Mc Graw Hill Education

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1 Advanced Accounting Twelfth Edition Joe B. Hoyle Associate Professor of Accounting Robins School of Business University of Richmond Thomas F. Schaefer KP MG 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 11 Equity Method Additional Issues 13 Reporting a Change to the Equity Method 14 Reporting lnvestee Other Comprehensive Income and Irregulär Items 15 Reporting lnvestee Losses 16 Reporting the Sale of an 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 xviii 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 A cquired 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 Acquired 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

3 Contents xix Testing Goodwillfor Impairment Steps 1 and2 111 Illustration Accounting and Repor fing for a Goodwill Impairment Loss 112 Reporting Units with Zero or Negative Carrying Amounts 113 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) 15 5 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 Expens es 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 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 Vnrealized Gross Profit Year of Transfer (Year 1) 205 Discussion Question: Earnings Management 206 TJnrealized Gross Profit Year Following Transfer 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 A ccounting for Land Transactions 224 Eliminating Unrealized Gains Land Transfers 225 Recognizing the Effect on Noncontrolling Interest Land Transfers 226 Intra-Entity T ransfer of Depreciable Assets 227 Deferral 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 Issties 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 Standards 260 Intra-Entity Debt Transactions 260 Acquisition of Affiliate's Debt from an Outside Party 261 Accounting for Intra-Entity Debt Transactions lnd.ivid.ual Financial Records 262

4 xx Contents 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 Consolidated Financial Statements Ownership Patterns and Income Taxes 307 Indirect Subsidiary Control 307 The Consolidation Process When Indirect Control Is Present 308 Consolidation Process Indirect Control 310 Indirect Subsidiary Control Connecting Affiliation 316 Mutual Ownership 318 Treasury Stock Approach 318 Mutual Ownership Illustrated 319 Income Tax Accounting for a Business Combination 321 Affiliated Groups 322 Deferred Income Taxes 322 Consolidated Tax Returns Illustration 323 Income Tax Expense Assignment 324 Filing of Separate Tax Returns 325 Deferred Tax on Undistributed Earnings Illustrated 326 Separate Tax Returns Illustrated 327 Temporary Differences Generated by Business Combinations 329 Business Combinations and Operating Loss Carryforwards 330 Income Taxes and Business Combinations Standards 332 Summary 332 Chapter Eight Segment and Interim Reporting 349 Segment Reporting 350 The Management Approach 350 Determination of Reportable Operating Segments 350 Quantitative Thresholds 351 T esting Procedures Complete Illustration 352 Other Guidelines 354 Information to Be Disclosed by Reportable Operating Segment 356 Reconciliations to Consolidated Totais 358 Explanation of Measurement 359 Examples of Operating Segment Disclosures 359 Entitywide Information 361 Information about Products and Services 361 Information about Geographie Areas 361 Discussion Question: How Does a Company Determine Whether a Foreign Country Is Material? 363 Information about Major Customers 365 IFRS Segment Reporting 365 Interim Reporting 365 Revenues 366 Inventory and Cost of Goods Sold 366 Other Costs and Expenses 367 Extraordinary Items 368 Income Taxes 369 Change in Accounting Principle 370 Seasonal Items 371 Minimum Disclosures in Interim Reports 371 Segment Information in Interim Reports 372 IFRS Interim Reporting 372 Summary 373 Chapter Nine Foreign Currency Transactions and Hedging Foreign Exchange Risk 393 Foreign Exchange Markets 393 Exchange Rate Mechanisms 394 Foreign Exchange Rates 394 Spot and Forward Rates 396 Option Contracts 396 Foreign Currency Transactions 397 Accounting Issue 398 Accounting Alternatives 398 Balance Sheet Date before Date of Payment 399 Hedges of Foreign Exchange Risk 401 Derivatives Accounting 401 Fundamental Requirement of Derivatives Accounting 402 Determination of Fair Value of Derivatives 402 Accounting for Changes in the Fair Value of Derivatives 402 Hedge Accounting 403 Nature of the Hedged Risk 403 Hedge Effectiveness 404 Hedge Documentation 404 Hedging Combinations 404 Hedges of Foreign Currency Denominated Assets and Liabilities 407 Cash Flow Hedge 407 Fair Value Hedge 407 Forward Contract Used to Hedge a Foreign Currency Denominated Asset 407

