Mc Graw Hill Education

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1 Fundamentals of Advanced Accounting Sixth Edition Joe B. Hoyle Associate Professor of Accounting Robins School of Business University of Richmond Thomas F. Schaefer KPMG Professor of Accountancy Mendoza College of Business University of Notre Dame Timothy S. Doupnik Professor of Accounting Daria Moore School of Business University of South Carolina Mc Graw Hill Education

2 Contents Walkthrough vi Chapter One The Equity Method of Accounting for Investments 1 The Reporting of Investments in Corporate Equity Securities 1 Fair- Value Method 2 Consolidation of Financial Statements 2 Equity Method 3 Discussion Question: Did the Cost Method Invite Earnings Manipulation? 4 International Accounting Standard 28 Investments in Associates 4 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 II Equity Method Additional Issues 13 Reporting a Change to the Equity Method 14 Reporting Investee Other Comprehensive Income and Irregulär Items 15 Reporting Investee Losses 16 Reporting the Sale ofan Equity Investment 17 Deferral of Unrealized 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 22 Summary 24 Chapter Two Consolidation of Financial Information 39 Expansion through Corporate Takeovers 40 Reasons for Firms to Combine 40 Campbell Soup and Bolthouse Farms 42 Microsoft and Skype 42 Duke Energy and Progress Energy 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 Transferredfor the Acquired Business 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 59 Intangibles 59 Preexisting Goodwill on Subsidiary's Books 61 A cquired In-Process Research and Development 61 Convergence between U.S. and International Accounting Standards 62 Summary 63 Appendix Legacy Methods of Accounting for Business Combinations 67 Chapter Three Consolidations Subsequent to the Date of Acquisition 85 Consolidation The Effects Created by the Passage of Time 85 Investment Accounting by the Acquiring Company 86 Internal Investment Accounting Alternatives The Equity Method, Initial Value Method, and Partial Equity Method 86 Subsequent Consolidation Investment Recorded by the Equity Method 88 Acquisition Made during the Current Year 88 Determination of Consolidated Totais 90 Consolidation Worksheet 92 Consolidation Subsequent to Year of Acquisition Equity Method 95 Subsequent Consolidations Investment Recorded Using Initial Value or Partial Equity Method 98 Acquisition Made during the Current Year 98 Consolidation Subsequent to Year of Acquisition Initial Value and Partial Equity Methods 102 Goodwill Impairment 107 Discussion Question: How Does a Company Really Decide Which Investment Method to Apply? 109 Assigning Goodwill to Reporting Units 109 Qualitative Assessment Option 110 xvii

3 xviii Contents Testing Goodwillfor lmpairmenl Steps 1 and2 III Illustration Accounting and Reporting for a Goodwill Impairment Loss 112 Reporting Units with Zero or Negative Carrying Amounts 113 Comparisons with International Accounting Standards 113 Goodwill Allocation 113 Impairment Testing 114 Determination of the Impairment Loss 114 Amortization and Impairment of Other Intangibles 114 Contingent Consideration 115 Accounting for Contingent Consideration in Business Combinations 115 Push-Down Accounting 117 External Reporting 117 Internal Reporting 118 Summary 118 Chapter Four Consolidated Financial Statements and Outside Ownership 149 Consolidated Financial Reporting in the Presence of a Noncontrolling Interest 150 Subsidiary Acquisition-Date Fair Value in the Presence of a Noncontrolling Interest 151 Discussion Question 152 Allocating Consolidated Net Income to the Parent and Noncontrolling Interest 154 Partial Ownership Consolidations (Acquisition Method) 155 Illustration Partial Acquisition with No Control Premium 156 Illustration Partial Acquisition with Control Premium 164 Effects Created by Alternative Investment Methods 168 Revenue and Expense Reporting for Midyear Acquisitions 168 Consolidating Postacquisition Subsidiary Revenue and Expenses 169 Acquisition Following an Equity Method Investment 170 Step Acquisitions 170 Control Achieved in Steps Acquisition Method 171 Example: Step Acquisition Resulting in Control Acquisition Method 171 Worksheet Consolidation for a Step Acquisition (Acquisition Method) 173 Example: Step Acquisition Resulting After Control Is Obtained 173 Discussion Question: Does GAAP Undervalue Post- Control Stock Acquisitions? 175 Parent Company Sales of Subsidiary Stock Acquisition Method 176 Cost-Flow Assumptions 177 Accounting for Shares That Remain 177 Comparisons with International Accounting Standards 178 Summary 178 Chapter Five Consolidated Financial Statements Intra-Entity Asset Transactions 203 Intra-Entity Inventory Transactions 204 The Sales and Purchases Accounts 204 Unrealized Gross Profit Year of Transfer (Year 1) 205 Discussion Question: Earnings Management 206 Unrealized Gross Profit Year Following Transfer fyiwj; 207 Unrealized Gross Profit Effect on Noncontrolling Interest 209 Intra-Entity Inventory Transfers Summarized 210 Intra-Entity Inventory Transfers Illustrated: Parent Uses Equity Method 211 Effects of Alternative Investment Methods on Consolidation 219 Discussion Question: What Price Should We Charge Ourselves? 222 Intra-Entity Land Transfers 224 Accounting for Land Transactions 224 Eliminating Unrealized Gains Land Transfers 225 Recognizing the Effect on Noncontrolling Interest Land Transfers 226 Intra-Entity Transfer of Depreciable Assets 227 Deferra! of Unrealized Gains 227 Depreciable Asset Transfers Illustrated 227 Years Following Downstream Intra-Entity Depreciable Asset Transfers Parent Uses Equity Method 229 Effect on Noncontrolling Interest Depreciable Asset Transfers 230 Summary 230 Chapter Six Variable Interest Entities, Intra-Entity Debt, Consolidated Cash Flows, and Other Issues 251 Consolidation of Variable Interest Entities 251 What Is a VIE? 252 Consolidation of Variable Interest Entities 253 Procedures to Consolidate Variable Interest Entities 257 Consolidation of a VIE Illustrated 257 Other Variable Interest Entity Disclosure Requirements 259 Proposed Accounting Standards Update on Variable Interest Entities 259 Comparisons with International Accounting Standards 260 Intra-Entity Debt Transactions 260 Acquisition of Affiliate's Debt from an Outside Party 261 Accounting for Intra-Entity Debt Transactions Individual Financial Records 262

