Advanced Financial Accounting - GBV
AdvancedFinancialAccountingNinth EditionRichard E. BakerNorthern Illinois UniversityTheodore E. ChristensenBrigham Young UniversityDavid M. CottrellBrigham Young UniversityWith contributions from:Valdean C. LembkeProfessor EmeritusThomas E. KingProfessor EmeritusSouthern Illinois University, EdwardsvilleCynthia G. JeffreyIowa State UniversityMeGrauuHillMcGraw-HillIrwin
Table of ContentsABOUT THE AUTHORSvPREFACE viiQuestions 28Cases 29Exercises 32Problems 43Chapter 1Chapter 2Intercorporate Acquisitions and Investmentsin Other Entities 1Reporting Intercorporate Investments andConsolidation of Wholly Owned Subsidiarieswith No Differential 53Kraft's Acquisition of Cadbury 1A Brief Introduction 2Berkshire Hathaway's Many Investments 53The Development of Complex Business Structures 4Accounting for Investments in Common Stock 54Enterprise Expansion 5Reasons for Investing in Common Stock 56Organizational Structure and Business Objectives 5The Cost Method 57Organizational Structure, Acquisitions, and EthicalAccounting Procedures under the Cost Method 57Considerations 6Declaration of Dividends in Excess of Earnings sinceBusiness Expansion and Forms of OrganizationalAcquisition 57Structure 6Acquisition at Interim Date 59Internal Expansion 6Changes in the Number of Shares Held 59External Expansion through Business Combinations 7The Equity Method 59Frequency of Business Combinations 8Use of the Equity Method 60Complex Organizational Structures 9Investor's Equity in the Investee 60Organizational Structure and Financial Reporting 10Recognition of Income 60Creating Business Entities 10Recognition of Dividends 61Business Combinations 12Comparison of the Carrying Amount of the InvestmentForms of Business Combinations 12under the Cost and Equity Methods 62Methods of Effecting Business Combinations 12Acquisition at Interim Date 62Valuation of Business Entities 14Changes in the Number of Shares Held 63Accounting for Business Combinations 15Comparison of the Cost and Equity Methods 65Acquisition Accounting 16The Fair Value Option 66Fair Value Measurements 16Overview of the Consolidation Process 66Applying the Acquisition Method 16Consolidation Procedures for Wholly OwnedGoodwill 17Subsidiaries That Are Created or Purchased at BookCombination Effected through the Acquisition of Net Assets 18 Value 67Combination Effected through Acquisition of Stock 22Consolidation Worksheets 67Financial Reporting Subsequent to a BusinessWorksheet Format 67Combination 23Nature of Eliminating Entries 69Disclosure Requirements 24Consolidated Balance Sheet with Wholly OwnedAdditional Considerations in Accounting for BusinessSubsidiary 69Combinations 24700 Percent Ownership Acquired at Book Value 70Uncertainty in Business Combinations 24Consolidation Subsequent to Acquisition 73In-Process Research and Development 26Consolidated Net Income 74 Noncontrolling'Equity Held Prior to Combination 26Consolidated Retained Earnings 75Acquisitions by Contract Alone 26Consolidated Financial Statements—100 PercentSummary of Key Concepts 26Ownership, Created or Acquired at Book Value 76Key Terms 27Initial Year of Ownership 77APPENDIX 1ASecond and Subsequent Years of Ownership 81Methods of Accounting for BusinessJConsolidated Net Income and Retained Earnings 83Combinations 27Summary of Key Concepts 84
xxviTable of ContentsKey Terms 85APPENDIX 2AAdditional Considerations Relating to theEquity Method 85APPENDIX 2BConsolidation and the Cost Method 88Questions 90Cases 92Exercises 94Problems 100Key Terms 134APPENDIX 3AConsolidation of Variable Interest EntitiesQuestions 135Cases 136Exercises 139Problems 147The Collapse of Enron and the Birth of a New Paradigm 107The Usefulness of Consolidated FinancialStatements 109Limitations of Consolidated Financial Statements 109Subsidiary Financial Statements 110Consolidated Financial Statements: Concepts andStandards 110113116116116Combined Financial Statements 118Additional Considerations—Different Approaches toConsolidation 11912212380 Percent Ownership Acquired at Book Value125Consolidation Subsequent to Acquisition—80 PercentOwnership Acquired at Book Value 127Initial Year of Ownership 127Second and Subsequent Years of Ownership133Treatment of a Positive Differential 165Illustration of Treatment of a Complex Differential100 Percent Ownership Acquired at Less than FairValue of Net Assets 169Illustration of Treatment of Bargain-PurchaseDifferential 169162166Intercompany Receivables and Payables 180Push-Down Accounting 180Summary of Key Concepts 181Key Terms 181APPENDIX 4APush-Down Accounting Illustrated 181Questions 184Cases 184Exercises 186Problems 197Consolidation of Less-than-Wholly-OwnedSubsidiaries Acquired at More than BookValue 206Consolidated Balance Sheet with a Less-than-WhollyOwned Subsidiary 124Summary of Key ConceptsConsolidation Procedures for Wholly OwnedSubsidiaries Acquired at More than Book ValueChapter 5119The Effect of a Noncontrolling InterestConsolidated Net Income 122Consolidated Retained EarningsWorksheet Format 124The Difference between Acquisition Price andUnderlying Book Value 159Initial Year of Ownership 171Second Year of Ownership 176112Off-Balance Sheet Financing 113Variable Interest Entities 114IFRS Differences in