5 Contents xxi Forward Contract Designated as Cash Flow Hedge 409 Forward Contract Designated as Fair Value Hedge 412 Discussion Question: Do We Have a Gain or What? 414 Cash Flow Hedge versus Fair Value Hedge 415 Foreign Currency Option Used to Hedge a Foreign Currency Denominated Asset 416 Option Designated as Cash Flow Hedge 417 Option Designated as Fair Value Hedge 419 Hedges of Unrecognized Foreign Currency Firm Commitments 421 Forward Contract Used as Fair Value Hedge of a Firm Commitment 422 Option Used as Fair Value Hedge of Firm Commitment 424 Hedge of Forecasted Foreign Currency Denominated Transaction 426 Forward Contract Cash Flow Hedge of a Forecasted Transaction 426 Option Designated as a Cash Flow Hedge of a Forecasted Transaction 428 Use of Hedging Instruments 430 The Euro 431 Foreign Currency Borrowing 431 Foreign Currency Loan 432 IFRS Foreign Currency Transactions and Hedges 432 Summary 433 Chapter Ten Translation of Foreign Currency Financial Statements 457 Exchange Rates Used in Translation 458 Discussion Question: How Do We Report This? 459 Translation Adjustments 460 Balance Sheet Exposure 460 Translation Methods 461 Current Rate Method 461 Temporal Method 462 Translation of Retained Earnings 464 Complicating Aspects of the Temporal Method 464 Calculation of Cost of Goods Sold 464 Application of the Lower-of-Cost-or-Market Rule 465 Fixed Assets, Depreciation, and Accumulated Depreciation 465 Gain or Loss on the Sale of an Asset 465 Treatment of Translation Adjustment 466 U.S. Rules 466 Two Translation Combinations 467 Highly Inflationary Economies 469 Appropriate Exchange Rate 470 The Process Illustrated 470 Translation of Financial Statements Current Rate Method 472 Translation of the Balance Sheet 473 Translation of the Statement of Cash Flows 475 Remeasurement of Financial Statements Temporal Method 476 Remeasurement of the Income Statement 476 Remeasurement of the Statement of Cash Flows 478 Nonlocal Currency Balances 478 Comparison of the Results from Applying the Two Different Methods 480 Underlying Valuation Method 480 Underlying Relationships 481 Hedging Balance Sheet Exposure 481 Disclosures Related to Translation 482 Consolidation of a Foreign Subsidiary 483 Translation of Foreign Subsidiary Trial Balance 484 Determination of Balance in Investment Account Equity Method 485 Consolidation Worksheet 486 IFRS Translation of Foreign Currency Financial Statements 487 Summary 489 Chapter Eleven Worldwide Accounting Diversity and International Standards 515 Evidence of Accounting Diversity 516 Reasons for Accounting Diversity 520 Legal System 520 Taxation 520 Financing System 521 Inflation 521 Political and Economic Ties 521 Culture 521 A General Model of the Reasons for International Differences in Financial Reporting 522 Problems Caused by Diverse Accounting Practices 523 International Accounting Standards Committee 524 The IOS CO Agreement 525 International Accounting Standards Board 525 International Financial Reporting Standards (IFRS) 526 Use of IFRS 527 FASB-IASB Convergence 529 SEC Acceptance of IFRS 530 IFRS Roadmap 530 A Possible Framework for Incorporating IFRS into U.S. Financial Reporting 531 First-Time Adoption of IFRS 532 IFRS Accounting Policy Hierarchy 535 Differences between IFRS and U.S. GAAP 536 Recognition Differences 536 Measurement Differences 536 Discussion Question: Which Accounting Method Really Is Appropriate? 538 Presentation and Disclosure Differences 538 IAS1, " Presentation of Financial Statements" 539 U.S. GAAP Reconciliations 539 A Principles-Based Approach to Standard Setting 543

6 xxii Contents Obstacles to Worldwide Comparability of Financial Statements 544 Translation of IFRS into Other Languages 544 The Impact of Culture on Financial Reporting 545 Summary 546 Chapter Twelve Financial Reporting and the Securities and Exchange Commission 557 The Work of the Securities and Exchange Commission 557 Purpose of the Federal Securities Laws 559 Füll and Fair Disclosure 561 Corporate Accounting Scandals and the Sarbanes-Oxley Act 563 Creation of the Public Company Accounting Oversight Board 564 Registration of Public Accounting Firms 565 The SEC's Authority over Generally Accepted Accounting Principles 566 Filings with the SEC 569 Electronic Data Gathering, Analysis, and Retrieval System (EDGAR) 574 Discussion Question: Is the Disclosure Worth the Cost? 575 Summary 576 Chapter Thirteen Accounting for Legal Reorganizations and Liquidations 583 Accounting for Legal Reorganizations and Liquidations 584 Bankruptcy Reform Act of Discussion Question: What Do We Do Now? 588 Discussion Question: How Much Is That Building Really Worth? 590 Statement of Financial Affairs Illustrated 591 Liquidation Chapter 7 Bankruptcy 594 Role of the Trustee 595 Statement of Realization and Liquidation Illustrated 596 The Liquidation Basis of Accounting 597 Reorganization Chapter 11 Bankruptcy 599 The Plan for Reorganization 600 Acceptance and Confirmation of Reorganization Plan 602 Financial Reporting during Reorganization 602 Financial Reporting for Companies Emerging from Reorganization 604 Fresh Start Accounting Illustrated 606 Discussion Question: Is This the Real Purpose of the Bankruptcy Laws? 608 Summary 609 Chapter Fourteen Partnerships: Formation and Operation 629 Partnerships Advantages and Disadvantages 630 Alternative Legal Forms 631 Subchapter S Corporation 631 Limited Partnerships (LPs) 632 Limited Liability Partnerships (LLPs) 632 Limited Liability Companies (LLCs) 632 Partnership Accounting Capital Accounts 632 Articles of Partnership 633 Discussion Question: What Kind of Business Is This? 634 Accounting for Capital Contributions 634 Additional Capital Contributions and Withdrawals 637 Discussion Question: How Will the Profits BeSplit? 638 Allocation of Income 639 Accounting for Partnership Dissolution 642 Dissolution Admission of a New Partner 643 Dissolution Withdrawal of a Partner 648 Summary 650 Chapter Fifteen Partnerships: Termination and Liquidation 667 Termination and Liquidation Protecting the Interests of All Parties 668 Termination and Liquidation Procedures Illustrated 669 Statement of Liquidation 671 Deficit Capital Balance Contribution by Partner 671 Deficit Capital Balance Loss to Remaining Partners 672 Discussion Question: What Happens If a Partner Becomes Insolvent? 678 Installment Liquidations 679 Preliminary Distribution of Partnership Assets 679 Predistribution Plan 681 Summary 684 Chapter Sixteen Accounting for State and Local Governments (Parti) 701 Introduction to the Accounting for State and Local Governments 702 Governmental Accounting User Needs 703 Two Sets of Financial Statements 704 The Advantage of Reporting Two Sets of Financial Statements 705 Internal Record-Keeping Fund Accounting 706 Fund Accounting Classifications 707 Overview of State and Local Government Financial Statements 711 Government-Wide Financial Statements 711 Fund Financial Statements 713

