87 acquired business. When the collective fair values of the a. Miller’s stock has a fair value of $32 per share. Using the acquisition method: liabilities assumed exceed the fair value of the consideratio 1. Prepare the necessary journal entries if Miller dissolves Richmond so it is no longer a separate legal entity. a. Recognized as an ordinary gain from a bargain purchase 2. Assume instead that Richmond will retain separate legal incorporation and maintain its own b. Treated as negative goodwill to be amortized over the p
Connect Accounting for Advanced Accounting, 13e The 13th Edition of Advanced Accounting has a full Connect package, with the following features available for instructors and students. ∙ (New for 13e!) SmartBook ® is the market-leading adaptive study resource that is proven to strengthen memory recall, increase retention, and boost grades. SmartBook, powered by LearnSmart, is the first and only adaptive reading experience designed to change the way students read and learn. SmartBook delivers a personalized reading experience by highlighting the most impactful concepts a student needs to learn at that moment in time. As a student engages with SmartBook, the reading experience continuously adapts by highlighting content based on what the student has mastered or is ready to learn. This ensures that the student stays focused on the content he or she needs to learn, while simultaneously promoting long-term retention of material. Both students and Instructors can use SmartBook’s real-time reports to quickly identify the concepts that require more attention from individual students—or the entire class. The end result? Students are more engaged with course content, can better prioritize their time, and come to class ready to participate. ∙The End-of-Chapter Content in Connect provides a robust offering of review and question material designed to aid and assess the student’s retention of chapter content. The End-of-Chapter content is composed of both static and algorithmic versions of the problems in each chapter, which are designed to challenge students using McGraw-Hill Education’s state-of-the-art online homework technology. Connect helps students learn more efficiently by providing feedback and practice material when and where they need it. Connect grades homework automatically, and students benefit from the immediate feedback that they receive, particularly on any questions they may have missed.
Example of End-of-Chapter Problem Prepare a consolidated balance sheet for Pratt and Spider as of December 31, 2018. PRATT COMPANY AND SUBSIDIARY Consolidated Balance Sheet December 31, 2018 Assets
∙ The Test Bank for each chapter has been updated for the 13th edition to stay current with new and revised chapter material, with all questions available for assignment through Connect. Instructors can also create tests and quizzes from the Test Bank through our TestGen software, which is available on the Instructor Resources page. ∙ The Instructor and Student Resources have been updated for the 13th edition and are available in the Connect Instructor Resources page. Available resources include Instructor and Solutions Manuals, PowerPoint presentations, Test Bank files, Excel templates, and Chapter Check Figures. All applicable Student Resources will be available in a convenient file that can be distributed to students for classes either directly, through Connect, or via courseware.
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Acknowledgments We could not produce a textbook of the quality and scope of Advanced Accounting without the help of a great number of people. Special thanks go to the following: ∙ James O’Brien of the University of Notre Dame for his contribution to Chapters 12 and 19 and corresponding Solutions Manual files. ∙ Gregory Schaefer for his Chapter 2 descriptions of recent business combinations. ∙ Joyce van der Laan Smith of the University of Richmond and Paul Copley of James Madison University for their work on detailed reviews of the Twelfth Edition. Their feedback and direction was instrumental during the revision process. ∙ Ilene Leopold Persoff of Long Island University (LIU Post) for her work on detailed reviews of the Twelfth Edition and for checking the Thirteenth Edition manuscript, solutions manuals, and test bank files for accuracy. Ilene’s subject matter knowledge, detail-oriented nature, and quality of work were instrumental in ensuring that this edition stayed accurate, relevant, and of tremendous quality. Additionally, we would like to thank Anna Lusher of Slippery Rock University, for updating and revising the PowerPoint presentations; Jack Terry of ComSource Associates for updating the Excel Template Exercises for students to use as they work the select end-of-chapter material; Stacie Hughes of Athens State University, Mark McCarthy of East Carolina University, and Beth Kobylarz of Accuracy Counts for checking the text and Solutions Manual for accuracy; John Abernathy of Kennesaw State University for checking the test bank for accuracy; and Barbara Gershman of Northern Virginia Community College for checking the PowerPoints. We also want to thank the many people who completed questionnaires and reviewed the book. Our sincerest thanks to them all: Thomas Collins University of Wisconsin–Platteville Charles Lewis Houston Community College Waqar Ahmed University of Illinois Michael Cohen Rutgers University Ling Harris University of South Carolina Stacie Hughes Athens State University
Zane Swanson University of Central Oklahoma Amy David Queens College John Abernathy Kennesaw State University David He Johns Hopkins University Suzanne Wright Penn State University
We also pass along a word of thanks to all the people at McGraw-Hill Education who participated in the creation of this edition. In particular, Dana Pauley, Senior Content Project Manager; Jennifer Pickel, Buyer; Egzon Shaqiri, Designer; Kevin Moran, Associate Director of Digital Content and Product Developer; Becky Olson, Executive Brand Manager; Tim Vertovec, Managing Director; Brian Nacik, Lead Assessment Content Project Manager; and Zach Rudin, Marketing Manager all contributed significantly to the project, and we appreciate their efforts.