4 Contents xix Effects on Consolidation Process 263 Assignment of Retirement Gain or Loss 264 Intra-Entity Debt Transactions Years Subsequent to Effective Retirement 264 Discussion Question: Who Lost This $300,000? 265 Subsidiary Preferred Stock 268 Consolidated Statement of Cash Flows 270 Acquisition Period Statement of Cash Flows 270 Statement of Cash Flows in Periods Subsequent to Acquisition 274 Consolidated Earnings per Share 274 Subsidiary Stock Transactions 277 Changes in Subsidiary Value Stock Transactions 278 Subsidiary Stock Transactions Illustrated 281 Summary 285 Chapter Seven Foreign Currency Transactions and Hedging Foreign Exchange Risk 307 Foreign Exchange Markets 307 Exchange Rate Mechanisms 308 Foreign Exchange Rates 308 Spot and Forward Rates 310 Option Contracts 310 Foreign Currency Transactions 311 Accounting Issue 312 Accounting Alternatives 312 Balance Sheet Date before Date of Payment 313 Hedges of Foreign Exchange Risk 315 Derivatives Accounting 315 Fundamental Requirement of Derivatives Accounting 316 Determination of Fair Value of Derivatives 316 Accounting for Changes in the Fair Value of Derivatives 316 Hedge Accounting 317 Nature of the Hedged Risk 317 Hedge EJfectiveness 318 Hedge Documentation 318 Hedging Combinations 318 Hedges of Foreign Currency Denominated Assets and Liabilities 321 Cash Flow Hedge 321 Fair Value Hedge 321 Forward Contract Used to Hedge a Foreign Currency Denominated Asset 321 Forward Contract Designated as Cash Flow Hedge 323 Forward Contract Designated as Fair Value Hedge 326 Discussion Question: Do We Have a Gain or What? 328 Cash Flow Hedge versus Fair Value Hedge 329 Foreign Currency Option Used to Hedge a Foreign Currency Denominated Asset 330 Option Designated as Cash Flow Hedge 331 Option Designated as Fair Value Hedge 333 Hedges of Unrecognized Foreign Currency Firm Commitments 335 Forward Contract Used as Fair Value Hedge of a Firm Commitment 336 Option Used as Fair Value Hedge of Firm Commitment 338 Hedge of Forecasted Foreign Currency Denominated Transaction 340 Forward Contract Cash Flow Hedge of a Forecasted Transaction 340 Option Designated as a Cash Flow Hedge of a Forecasted Transaction 342 Use of Hedging Instruments 344 The Euro 345 Foreign Currency Borrowing 345 Foreign Currency Loan 346 IFRS Foreign Currency Transactions and Hedges 346 Summary 347 Chapter Eight Translation of Foreign Currency Financial Statements 371 Exchange Rates Used in Translation 372 Discussion Question: How Do We Report This? 373 Translation Adjustments 374 Balance Sheet Exposure 374 Translation Methods 375 Current Rate Method 375 Temporal Method 376 Translation of Retained Earnings 378 Complicating Aspects of the Temporal Method 378 Calculation of Cost of Goods Sold 378 Application of the Lower-of-Cost-or-Market Rule 379 Fixed Assets, Depreciation, and Accumulated Depreciation 379 Gain or Loss on the Sale of an Asset 379 Treatment of Translation Adjustment 380 U.S. Rules 380 Two Translation Combinations 381 Highly Inflationary Economies 383 Appropriate Exchange Rate 384 The Process Illustrated 384 Translation of Financial Statements Current Rate Method 386 Translation of the Balance Sheet 387 Translation of the Statement of Cash Flows 389 Remeasurement of Financial Statements Temporal Method 390 Remeasurement of the Income Statement 390 Remeasurement of the Statement of Cash Flows 392 Nonlocal Currency Balances 392 Comparison of the Results from Applying the Two Different Methods 394 Underlying Valuation Method 394 Underlying Relationships 395 Hedging Balance Sheet Exposure 395 Disclosures Related to Translation 396

