Solution ManualChapter 1 - Accounting for Intercorporate
Investments1. a.If the investor acquired 100% of the investee at
book value, the Equity Investment account is equal to the
Stockholders Equity of the investee company. It, therefore,
includes the assets and liabilities of the investee company in one
account. The investors balance sheet, therefore, includes the
Stockholders Equity of the investee company, and, implicitly, its
assets and liabilities. In the consolidation process, the balance
sheets of the investor and investee company are brought together.
Consolidated Stockholders Equity will be the same as that which the
investor currently reports; only total assets and total liabilities
will change. b. If the investor owns 100% of the investee, the
equity income that the investor reports is equal to the net income
of the investee, thus implicitly including its revenues and
expenses. Replacing the equity income with the revenues and expense
of the investee company in the consolidation process will yield the
same net income.
2. FASB ASC 323-10 provides the following guidance with respect
to the accounting for receipt of dividends using the equity
method:
The equity method tends to be most appropriate if an investment
enables the investor to influence the operating or financial
decisions of the investee. The investor then has a degree of
responsibility for the return on its investment, and it is
appropriate to include in the results of operations of the investor
its share of the earnings or losses of the investee.
(323-10-05-5)
The equity method is an appropriate means of recognizing
increases or decreases measured by generally accepted accounting
principles (GAAP) in the economic resources underlying the
investments. Furthermore, the equity method of accounting more
closely meets the objectives of accrual accounting than does the
cost method because the investor recognizes its share of the
earnings and losses of the investee in the periods in which they
are reflected in the accounts of the investee. (323-10-05-4).
Under the equity method, an investor shall recognize its share
of the earnings or losses of an investee in the periods for which
they are reported by the investee in its financial statements
rather than in the period in which an investee declares a dividend
(323-10- 35-4).
3. The recognition of equity income does not mean that cash has
been received. In fact, dividends paid by the investee to the
investor are typically a small percentage of their reported net
income. The projection of future net income that includes equity
income as a significant component might not, therefore, imply
significant generation of cash.
4. The accounting for CBS investment in Westwood One depends on
the degree of influence or control it can exert over that company.
A classification of no influence does not appear appropriate since
CBS owns 18% of the outstanding common stock and also manages
Westwood under a management agreement. CBS also does not appear to
control Westwood. It only has one seat on the board of directors.
Although we are not provided with the number of seats on the board
of directors, control of one seat does not likely relate to control
the board. A classification of significant influence seems most
appropriate given the facts, and this classification warrants
accounting for the investment using the equity method of
accounting.
5. a.An investor may write down the carrying amount of its
Equity Investment if the market value of that investment has
declined below its carrying value and that decline is deemed to be
other than temporary.
b.There is considerable judgment in determining whether a
decline in market value is other than temporary. The write-down
amounts to a prediction that the future market value of the
investment will not rise above the current carrying amount. If a
company deems the decline to be temporary, it does not write down
the investment, and a loss is not recognized in its income
statement. If the decline is deemed to be other than temporary, the
investment is written down and a loss is reported. Companies can
use this flexibility to decide whether to recognize a loss in the
current year or to postpone it to a future year.
6. Under the equity method, an investor recognizes its share of
the earnings or losses of an investee in the periods for which they
are reported by the investee in its financial statements. FASB ASC
323-10-35-7 states that Intra-entity profits and losses shall be
eliminated until realized by the investor or investee as if the
investee were consolidated. These intercompany items are eliminated
to avoid double counting and prematurely recognizing income.
7. FASB ASC 323-10-15 requires the use of the equity method of
accounting for an investor whose investment in voting stock gives
it the ability to exercise significant influence over operating and
financial policies of an investee. Section 15-6 states that Ability
to exercise significant influence over operating and financial
policies of an investee may be indicated in several ways, including
the following: Representation on the board of directors,
Participation in policy-making processes, Material intra-entity
transactions, change of managerial personnel, Technological
dependency, and Extent of ownership by an investor in relation to
the concentration of other shareholdings (but substantial or
majority ownership of the voting stock of an investee by another
investor does not necessarily preclude the ability to exercise
significant influence by the investor) (emphasis added). It is
clear, in this case, that the investee is critically dependent upon
the technology licensed to it by the investor. The investor should,
therefore, account for its investment using the equity method.