7 Contents xxiii Accounting for Governmental Funds 717 The Importance of Budgets and the Recording of Budgetary Entries 717 Encumbrances 719 Recognition of Expenditures for Operations and Capital Additions 721 Discussion Question: Is It an Asset or a Liability? 723 Recognition of Revenues Overview 725 Derived Tax Revenues Such As Income Taxes and Sales Taxes 725 Imposed Nonexchange Revenues Such As Property Taxes and Fines 726 Government-Mandated Nonexchange Transactions and Voluntary Nonexchange Transactions 727 Issuance of Bonds 728 Special Assessments 730 Interfund Transactions 732 Summary 735 Chapter Seventeen Accounting for State and Local Governments (Part 2) 759 Capital Leases 759 Leases Government- Wide Financial Statements 760 Leases Fund Financial Statements 761 Solid Waste Landfi Landfills Government- Wide Financial Statements 763 Landfills Fund Financial Statements 764 Defined Benefit Pension Plans 764 Works of Art and Historical Treasures 766 Infrastructure Assets and Depreciation 767 Comprehensive Annual Financial Report 769 The Primary Government and Component Units 770 Primary Government 770 Component Units 771 Discussion Question: Is It Part of the County? 773 Special Purpose Governments 773 Acquisitions, Mergers, and Transfers of Operations 774 Government-Wide and Fund Financial Statements Illustrated 775 Statement of Net Position Government- Wide Financial Statements 775 Statement of Activities Government- Wide Financial Statements 776 Balance Sheet Governmental Funds Fund Financial Statements 780 Statement of Revenues, Expenditures, and Other Changes in Fund Balances Governmental Funds Fund Financial Statements 782 Statement of Net Position Proprietary Funds Fund Financial Statements 784 Statement of Revenues, Expenses, and Other Changes in Net Position Proprietary Funds Fund Financial Statements 784 Statement of Cash Flows Proprietary Funds Fund Financial Statements 784 Reporting Public Colleges and Universities 789 Summary 794 Chapter Eighteen Accounting and Reporting for Private Not-for-Profit Entities 815 The Structure of Financial Reporting 816 Financial Statements for Private Not-for-Profit Entities 817 Statement of Financial Position 818 Statement of Activities 819 Statement of Functional Expenses 823 Accounting for Contributions 823 Discussion Question: Are Two Sets of GAAP Really Needed for Colleges and Universities? 826 Reporting Works of Art and Historical Treasures 827 Holding Contributions for Others 827 Contributed Services 829 Exchange Transactions 830 Tax-Exempt Status 831 Mergers and Acquisitions 832 Transactions for a Private Not-for-Profit Entity Illustrated 834 Transactions Reported on Statement of Activities 836 Accounting for Health Care Entities 837 Accounting for Patient Service Revenues 837 Discussion Question: Is This Really an Asset? 838 Summary 840 Chapter Nineteen Accounting for Estates and Trusts 859 Accounting for an Estate 859 Administration of the Estate 860 Property Included in the Estate 861 Discovery of Claims against the Decedent 861 Protection for Remaining Family Members 862 Estate Distributions 862 Estate and Inheritance Taxes 864 The Distinction between Income and Principal 868 Recording of the Transactions of an Estate 869 Discussion Question: Is This Really an Asset? 872 Charge and Discharge Statement 873 Accounting for a Trust 874 Record-Keeping for a Trust Fund 877 Accounting for the Activities of a Trust 878 Summary 879 INDEX 893