Brief Contents Walkthrough x 1. The Equity Method of Accounting for Investments 1 2. Consolidation of Financial Information 39 3. Consolidations—Subsequent to the Date of Acquisition 89 4. Consolidated Financial Statements and Outside Ownership 155 5. Consolidated Financial Statements— Intra-Entity Asset Transactions 211 6. Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues 261
Worldwide Accounting Diversity and International Standards 533
12. Financial Reporting and the Securities and Exchange Commission 589 13. Accounting for Legal Reorganizations and Liquidations 615 14. Partnerships: Formation and Operation 663 15. Partnerships: Termination and Liquidation 701 16. Accounting for State and Local Governments (Part 1) 735 17. Accounting for State and Local Governments (Part 2) 793
7. Consolidated Financial Statements— Ownership Patterns and Income Taxes 319
18. Accounting and Reporting for Private Notfor-Profit Entities 849
8. Segment and Interim Reporting 363
19. Accounting for Estates and Trusts 895
9. Foreign Currency Transactions and Hedging Foreign Exchange Risk 407
10. Translation of Foreign Currency Financial Statements 473
Contents Walkthrough x Chapter One The Equity Method of Accounting for Investments 1 The Reporting of Investments in Corporate Equity Securities 1 Fair-Value Method 2 Cost Method (Investments in Equity Securities without Readily Determinable Fair Values) 2 Consolidation of Financial Statements 3
Discussion Question: Did the Cost Method Invite Earnings Manipulation? 4 Equity Method 4
International Accounting Standard 28—Investments in Associates 5 Application of the Equity Method 5 Criteria for Utilizing the Equity Method 5 Accounting for an Investment—The Equity Method 7
Equity Method Accounting Procedures 9 Excess of Investment Cost over Book Value Acquired 9
Discussion Question: Does the Equity Method Really Apply Here? 10 The Amortization Process 12
Equity Method—Additional Issues 14 Reporting a Change to the Equity Method 14 Reporting Investee’s Other Comprehensive Income and Irregular Items 16 Reporting Investee Losses 16 Reporting the Sale of an Equity Investment 17
Deferral of Intra-Entity Gross Profits in Inventory 18 Downstream Sales of Inventory 19 Upstream Sales of Inventory 20
Financial Reporting Effects and Equity Method Criticisms 21 Equity Method Reporting Effects 21 Criticisms of the Equity Method 22
Fair-Value Reporting for Equity Method Investments 23 Summary 24
Chapter Two Consolidation of Financial Information 39 Expansion through Corporate Takeovers 40 Reasons for Firms to Combine 40 Facebook and WhatsApp 42 AT&T and DirecTV 42 MeadwestVaco and Rock-Tenn 43
Business Combinations, Control, and Consolidated Financial Reporting 43 Business Combinations—Creating a Single Economic Entity 44
Control—An Elusive Quality 45 Consolidation of Financial Information 46
Financial Reporting for Business Combinations 47 The Acquisition Method 47 Consideration Transferred for the Acquired Business 47 Contingent Consideration: An Additional Element of Consideration Transferred 47 Assets Acquired and Liabilities Assumed 48 Goodwill and Gains on Bargain Purchases 49
Procedures for Consolidating Financial Information 49 Acquisition Method When Dissolution Takes Place 50 Related Costs of Business Combinations 54 The Acquisition Method When Separate Incorporation Is Maintained 55
Acquisition-Date Fair-Value Allocations— Additional Issues 60 Intangibles 60 Preexisting Goodwill on Subsidiary’s Books 61 Acquired In-Process Research and Development 62
Convergence between U.S. and International Accounting Standards 63 Summary 63 Appendix A Legacy Methods of Accounting for Business Combinations 67 Appendix B Pushdown Accounting 72
Chapter Three Consolidations—Subsequent to the Date of Acquisition 89 Consolidation—The Effects Created by the Passage of Time 90 Consolidated Net Income Determination 90 The Parent’s Choice of Investment Accounting 90