8. Even though the investor owns 30% of the investee, it should
not use the equity method as it cannot exert significant influence
over the investee. Further, since the investee is not a public
company (all of the remaining stock is privately held), the
investor should use the cost method to account for this investment
as the market method presumes a publicly traded stock with
sufficient liquidity to reasonably determine a fair value.
9. a.The losses did not affect Enrons income statement. Since
the investees were insolvent, Enrons Equity Investment was reduced
to zero (it had not made any loans or other advances to the
investee companies). As a result, Enron discontinued reporting for
these Equity Investments using the equity method and, therefore,
did not recognize its proportionate share of investee losses.
b. only after its share of that net income equals the share of
net losses not recognized during the period the equity method was
suspended means that the investee has recouped all of the losses
that have been reported. Since the investor ceases to account for
its Equity Investment using the equity method once the balance
reaches zero (assuming that it has not guaranteed the debts of the
investee company), this generally implies that the investees
Stockholders Equity is below zero (i.e., a deficit). The investor
resumes its accounting for the Equity investment using the equity
method once the investees Stockholders Equity is positive. It is at
that point when the investee company has recouped all of its prior
losses (assuming that the investee company has not raised
additional equity capital).
10. FASB ASC 323 provides the following list of required
disclosures for equity method investments:a. (1) the name of each
investee and percentage of ownership of common stock, (2) the
accounting policies of the investor with respect to investments in
common stock, and (3) the difference, if any, between the amount at
which an investment is carried and the amount of underlying equity
in net assets and the accounting treatment of the difference.
b. For those investments in common stock for which a quoted
market price is available, the aggregate value of each identified
investment based on the quoted market price usually should be
disclosed. This disclosure is not required for investments in
common stock of subsidiaries.
c. When investments in common stock of corporate joint ventures
or other investments accounted for under the equity method are, in
the aggregate, material in relation to the financial position or
results of operations of an investor, it may be necessary for
summarized information as to assets, liabilities, and results of
operations of the investees to be presented in the notes or in
separate statements, either individually or in groups, as
appropriate.
d. Conversion of outstanding convertible securities, exercise of
outstanding options and warrants and other contingent issuances of
an investee may have a significant effect on an investor's share of
reported earnings or losses. Accordingly, material effects of
possible conversions, exercises or contingent issuances should be
disclosed in notes to the financial statements of an investor.
11. Answer: d
In a (basket) net asset acquisition that does not constitute a
business, as that term is defined in FASB ASC 805 (Business
Combinations), the total consideration paid for the net assets is
allocated to the individual net asset accounts on the basis of
proportional fair value, as follows:
Net Assets - Dr. (Cr.)Fair value%FVAssigned
Production equipment20022.2%222
Factory60066.7%667
Licenses25027.8%278
Mortgage liability(150)-17%(167)
Total900100.0%1000
12. Answer: b
Goodwill is only recorded when the acquired net assets (or legal
entity) constitutes a business, as that term is defined in FASB ASC
805 (Business Combinations).
13. Answer: c
When acquired net assets (or a legal entity) constitute a
business, as that term is defined in FASB ASC 805 (Business
Combinations), the individual identifiable acquired net assets are
reported at fair value on the acquisition date.
14. Answer: c
When acquired net assets (or a legal entity) constitute a
business, as that term is defined in FASB ASC 805 (Business
Combinations), the amount of recognized goodwill is equal to the
fair value of the entire acquired business (i.e., $1,000
consideration transferred) less the fair value of the identifiable
net assets (i.e., $900, see above solution to #11). This results in
$100 of goodwill recognized on the acquisition date.
