Solutions for Financial Accounting, 11th Edition by Robert Libby
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Course
Financial Accounting
Institution
Financial Accounting
Complete Solutions Manual for Financial Accounting, 11th Edition 11e by Robert Libby, Patricia Libby and Frank Hodge. ISBN-13: 9734
Full Chapters Solutions are included
CHAPTER 1: Financial Statements and Business Decisions
Focus Company: Le-Nature’s Inc.
CHAPTER 2: Investing and Fi...
Appendix A
Reporting and Interpreting Investments in
Other Corporations
ANSWERS TO QUESTIONS
1. A short-term investment is one that meets the two tests of (1) ready marketability
and (2) management’s intention to convert it to cash in the short run. In contrast,
a long-term investment is one that does not meet both of these tests. A short-term
investment is classified as a current asset on the balance sheet, while long-term
investments are reported as noncurrent assets.
2. For passive investments in bonds, companies may report the investment at
amortized cost if the intent is to hold the bonds until maturity. Otherwise, the
investments in bonds are to be accounted for using the fair value method with the
investments adjusted up or down to fair value at year end. If management’s
intent is to trade the bond securities actively, the trading securities are classified
as current assets with unrealized gains/losses reported on the income statement.
If the intent is not to trade the securities actively or hold to maturity, the available-
for-sale securities are classified as either current or noncurrent assets with
unrealized gains/losses reported on the statement of comprehensive income.
Passive equity investments are those in which the investor has less than 20% of
the outstanding shares of voting common stock, unless there is evidence to the
contrary. These investments are treated like trading securities, but may be
reported as current or noncurrent assets.
When a company can exert significant influence over the investing and financing
decisions of another company, the equity method is used to account for and
report the investment. In applying the equity method, considered a “one-line
consolidation,” the percentage share of dividends declared by the affiliate
company reduces the investment account; the investor’s percentage share of the
affiliate’s net income or loss is included as income or loss on the investor’s
income statement with an offsetting change in the investment account. The
ability to exert significant influence over an affiliate company is presumed if the
investor owns between 20% and 50% of the outstanding shares of voting
common stock.
When an investor owns over 50% of the outstanding shares of voting common
stock, the investor has control over the affiliate. Consolidated statements are
prepared.
Financial Accounting, 11/e Appendix A-1
, 3. Only bonds that management has the plans and ability to hold until maturity can
be reported in the held-to-maturity portfolio. The investments in held-to-maturity
bonds are reported on the balance sheet at amortized cost, not fair value, at the
end of each year and are classified as current or noncurrent assets, depending
on the maturity date.
4. Under the fair value method, revenues are measured by the investor company
when (1) the other company declares a cash dividend on equity securities or
interest revenue is earned on debt securities, (2) unrealized gains and losses are
recorded on trading securities (debt instruments) and passive investments in
equity securities, and (3) gains and losses occur on sales of available-for-sale
securities in debt instruments.
5. Under the equity method, investment revenue is measured on a proportionate
basis by the investor company when earnings are reported by the affiliate
company, rather than when the dividends are declared. This is because the
equity method is applied when the investor company has a sufficient number of
the shares of voting stock of the other company to exercise a significant
influence. When the investor can exercise significant influence over the operating
and financing policies of the affiliate, it means that cash dividends of the affiliate
can be obtained, almost at will, by the investor company. Thus, when the affiliate
company reports income, the investor company should record a proportionate
share of that income as investment revenue because it is considered earned
under the requirements of the revenue principle; however, any dividends declared
by the affiliate are not considered revenue.
6. Under the equity method, the investor’s share of dividends declared by the
affiliate company (the other company) are not recorded as revenue because,
when an investor can exercise significant influence over the dividend policies of
another corporation, it means that cash dividends of the affiliate can be obtained,
almost at will, by the investor company. To record the dividends as revenue
would involve double-counting because the investor company has already shown,
as revenue earned, its proportionate share of the earnings of the affiliate
company. Because the dividends from the affiliate company are paid out of those
earnings, to record them as revenue by the investor company would be double-
counting. As a consequence, under the equity method, the share of dividends
declared by the affiliate company is debited to Cash and credited to the
Investment account.
7. The identifiable assets and liabilities of the acquired company are recorded at
their fair value on the date of acquisition. This is called the acquisition method.
8. Goodwill is only recorded when one company purchases a controlling interest in
another. Goodwill is equal to the purchase price minus the fair value of the
identifiable assets less liabilities of the acquired company. The goodwill must be
recognized as an asset and is not expensed unless impaired.
Appendix A-2 Solutions Manual
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