Investment Accounting by the Acquiring Company 90 Internal Investment Accounting Alternatives—The Equity Method, Initial Value Method, and Partial Equity Method 91
Subsequent Consolidation—Investment Recorded by the Equity Method 92 Acquisition Made during the Current Year 92 Determination of Consolidated Totals 94 Consolidation Worksheet 96 Consolidation Subsequent to Year of Acquisition—Equity Method 98
Subsequent Consolidations—Investment Recorded Using Initial Value or Partial Equity Method 103 Acquisition Made during the Current Year 103 Consolidation Subsequent to Year of Acquisition—Initial Value and Partial Equity Methods 107
Discussion Question 111 xvii
Discussion Question: How Does a Company Really Decide Which Investment Method to Apply? 112 Excess Fair Value Attributable to Subsidiary Long-Term Debt: Post-Acquisition Procedures 113 Goodwill Impairment 115 Assigning Goodwill to Reporting Units 116 Qualitative Assessment Option 116 Testing Goodwill for Impairment 117 Illustration—Accounting and Reporting for a Goodwill Impairment Loss 118 Reporting Units with Zero or Negative Carrying Amounts 119 Goodwill Impairment Simplified—Proposed Accounting Standards Update (ASU) 119 Comparisons with International Accounting Standards 120
Amortization and Impairment of Other Intangibles 121 Contingent Consideration 122 Accounting for Contingent Consideration in Business Combinations 122
Summary 123 Appendix Private Company Accounting for Business Combinations 127
Chapter Four Consolidated Financial Statements and Outside Ownership 155 Consolidated Financial Reporting in the Presence of a Noncontrolling Interest 156 Subsidiary Acquisition-Date Fair Value in the Presence of a Noncontrolling Interest 157
Discussion Question 158 Allocating Consolidated Net Income to the Parent and Noncontrolling Interest 161
Partial Ownership Consolidations (Acquisition Method) 162 Illustration—Partial Acquisition with No Control Premium 162 Illustration—Partial Acquisition with Control Premium 170 Effects Created by Alternative Investment Methods 174
Revenue and Expense Reporting for Midyear Acquisitions 175 Consolidating Postacquisition Subsidiary Revenue and Expenses 175 Acquisition Following an Equity Method Investment 177
Step Acquisitions 177 Control Achieved in Steps—Acquisition Method 177 Example: Step Acquisition Resulting in Control—Acquisition Method 177 Worksheet Consolidation for a Step Acquisition (Acquisition Method) 179 Example: Step Acquisition Resulting after Control Is Obtained 181
Discussion Question: Does GAAP Undervalue PostControl Stock Acquisitions? 182
Parent Company Sales of Subsidiary Stock—Acquisition Method 182 Cost-Flow Assumptions 184 Accounting for Shares That Remain 184
Comparisons with International Accounting Standards 184 Summary 185
Chapter Five Consolidated Financial Statements— Intra-Entity Asset Transactions 211 Intra-Entity Inventory Transfers 212 The Sales and Purchases Accounts 212 Intra-Entity Gross Profit—Year of Transfer (Year 1) 213
Discussion Question: Earnings Management 214 Intra-Entity Gross Profit—Year Following Transfer (Year 2) 215 Intra-Entity Gross Profit—Effect on Noncontrolling Interest 217 Intra-Entity Inventory Transfers Summarized 218 Intra-Entity Inventory Transfers Illustrated: Parent Uses Equity Method 219 Effects of Alternative Investment Methods on Consolidation 227
Discussion Question: What Price Should We Charge Ourselves? 230 Intra-Entity Land Transfers 232 Accounting for Land Transactions 232 Eliminating Intra-Entity Gains—Land Transfers 232 Recognizing the Effect on Noncontrolling Interest—Land Transfers 234
Intra-Entity Transfer of Depreciable Assets 234 Deferral and Subsequent Recognition of Intra-Entity Gains 235 Depreciable Asset Intra-Entity Transfers Illustrated 235 Years Following Downstream Intra-Entity Depreciable Asset Transfers—Parent Uses Equity Method 238 Effect on Noncontrolling Interest—Depreciable Asset Transfers 239