15. Answer: d
Given that fair value of net assets approximates the book value
of net assets and there is no goodwill recognized, this means that
the book value of net assets of the subsidiary approximates the
overall value of the consideration transferred for the company
(i.e., $136,000). Given that the parent company transferred 4,000
shares, this means that the per share value for the parent company
stock is $34/share (i.e., $136,000/4,000).
16. Answer: b
Given that fair value of net assets approximates the book value
of net assets and there is no goodwill recognized, this means that
the book value of net assets of the subsidiary approximates the
overall value of the consideration transferred for the company
(i.e., $136,000). This means that the investment account equals
$136,000 on the acquisition date.
17. Answer: b
In a business combination, goodwill is equal to the fair value
of the entire acquired business (i.e., $378,000 = 18,000 shares x
$21/share) less the fair value of the identifiable net assets
(i.e., $486,000 - $114,000 = $372,000), which equals $6,000.
18. Answer: d
The amount recorded for the investment account is the value of
the consideration transferred in exchange for the investees common
stock (i.e., $378,000 = 18,000 shares x $21/share).
19. Answer: b
The cost method is used for reporting noncontrolling investments
in equity securities that (1) do not convey to the holder of the
securities significant influence over the investee and (2) that are
not marketable. Under the cost method, the investment is reported
by the investor at the original cost of the investment. (Assuming
the investment is not considered impaired. There is no evidence of
impairment in the present problem.) Thus, at December 31, 2013, the
investment is reported at $90,000 (i.e., $9 x 10,000 shares
purchased on January 1, 2013.).
(The following is not addressed in the problem. We are providing
this discussion for completeness. Noncontrolling investments in
marketable equity securities that also do not convey to the holder
of the securities significant influence over the investee are
reported in the balance sheet at fair value. If the securities are
designated as trading securities, the change in fair value is
reported in net income. If the securities are designated as
available for sale securities, the change in fair value is reported
in other comprehensive income.)
20. Answer: c
The equity method is used for reporting noncontrolling
investments in equity securities that convey to the holder of the
securities significant influence over the investee. Under the
equity method, the investment is reported by the investor at the
original cost of the investment and then is adjusted for the
investors ownership percentage of all of the items that change the
stockholders equity of the investee. (Most textbook problems in
intermediate accounting and advanced accounting assume that the
only changes to the stockholders equity of the subsidiary are net
income and dividends.) In addition, any unrecorded net assets
implicit in the investment is amortized. In this case, the AAP is
zero because the fair value of the consideration equals the book
value of the proportionate share of the investees net assets, and
fair values of the individual identifiable net assets approximate
book values. The December 31, 2013 balance is determined as
follows:
Beginning Investment ($9 x 10,000 shares)$ 90,000
Plus: p% x NI (20% x $22,500)4,500
Less: p% x Dividends (20% x $12,000) (2,400)
Ending Investment$ 92,100
21. Answer: c
The cost method is used for reporting noncontrolling investments
in equity securities that (1) do not convey to the holder of the
securities significant influence over the investee and (2) that are
not marketable. Under the cost method, the investment is reported
by the investor at the original cost of the investment. (Assuming
the investment is not considered impaired. There is no evidence of
impairment in the present problem.) Thus, at December 31, 2013, the
investment is reported at $168,000 (i.e., $12 x 14,000 shares
purchased on January 1, 2013.).
(The following is not addressed in the problem. We are providing
this discussion for completeness. Noncontrolling investments in
marketable equity securities that also do not convey to the holder
of the securities significant influence over the investee are
reported in the balance sheet at fair value. If the securities are
designated as trading securities, the change in fair value is
reported in net income. If the securities are designated as
available for sale securities, the change in fair value is reported
in other comprehensive income.)