5 xx Contents Consolidation of a Foreign Subsidiary 397 Translation of Foreign Subsidiary Trial Balance 398 Determination of Balance in Investment Account Equity Method 399 Consolidation Worksheet 400 IFRS Translation of Foreign Currency Financial Statements 401 Summary 403 Chapter Nine Partnerships: Formation and Operation 429 Partnerships Advantages and Disadvantages 430 Alternative Legal Forms 431 Subchapter S Corporation 431 Limited Partnerships (LPs) 432 Limited Liability Partnerships (LLPs) 432 Limited Liability Companies (LLCs) 432 Partnership Accounting Capital Accounts 432 Articles of Partnership 433 Discussion Question: What Kind of Business Is This? 434 Accounting for Capital Contributions 434 Additional Capital Contributions and Withdrawals 437 Discussion Question: How Will the Profits Be Split? 438 Allocation of Income 439 Accounting for Partnership Dissolution 442 Dissolution Admission of a New Partner 443 Dissolution Withdrawal of a Partner 448 Summary 450 ChapterTen Partnerships: Termination and Liquidation 467 Termination and Liquidation Protecting the Interests of All Parties 468 Termination and Liquidation Procedures Illustrated 469 Statement of Liquidation 471 Deficit Capital Balance Contribution by Partner 471 Deficit Capital Balance Loss to Remaining Partners 472 Discussion Question: What Happens If a Partner Becomes Insolvent? 478 Installment Liquidations 479 Preliminary Distribution of Partnership Assets 479 Predistribution Plan 481 Summary 484 Chapter Eleven Accounting for State and Local Governments (Parti) 501 Introduction to the Accounting for State and Local Governments 502 Governmental Accounting User Needs 503 Two Sets of Financial Statements 504 The Advantage of Reporting Two Sets of Financial Statements 505 Internal Record-Keeping Fund Accounting 506 Fund Accounting Classifications 507 Overview of State and Local Government Financial Statements 511 Government- Wide Financial Statements 511 Fund Financial Statements 513 Accounting for Governmental Funds 517 The Importance of Budgets and the Recording of Budgetary Entries 517 Encumbrances 519 Recognition of Expenditures for Operations and Capital Additions 521 Discussion Question: Is It an Asset or a Liability? 523 Recognition of Revenues Overview 525 Derived Tax Revenues Such As Income Taxes and Sales Taxes 525 Imposed Nonexchange Revenues Such As Property Taxes and Fines 526 Government-Mandated Nonexchange Transactions and Voluntary Nonexchange Transactions 527 Issuance of Bonds 528 Special Assessments 530 Interfund Transactions 532 Summary 535 Chapter Twelve Accounting for State and Local Governments (Part 2) 559 Capital Leases 559 Leases Government- Wide Financial Statements 560 Leases Fund Financial Statements 561 Solid Waste Landfill 562 Landfills Government- Wide Financial Statements 563 Landfills Fund Financial Statements 564 Defined Benefit Pension Plans 564 Works of Art and Historical Treasures 566 Infrastructure Assets and Depreciation 567 Comprehensive Annual Financial Report 569 The Primary Government and Component Units 570 Primary Government 570 Component Units 571 Discussion Question: Is It Part of the County? 573 Special Purpose Governments 573 Acquisitions, Mergers, and Transfers of Operations 574 Government-Wide and Fund Financial Statements Illustrated 575 Statement of Net Position Government-Wide Financial Statements 575 Statement of Activities Government-Wide Financial Statements 576

6 Contents xxi Balance Sheet Governmental Funds Fund Financial Statements 580 Statement of Revenues, Expenditures, and Other Changes in Fund Balances Governmental Funds Fund Financial Statements 582 Statement of Net Position Proprietary Funds Fund Financial Statements 584 Statement of Revenues, Expenses, and Other Changes in Net Position Proprietary Funds Fund Financial Statements 584 Statement of Cash Flows Proprietary Funds Fund Financial Statements 584 Reporting Public Colleges and Universities 589 Summary 594 INDEX 615