Chapter Six Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues 261 Consolidation of Variable Interest Entities 261 What Is a VIE? 262 Consolidation of Variable Interest Entities 263 Procedures to Consolidate Variable Interest Entities 267 Consolidation of a Primary Beneficiary and VIE Illustrated 268
Comparisons with International Accounting Standards 271 Intra-Entity Debt Transactions 272
Acquisition of Affiliate’s Debt from an Outside Party 273 Accounting for Intra-Entity Debt Transactions—Individual Financial Records 273 Effects on Consolidation Process 275 Assignment of Retirement Gain or Loss 276 Intra-Entity Debt Transactions—Years Subsequent to Effective Retirement 276
Discussion Question: Who Lost This $300,000? 277 Subsidiary Preferred Stock 279 Consolidated Statement of Cash Flows 281 Acquisition Period Statement of Cash Flows 282 Statement of Cash Flows in Periods Subsequent to Acquisition 286
Consolidated Earnings per Share 286 Subsidiary Stock Transactions 288 Changes in Subsidiary Value—Stock Transactions 289 Subsidiary Stock Transactions—Illustrated 292
Chapter Seven Consolidated Financial Statements—Ownership Patterns and Income Taxes 319 Indirect Subsidiary Control 319 The Consolidation Process When Indirect Control Is Present 320 Consolidation Process—Indirect Control 322
Income Tax Accounting for a Consolidated Entity 333 Affiliated Groups 334 Deferred Income Taxes 334 Consolidated Tax Returns—Illustration 335 Income Tax Expense Assignment 336 Filing of Separate Tax Returns 337 Deferred Tax on Undistributed Earnings—Illustrated 338 Separate Tax Returns Illustrated 339 Temporary Differences Generated by Business Combinations 341 Consolidated Entities and Operating Loss Carryforwards 342
Income Taxes and Consolidated Entities—Comparisons with International Accounting Standards 344 Summary 344
Chapter Eight Segment and Interim Reporting 363 Segment Reporting 364 The Management Approach 364
Determination of Reportable Operating Segments 364 Quantitative Thresholds 365
Testing Procedures—Complete Illustration 366 The Revenue Test 366 The Profit or Loss Test 367 The Asset Test 368 Summary of Test Results 368
Other Guidelines 368 Information to Be Disclosed by Reportable Operating Segments 370 Reconciliations to Consolidated Totals 372 Explanation of Measurement 373
Examples of Operating Segment Disclosures 373 Entitywide Information 375 Information about Products and Services 375 Information about Geographic Areas 375
Discussion Question: How Does a Company Determine Whether a Foreign Country Is Material? 377 Information about Major Customers 378
International Financial Reporting Standard 8—Operating Segments 379 Interim Reporting 379 Revenues 380 Inventory and Cost of Goods Sold 380 Other Costs and Expenses 381 Income Taxes 382 Change in Accounting Principle 383 Seasonal Items 384
Minimum Disclosures in Interim Reports 385 Segment Information in Interim Reports 386 International Accounting Standard 34—Interim Financial Reporting 386 Summary 386
Foreign Currency Transactions 411 Accounting Issue 412 Balance Sheet Date before Date of Payment 413
International Accounting Standard 21—The Effects of Changes in Foreign Exchange Rates 415 Foreign Currency Borrowing 415 Foreign Currency Loan 416
Hedges of Foreign Exchange Risk 417 Derivatives Accounting 417 Fundamental Requirement of Derivatives Accounting 418 Determination of Fair Value of Derivatives 418 Accounting for Changes in the Fair Value of Derivatives 418
Hedge Accounting 419 Nature of the Hedged Risk 419
Hedges of Foreign Currency Denominated Assets and Liabilities 423 Cash Flow Hedge 423 Fair Value Hedge 423
Forward Contract Used to Hedge a Foreign Currency Denominated Asset 423 Forward Contract Designated as Cash Flow Hedge 425 Forward Contract Designated as Fair Value Hedge 428
Discussion Question: Do we have a Gain or what? 430 Cash Flow Hedge versus Fair Value Hedge 431