22. Answer: c
The equity method is used for reporting noncontrolling
investments in equity securities that convey to the holder of the
securities significant influence over the investee. Under the
equity method, the investment is reported by the investor at the
original cost of the investment and then is adjusted for the
investors ownership percentage of all of the items that change the
stockholders equity of the investee. (Most textbook problems in
intermediate accounting and advanced accounting assume that the
only changes to the stockholders equity of the subsidiary are net
income and dividends.) In addition, any accounting acquisition
premium (AAP) implicit in the investment is amortized. In this
case, the 20% AAP is equal to $28,000 ($168,000 fair value of
consideration paid for 20% [see answer to #21] less 20% x book
value of net assets (i.e., $140,000 = 20% x $700,000). The only
depreciable asset in the 20% AAP is the customer list, which has
$10,000 of AAP assigned to it (i.e., 20% x $50,000). This results
in 20% AAP amortization of $2,000 per year (i.e., $10,000/5). The
December 31, 2013 equity-method investment balance is determined as
follows:
Beginning Investment ($9 x 10,000 shares)$ 168,000
Plus: p% x NI (20% x $22,500)8,400
Less: p% x Dividends (20% x $12,000)(4,000)
Less: p% AAP amortization(2,000)
Ending Investment$ 170,400
23. new Hopkins problem
a. The cost is allocated to the acquired net assets based on
relative fair values:
Net Assets - Dr. (Cr.)Fair value%FVAssigned
Production equipment20011.1%222
Factory1,00055.6%1,111
Land25013.9%278
Patents50027.8%556
Secured debt(150)-8.3%(167)
Total1,800100.0%2,000
continued next page
a.continuedThis results in the following journal entry:
Production equipment222
Factory1,111
Land278
Patents556
Secured debt167
Cash2,000
(to record purchase of the assets and assumption of the
liabilities that does not qualify as a business)
b. Production equipment200
Factory1,000
Land250
Patents500
Goodwill200
Secured debt150
Cash2,000
(to record purchase of the assets and assumption of the
liabilities that qualifies as a business)
24. a. Cash1,000
Accounts receivable2,000
Inventories4,000
PPE. net10,000
Accounts payable2,000
Accrued liabilities3,000
Long-term liabilities4,000
Cash8,000
(to record purchase of the assets and assumption of the
liabilities of a business)
b. Equity investment8,000
Cash8,000
(to record purchase of the assets and assumption of the
liabilities of a business)
25. a.Cash1,000
Accounts receivable2,000
Inventories4,000
PPE. net14,000
Customer list3,000
Accounts payable2,000
Accrued liabilities3,000
Long-term liabilities4,000
Cash15,000
(to record purchase of the assets and assumption of the
liabilities of a business)
b.Equity investment15,000
Cash15,000
(to record purchase of the assets and assumption of the
liabilities of a business)
26. In both parts of this problem, the value of the common stock
issued by the investor company is the same: $332,500 (i.e., 9,500
shares x $35/share). On the investors books, this is split between
Common stock ($1 par) for $9,500 and Additional paid-in capital for
$323,000. The difference between parts a and b is whether (a) the
investor recognizes the investees individual net assets at fair
value or (b) an investment account.
When the investor recognizes the individual net assets in part
a, it will also recognize goodwill implicit in the acquisition. The
goodwill is equal to $22,500 (i.e., FV of investee, $332,500 FV of
the identifiable net asset of the investee, $310,000). In part b,
we only recognize the investment account in the pre-consolidation
financial statements of the acquirer; thus, the goodwill is inside
the investment account and only becomes part of the investors
financial statements after consolidation.