Foreign Currency Option Used to Hedge a Foreign Currency Denominated Asset 432 Option Designated as Cash Flow Hedge 433 Option Designated as Fair Value Hedge 435
Hedges of Unrecognized Foreign Currency Firm Commitments 438 Forward Contract Used as Fair Value Hedge of a Firm Commitment 438 Option Used as Fair Value Hedge of Firm Commitment 440
Hedge of Forecasted Foreign Currency Denominated Transaction 443 Forward Contract Cash Flow Hedge of a Forecasted Transaction 443 Option Designated as a Cash Flow Hedge of a Forecasted Transaction 445
Use of Hedging Instruments 446 The Euro 448
International Financial Reporting Standard 9—Financial Instruments 448 Summary 448
Chapter Ten Translation of Foreign Currency Financial Statements 473 Exchange Rates Used in Translation 474 Discussion Question: How Do We Report This? 475 Translation Adjustments 476 Balance Sheet Exposure 476
Translation Methods 477 Current Rate Method 477 Temporal Method 478 Translation of Retained Earnings 479
Complicating Aspects of the Temporal Method 480 Calculation of Cost of Goods Sold 480 Application of the Lower-of-Cost-or-Net-Realizable-Value Rule 481 Property, Plant, and Equipment, Depreciation, and Accumulated Depreciation 481 Gain or Loss on the Sale of an Asset 481
Treatment of Translation Adjustment 482 Authoritative Guidance 482 Determining the Appropriate Translation Method 483
International Accounting Standard 21—The Effects of Changes in Foreign Exchange Rates 486 The Translation Process Illustrated 487 Translation of Financial Statements—Current Rate Method 489 Translation of the Balance Sheet 490 Translation of the Statement of Cash Flows 492
Remeasurement of Financial Statements—Temporal Method 492 Remeasurement of the Income Statement 493 Remeasurement of the Statement of Cash Flows 495 Nonlocal Currency Balances 496
Comparison of the Results from Applying the Two Different Methods 496 Underlying Valuation Method 497 Underlying Relationships 498
Hedging Balance Sheet Exposure 498 International Financial Reporting Standard 9—Financial Instruments 499 Disclosures Related to Translation 499 Consolidation of a Foreign Subsidiary 500 Translation of Foreign Subsidiary Trial Balance 501 Determination of Balance in Investment Account—Equity Method 502 Consolidation Worksheet 503
Chapter Eleven Worldwide Accounting Diversity and International Standards 533 Evidence of Accounting Diversity 533 Reasons for Accounting Diversity 536 Legal System 538 Taxation 538 Financing System 539 Inflation 539 Political and Economic Ties 539
Problems Caused by Diverse Accounting Practices 539 International Accounting Standards Committee 540 The IOSCO Agreement 541
International Accounting Standards Board and IFRS 541 International Financial Reporting Standards (IFRS) 542 Use of IFRS 542 IFRS for SMEs 545
First-Time Adoption of IFRS 546 IFRS Accounting Policy Hierarchy 549
FASB–IASB Convergence 550 SEC Recognition of IFRS 552 IFRS Roadmap 553 A Possible Framework for Incorporating IFRS into U.S. Financial Reporting 553 Relevance of IFRS for U.S. Accountants 554
Differences between IFRS and U.S. GAAP 554 Recognition Differences 554 Measurement Differences 556
Discussion Question: Which Accounting Method Really Is Appropriate? 557 Classification, Presentation, and Disclosure Differences 557 IAS 1, “Presentation of Financial Statements” 558 Conversion of IFRS Financial Statements to U.S. GAAP 558
Obstacles to Worldwide Comparability of Financial Statements 564 Translation of IFRS into Other Languages 564 The Impact of Culture on Financial Reporting 564
Chapter Twelve Financial Reporting and the Securities and Exchange Commission 589 The Work of the Securities and Exchange Commission 589 Purpose of the Federal Securities Laws 591 Full and Fair Disclosure 593
Corporate Accounting Scandals and the Sarbanes-Oxley Act 595 Creation of the Public Company Accounting Oversight Board 596 Registration of Public Accounting Firms 597
The SEC’s Authority and SEC Filings 598 The SEC’s Authority over Generally Accepted Accounting Principles 598 Filings with the SEC 601 Electronic Data Gathering, Analysis, and Retrieval System (EDGAR) 606
Discussion Question: Is the Disclosure Worth the Cost? 607 Summary 608
Chapter Thirteen Accounting for Legal Reorganizations and Liquidations 615 An Overview of U. S. Bankruptcy Laws 616 Bankruptcy Reform Act of 1978 618
Discussion Question: What Do We Do Now? 622 Discussion Question: How Much Is That Building Really Worth? 624 Statement of Financial Affairs Illustrated 625
Liquidation—Chapter 7 Bankruptcy 626 Role of the Trustee 628 Statement of Realization and Liquidation Illustrated 629 The Liquidation Basis of Accounting 631
Reorganization—Chapter 11 Bankruptcy 633 The Plan for Reorganization 633 Acceptance and Confirmation of Reorganization Plan 635
Financial Reporting during Reorganization 636 Financial Reporting for Companies Emerging from Reorganization 638 Fresh Start Accounting Illustrated 639
Discussion Question: Is This the Real Purpose of the Bankruptcy Laws? 641 Summary 642
Chapter Fourteen Partnerships: Formation and Operation 663 Partnerships—Advantages and Disadvantages 664 Alternative Legal Forms 665 Subchapter S Corporation 665 Limited Partnerships (LPs) 666 Limited Liability Partnerships (LLPs) 666 Limited Liability Companies (LLCs) 666
Partnership Accounting—Capital Accounts 666 Articles of Partnership 667
Discussion Question: What Kind of Business Is This? 668 Accounting for Capital Contributions 668 Additional Capital Contributions and Withdrawals 671
Discussion Question: How Will the Profits Be Split? 672 Allocation of Income 672
Accounting for Partnership Dissolution 676 Dissolution—Admission of a New Partner 676 Dissolution—Withdrawal of a Partner 681
Chapter Fifteen Partnerships: Termination and Liquidation 701 Termination and Liquidation—Protecting the Interests of All Parties 702 Termination and Liquidation Procedures Illustrated 702 Statement of Liquidation 705 Deficit Capital Balance—Contribution by Partner 705 Deficit Capital Balance—Loss to Remaining Partners 706
Discussion Question: What Happens If a Partner Becomes Insolvent? 712 Installment Liquidations 713 Preliminary Distribution of Partnership Assets 713 Predistribution Plan 715
Chapter Sixteen Accounting for State and Local Governments (Part 1) 735 Introduction to the Financial Reporting for State and Local Governments 736 Governmental Accounting—User Needs 737 Two Sets of Financial Statements 737 The Advantage of Reporting Two Sets of Financial Statements 739
Internal Record-Keeping—Fund Accounting 740 Fund Accounting Classifications 741
Overview of State and Local Government Financial Statements 745 Government-Wide Financial Statements 745 Fund Financial Statements 747
Accounting for Governmental Funds 751 The Importance of Budgets and the Recording of Budgetary Entries 751 Encumbrances 754
Recognition of Expenditures and Revenues 755 Discussion Question: Is It an Asset or a Liability? 757 Recognition of Revenues—Overview 759 Derived Tax Revenues Such As Income Taxes and Sales Taxes 759 Imposed Nonexchange Revenues Such As Property Taxes and Fines 760 Government-Mandated Nonexchange Transactions and Voluntary Nonexchange Transactions 761 Issuance of Bonds 762 Special Assessments 765 Interfund Transactions 766
Chapter Seventeen Accounting for State and Local Governments (Part 2) 793 The Hierarchy of U.S. Generally Accepted Accounting Principles (GAAP) for State and Local Governments 793 Tax Abatement Disclosure 795
Defined Benefit Pension Plans 798 Works of Art and Historical Treasures 800 Infrastructure Assets and Depreciation 802 Comprehensive Annual Financial Report 803 The Primary Government and Component Units 804 Primary Government 804 Identifying Component Units 805 Reporting Component Units 806 Special Purpose Governments 807