a. The journal entry to record the acquisition of the net assets
follows:
Receivables & Inventories 45,000
Land 150,000
Property & Equipment 130,000
Trademarks & Patents 80,000
Goodwill 22,500
Liabilities 95,000
Common Stock ($1 par) 9,500
APIC 323,000
continued next page
a.continuedThe effects of this entry are reflected in the FV
Investee column in the following worksheet:
(BV)(FV)
Dr. (Cr)InvestorInvesteePost-Acqu.*
Receivables & Inventories 100,00045,000145,000
Land 200,000150,000350,000
Property & Equipment 225,000130,000355,000
Trademarks & Patents 80,00080,000
Investment in Investee -
Goodwill 22,50022,500
Total Assets 525,000427,500952,500
Liabilities (150,000)(95,000)(245,000)
Common Stock ($1 par) (20,000)(9,500)(29,500)
APIC (280,000)(323,000)(603,000)
Retained Earnings (75,000)-(75,000)
Total Liabilities & Equity (525,000)(427,500)(952,500)
b. The journal entry to record the acquisition of the common
stock of the investee follows:
Investment in Investee 332,500
Common Stock ($1 par) 9,500
APIC 323,000
(BV)(FV)
Dr. (Cr)InvestorInvesteePost-Acqu.*
Receivables & Inventories 100,000100,000
Land 200,000200,000
Property & Equipment 225,000225,000
Trademarks & Patents
Investment in Investee 332,500332,500
Goodwill
525,000332,500857,500
Liabilities (150,000)(150,000)
Common Stock ($1 par) (20,000)(9,500)(29,500)
APIC (280,000)(323,000)(603,000)
Retained Earnings (75,000)(75,000)
Total Liabilities & Equity (525,000)(332,500)(857,500)
* = Pre-consolidation
27. a.The investor reports equity income equal to its
proportionate share of the net income of the investee company:
$430,000 x 30% = $129,000.
b.The balance of the Equity Investment account at the end of the
year is $579,000 ($500,000 + $129,000 - $50,000).
c. The market value of the investee company is not reflected in
the financial statements of the investor company. Under the equity
method, the Equity Investment account is reported at adjusted cost
(adjusted for equity income and dividends). Changes in the market
value of the investee company do not affect this reported amount
(unless the market value declines below the carrying amount of the
Equity Investment and the decline is deemed to be other than
temporary).
d. Possibly, yes. APB 18, 19d provides the following guidance:
The investor's share of extraordinary items should be classified in
a similar manner unless they are immaterial in the income statement
of the investor. Provided that the extraordinary item is material
for the investor, it would report the extraordinary component as
extraordinary income in its own income statement.
28. Equity investment108,000
Cash108,000
(to record the purchase of the Equity Investment)
Equity investment24,000
Equity income24,000
(to record equity income)
Cash15,000
Equity investment15,000
(to record receipt of the cash dividend)
Cash120,500
Equity investment*117,000
Gain on sale3,500
(to record the sale of the Equity Investment)
* Equity Investment balance on date of sale = $108,000 + $24,000
- $15,000 = $117,000
29. a.The gross profit remaining in ending inventory = $40,000 x
20% = $8,000.Equity income = ($100,000 - $8,000) x 30% =
$27,600
b.Beginning Equity Investment$300,000
Equity income27,600
Dividends(20,000)
Ending Equity Investment$307,600
c. Equity income = ($150,000 + $8,000) x 30% = $47,400
30. a.The amount of deferred profit is $494 thousand [$969 gross
profit on sales to TV Guide Network x .51 ownership interest in TV
Guide Network).
b. The equity income and investment account decrease by the
amount of profit deferred, or $494 (found above). The journal entry
is as follows:
Equity income$494 thousandEquity investment$494 thousand
31. Equity investment200,000
Cash200,000
(to record the purchase of the Equity investment)
Equity investment40,000
Equity income40,000
(to record equity income)
Cash15,000
Equity investment15,000
(to record receipt of the cash dividend)
Equity income4,000
Equity investment4,000
(to record the amortization of the patent asset)
Cash230,000
Equity investment*221,000
Gain on sale9,000
(to record the sale of the Equity investment)
*The Equity Investment balance on the date of sale is ($200,000
+ $40,000 - $15,000 - $4,000 = $221,000)
32. a.A change from the market method to equity method requires
removing the cumulative fair value adjustments and recording the
cumulative equity income less dividends. RETROACTIVE
adjustment.