Discussion Question: Is It Part of the County? 808 Acquisitions, Mergers, and Transfers of Operations 808 Government-Wide and Fund Financial Statements Illustrated 809 Statement of Net Position—Government-Wide Financial Statements 810 Statement of Activities—Government-Wide Financial Statements 811 Balance Sheet—Governmental Funds—Fund Financial Statements 815 Statement of Revenues, Expenditures, and Other Changes in Fund Balances—Governmental Funds—Fund Financial Statements 817
Statement of Net Position—Proprietary Funds— Fund Financial Statements 817 Statement of Revenues, Expenses, and Other Changes in Net Position—Proprietary Funds—Fund Financial Statements 821 Statement of Cash Flows—Proprietary Funds—Fund Financial Statements 821
Reporting Public Colleges and Universities 824 Summary 830
Chapter Eighteen Accounting and Reporting for Private Not-for-Profit Entities 849 The Structure of Financial Reporting 850 Financial Statements for Private Not-for-Profit Entities 851 Statement of Financial Position 853 Statement of Activities 854 Statement of Functional Expenses 858
Accounting for Contributions 860 Discussion Question: Is This Really an Asset? 862 Reporting Works of Art and Historical Treasures 862 Holding Contributions for Others 863 Contributed Services 865 Exchange Transactions 866 Tax-Exempt Status 867 Mergers and Acquisitions 868
Transactions for a Private Not-for-Profit Entity Illustrated 870 Transactions Reported on Statement of Activities 872
Discussion Question: Are Two Sets of GAAP Really Needed for Colleges and Universities? 873 Accounting for Health Care Entities 873 Accounting for Patient Service Revenues 874
Chapter Nineteen Accounting for Estates and Trusts 895 Accounting for an Estate 895 Administration of the Estate 896 Property Included in the Estate 897 Discovery of Claims against the Decedent 897 Protection for Remaining Family Members 898 Estate Distributions 898 Estate and Inheritance Taxes 900 The Distinction between Income and Principal 904 Recording of the Transactions of an Estate 905
Discussion Question: Is This Really an Asset? 908 Charge and Discharge Statement 909
Accounting for a Trust 910 Record-Keeping for a Trust Fund 913 Accounting for the Activities of a Trust 914
The Equity Method of Accounting for Investments
he first several chapters of this text present the accounting and reporting for investment activities of businesses. The focus is on investments when one firm possesses either significant influence or control over
another through ownership of voting shares. When one firm owns enough voting shares to be able to affect the decisions of another, accounting for
1 Learning Objectives After studying this chapter, you should be able to: LO 1-1
the investment can become challenging and complex. The source of such complexities typically stems from the fact that transactions among the firms affiliated through ownership cannot be considered independent, arm’s-length
transactions. As in many matters relating to financial reporting, we look to transactions with outside parties to provide a basis for accounting valuation. When firms are affiliated through a common set of owners, measurements that recognize the relationships among the firms help to provide objectivity in
The Reporting of Investments in Corporate Equity Securities In its recent annual report, The Coca-Cola Company describes its 28 percent investment in Coca-Cola FEMSA, a Mexican bottling company with operations throughout much of Latin America. The Coca-Cola Company uses the equity method to account for several of its bottling company investments, including Coca-Cola FEMSA. The Coca-Cola Company states, We use the equity method to account for investments in companies, if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company’s proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investment includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions.
Such information is hardly unusual in the business world; corporate investors frequently acquire ownership shares of both domestic and foreign businesses. These investments can range from the purchase of a few shares to the acquisition of 100 percent control. Although purchases of corporate equity securities (such as the ones made by Coca-Cola) are not uncommon, they pose a considerable number of financial reporting issues because a close relationship has been established without the investor gaining actual control. These issues are currently addressed by the equity method. This chapter deals with accounting for stock investments that fall under the application of this method.
Describe in general the various methods of accounting for an investment in equity shares of another company. Identify the sole criterion for applying the equity method of accounting and know the guidelines to assess whether the criterion is met. Describe the financial reporting for equity method investments and prepare basic equity method journal entries for an investor. Allocate the cost of an equity method investment and compute amortization expense to match revenues recognized from the investment to the excess of investor cost over investee book value. Understand the financial reporting consequences for: a. A change to the equity method. b. Investee’s other comprehensive income. c. Investee losses. d. Sales of equity method investments. Describe the rationale and computations to defer the investor’s share of gross profits on intra-entity inventory sales until the goods are either consumed by the owner or sold to outside parties. Explain the rationale and reporting implications of fair-value accounting for investments otherwise accounted for by the equity method.
2 Chapter 1 LO 1-1 Describe in general the various methods of accounting for an investment in equity shares of another company.
Generally accepted accounting principles (GAAP) recognize four different approaches to the financial reporting of investments in corporate equity securities: 1. Fair-value method. 2. Cost method for equity securities without readily determinable fair values. 3. Consolidation of financial statements. 4. Equity method. The financial statement reporting for a particular investment depends primarily on the degree of influence that the investor (stockholder) has over the investee, a factor most often indicated by the relative size of ownership.1 Because voting power typically accompanies ownership of equity shares, influence increases with the relative size of ownership. The resulting influence can be very little, a significant amount, or, in some cases, complete control.
Fair-Value Method In many instances, an investor possesses only a small percentage of an investee company’s outstanding stock, perhaps only a few shares. Because of the limited level of ownership, the investor cannot expect to significantly affect the investee’s operations or decision making. These shares are bought in anticipation of cash dividends or in appreciation of stock market values. Such investments are recorded at cost and periodically adjusted to fair value according to the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 321, “Investments—Equity Securities.” Fair value is defined by the ASC (Master Glossary) as the “price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” For most investments in equity securities, quoted stock market prices represent fair values. Because a full coverage of limited ownership investments in equity securities is presented in intermediate accounting textbooks, only the following basic principles are noted here: ∙ Initial investments in equity securities are recorded at cost and subsequently adjusted to fair value if fair value is readily determinable (typically by reference to market value); otherwise, the investment remains at cost. ∙ Changes in the fair values of equity securities during a reporting period are recognized as income.2 ∙ Dividends declared on the equity securities are recognized as income. The above procedures are followed for equity security investments (with readily determinable fair values) when the owner possesses neither significant influence nor control.
Cost Method (Investments in Equity Securities without Readily Determinable Fair Values) When the fair value of an investment in equity securities is not readily determinable, and the investment provides neither significant influence nor control, the investment may be measured at cost. Such investments sometimes can be found in ownership shares of firms that are not publicly traded or experience only infrequent trades. 1
The relative size of ownership is most often the key factor in assessing one company’s degree of influence over another. However, as discussed later in this chapter, other factors (e.g., contractual relationships between firms) can also provide influence or control over firms regardless of the percentage of shares owned. 2 FASB Accounting Standards Update (ASU) No. 2016-01, Financial Instruments—Overall, requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, unless fair values are not readily determinable. Thus, the previous available-for-sale category with fair value changes recorded in other comprehensive income will no longer be available. The ASU is effective for fiscal years beginning after December 15, 2017, with early adoption permitted.