Here are the T accounts prior to the change in ownership and
accounting:Investment in SAOCI Shareholders Equity
Cost 300,000
FMV adj 125,000125,000 FMV adjust
Bal prior to change 425,000
Unrealized holding gain (AOCI)125,000
Investment - Fair value adjustment125,000
(to remove the unrealized gain from stockholders equity and the
fair value adjustment from the investment account)
Equity Investment50,000
Retained earnings (prior period adjustment)50,000
(to adjust the Equity Investment to its correct amount at the
beginning of the year and to increase the beginning of the year
Retained Earnings for the cumulative equity income that would have
been recognized)
b.Equity Investment50,000
Retained earnings (prior period adjustment)50,000
Here are the T accounts after adjusting for the change in
ownership and accounting:Investment in SAOCI Shareholders
Equity
Cost 300,000
FMV adj 125,000125,000 FMV adjust
Bal prior to change 425,000125,000 Balance
125,000 Entry 1Entry 1 125,000
Entry 2 50,0000 Balance
Bal after change 350,000
e.
33. a.The equity income is 50% ($1,223 / $2,470) of investee net
income and the equity investment is 46% ($3,405 / [$23,789 -
$16,421]) of investee net assets. The average ownership percentage
is approximately 46% of the investee companies.
b.No, the liabilities are not reported on Dow Chemicals balance
sheet, only the balance of the Equity Investment which represents
Dows proportionate ownership in the investees Stockholders Equity.
Although Dow most likely does not have legal obligation for the
debts of its investee companies, were they to encounter financial
difficulties, Dow might have to invest additional equity capital
into those businesses in order to keep them solvent. Why? Because
Dow uses these Equity Investments as a significant component of its
business model (they represent 5% of total assets and 44% of net
income). If Dow allows one of these investee companies to fail, it
might find that the market will no longer finance future
investments of this kind. It may have a real obligation for these
investees even though it may have no legal obligation.
34. a. Equity income of $498 = $996 million x 50%.
b. Equity investment of $159 million = ($1,354 - $1,037) x 50%,
rounded to $159 million.
35. The equity income that Cummins reports is 43% ($192 / $451)
of the net income of its investee companies. And, the Equity
Investment is 43% ($514 / $1,182) of the Stockholders Equity of the
investee companies. Cummins owns approximately 43% of these
investee companies. (As an aside, this is typically the amount of
information that companies provide in their Equity Investments
footnotes).
36. a. Yes. The equity income that Corning reports of $345
million is 50% of Dow Cornings net income of $690 million.
b. Yes. Dow Corning Stockholders Equity is equal to $2,361
million ($3,511 + $3,688 - $24 - $1,243 - $43 - $3,145 - $383 =
$2,361). One-half of this amount is $1,180.5 million. Cornings
Equity investment balance is $931 million. The difference between
these two amounts is $249.5 million. In its footnote, Corning
considers the $249 million difference between the carrying value of
its investment in Dow Corning and its 50% share of Dow Cornings
equity to be permanent. That is, Corning wrote down its Equity
investment by that amount when Dow Corning petitioned for
bankruptcy.
c. Corning fully impaired its investment of Dow Corning upon its
entry into bankruptcy proceedings. Fully impaired means that
Corning wrote the Equity investment down to zero. The Equity
investment balance cannot fall below zero. So, Corning discontinued
recognition of equity losses once its Equity Investment reached
zero. Subsequently, Dow Corning began to report profits. Once Dow
Cornings Stockholders Equity is positive, Corning can begin to
recognize equity income.
d. Corning is a shareholder in Dow Corning and accounts for its
Equity investment using the equity method. This footnote indicates
that Corning has had to invest additional capital into Dow Corning
in order to gain a release from the latters obligations. Corning
has, in effect, been held liable for its investees obligations. One
criticism of the equity method of accounting is that it only
reports the net equity owned on the investors balance sheet, and
does not provide useful information about the potential liability
arising from that investment. Remember this example the next time
you see an Equity investment on a balance sheet.
37. a.The carrying value of Lions Gates equity method investment
in Break Media is decreased by $5,817, or Lions Gates 42% share of
Break Medias losses ($13,849 x .42 = $5,817).
b.Break Media appears NOT to have paid any significant dividends
to Lions Gate. Lions Gates $5,817 share of losses is approximately
the same as the change in the carrying value of the Break Media
equity investment [$8,477 - $14,293/(14,293) = $5,816].
c. Assuming the same ownership percentage in Break Media of 42%,
Lions Gate share of Break Medias 2010 loss is 5,723 x .42, or
$2,403. The beginning investment balance (X), assuming no
dividends, can be found as follows:
March 31, 2010 (Beginning balance): X
Less: Share of losses ($2,403)
Less: Dividends$0
= March 31, 2011 (end balance):$14,293
X = $16,696
To determine the beginning balance, this solution uses the same
quarter lag from the notes to the financial statements for the
reporting of income/losses equity investments.
38. a.AT&Ts investment in and advances to Cingular reported
on AT&Ts balance sheet at December, 2005, total $31,404.
AT&Ts advances to Cingular are $4,108 at December, 2005. The
interest earned on these advances is $311. The equity investment
is, therefore, $26,985 ($31,404 - $4,108 - $311).
Cingulars equity at 2005 is $6,049 million + $73,270 million -
$10,008 million - $24,333 million = $44,978 million. The equity
investment, thus, represents its 60% ($26,985 million / $44,978
million) equity interest.
b. Cingular paid no dividends during 2005. The receipt of
dividends reduces the equity method investment on AT&Ts books.
The reconciliation of the investment balance from 2004 to 2005
shows no reduction due to the payment of dividends.
c. AT&T reports equity income equal to its proportionate
share of Cingulars net income or $200 million (60% $333
million).
d. Undistributed earnings are earnings that have not yet been
paid out as dividends. This is retained earnings. Of Cingulars
$44,978 million of stockholders equity, $2,711 is, apparently,
retained earnings.
39. a.General Mills accounts for the investments in its joint
ventures using the equity method. Consolidation is not appropriate
because General Mills does not control these entities (General
Mills does not have >50% equity interest). Also, the market
method is inappropriate because General Mills is able to exert
significant influence in the management of these businesses
(Companies may take an irrevocable option to value each individual
equity investment at fair value under ASC 825-10-25.).
Under the equity method, these investments are reflected on
General Mills balance sheet at adjusted cost (i.e., beginning
balance plus proportionate share of investee companys earnings less
any dividends received). General Mills reports its proportionate
share of investee company earnings as income. Under the equity
method of accounting, dividends are not income. Instead, they are
treated as a return of the investment.
b. The $295 million investment balance on General Mills balance
sheet represents the net equity of its joint ventures (together
with aggregate advances of $158 million). General Mills
proportionate share of the assets of the joint ventures, as well as
its proportionate share of the joint ventures liabilities, is not
reflected on its balance sheet, only the net equity. As a result,
General Mills balance sheet does not reflect the actual investment
and liabilities required to conduct these operations. For example,
the total joint venture assets of $1.713 billion less the
investment balance of $295 million equal over $1.4 billion and
these are not recorded on General Mills balance sheet. Similarly,
the liabilities of $1.3 billion are also excluded. This is the
primary criticism of equity method accounting.
c. Although General Mills may not have legal liability for the
obligations of its joint ventures, it might have an implicit
obligation to stand behind the entities that it has created (which
includes their financing). That is, General Mills would be
hard-pressed to walk away from one of these entities should it fail
to pay its debts.
d. Equity method accounting presents at least two challenges for
analysis purposes. (i) Equity method accounting obscures the actual
assets and liabilities of the investee company on the books of the
investor company. (ii) The equity investments are reported at
adjusted cost. As a result, unrealized gains (say, from market
value appreciation) are not reflected on the balance sheet or in
the income statement.
Cambridge Business Publishers, 20141-4Advanced Accounting by
Halsey & Hopkins, 2nd EditionCambridge Business Publishers,
20141-3Solutions Manual, Chapter 1