Determining Control ofVIEsandSPEs116Theories of Consolidation 119Comparison of Alternative TheoriesCurrent Practice 122How Much Work Does It Really Take to Consolidate?Ask the People Who Do It at Disney 157Dealing with the Differential 158Consolidated Financial Statements—100 PercentOwnership Acquired at More than Book Value 171Special-Purpose and Variable Interest EntitiesComputation of Noncontrolling InterestPresentation of Noncontrolling Interest.Consolidation of Wholly Owned SubsidiariesAcquired at More than Book Value 157The Reporting Entity and Consolidation ofLess-than-Wholly-Owned Subsidiaries withNo Differential 107Noncontrolling Interest-Chapter 4Chapter 3Traditional View of Control 110Indirect Control 111Ability to Exercise Control 111Differences in Fiscal Periods 112Changing Concept of the Reporting Entity134131Cisco Acquires a Controlling Interest in Nuova 206A Noncontrolling Interest in Conjunction witha Differential 207Consolidated Balance Sheet with Majority-OwnedSubsidiary 207Consolidated Financial Statements with aMaj ority-Owned Subsidiary 210Initial Year of Ownership 210Second Year of Ownership 214Discontinuance of Consolidation217
Table of Contents xxviiTreatment of Other Comprehensive Income220Modification of the Consolidation Worksheet 220Adjusting Entry Recorded by Subsidiary 220Adjusting Entry Recorded by Parent Company 220Consolidation Worksheet—Second Year FollowingCombination 221Consolidation Procedures 221Consolidation Worksheet—Comprehensive Incomein Subsequent Years 224Additional Considerations224Subsidiary Valuation Accounts at Acquisition224Negative Retained Earnings of Subsidiary atAcquisition 225Other Stockholders' Equity Accounts 225Subsidiary's Disposal of Differential-Related Assets 225Summary of Key ConceptsKey Terms 227Questions 227Cases 228Exercises 229Problems 239227Intercompany Inventory Transactions 254Inventory Transfers at Toys Si Us 254Overview of the Consolidated Entity andIntercompany Transactions 255Elimination of Intercompany Transfers 256Elimination of Unrealized Profits and Losses256Transfers at Cost 257Transfers at a Profit or Loss 25 7Effect of Type of Inventory System 257Downstream Sale of Inventory258Resale in Period of Intercorporate Transfer 259Resale in Periodfollowing Intercorporate TransferInventory Held for Two or More Periods 266Micron's Intercompany Fixed Asset Sale 306Intercompany Long-Term Asset Transfers 307Intercompany Transfers of Services 309Intercompany Land Transfers 309Overview of the Profit Elimination Process 309Assignment of Unrealized Profit Elimination311Downstream Sale of Land 313Upstream Sale of Land 317Eliminating the Unrealized Gain after theFirst Year 321Subsequent Disposition of the Asset 321Downstream Sale 323Change in Estimated Life of Asset upon TransferUpstream Sale 331Asset Transfers before Year-End 341331260267Equity-Method Entries—20X1267Consolidation Worksheet—20X1 268Consolidated Net Income—20X1269Equity-Method Entries—20X2270Consolidation Worksheet—20X2 270Consolidated Net Income—20X2 2 72Additional ConsiderationsIntercompany Transfers of Services andNoncurrent Assets 306Intercompany Transfers of Amortizable Assets 341Summary of Key Concepts 341Key Terms 341APPENDIX 7AIntercompany Noncurrent Asset Transactions—Modified Equity Method and Cost Method 342Questions 349Cases 350Exercises 352Problems 360256Upstream Sale of InventoryChapter 7Intercompany Transfers of DepreciableAssets 323Chapter 6Inventory TransactionsQuestions 281Cases 282Exercises 284Problems 292272Sale from One Subsidiary to Another 272Costs Associated with Transfers 2 73Lower of Cost or Market 2 73Sales and Purchases before Affiliation 2 73Summary of Key Concepts 274Key Terms 274APPENDIX 6AIntercompany Inventory Transactions—ModifiedEquity Method and Cost Method 274Chapter 8Intercompany Indebtedness 373Ford's Debt Transfers 373Consolidation Overview 374Bond Sale Directly to an AffiliateTransfer at Par Value 375Transfer at a Discount or Premium3753 76Bonds of Affiliate Purchased from aNonaffiliate 378Purchase at Book Value 3 78 Purchase at an Amount Less than Book Value 3 79Purchase at an Amount Greater than Book Value 390Summary of Key Concepts 392Key Terms 392APPPENDIX 8AIntercompany Indebtedness—Modified EquityMethod and Cost Method 392
xxviii Table of ContentsQuestions 399Cases 400Exercises 401Problems 406Chapter 9Consolidation Ownership Issues 420Berkshire Hathaway's Varied Investments 420Subsidiary Preferred Stock Outstanding 421Consolidation with Subsidiary Preferred StockOutstanding 421Subsidiary Preferred Stock Held by Parent 423Subsidiary Preferred Stock with SpecialProvisions 426Illustration of Subsidiary Preferred Stock with SpecialFeatures 427Changes in Parent Company Ownership 429Parent's Purchase of Additional Shares fromNonaffiliate 429Parent's Sale of Subsidiary Shares to Nonaffiliate 432Subsidiary's Sale of Additional Shares toNonaffiliate 434Subsidiary s Sale of Additional Shares to Parent 43 7Subsidiary s Purchase of Shares from Nonaffiliate 439Subsidiary's Purchase of Shares from Parent 441Complex Ownership Structures 444Multilevel Ownership and Control 444Reciprocal or Mutual Ownership 449Subsidiary Stock Dividends 452Illustration of Subsidiary Stock Dividends 453Impact on Subsequent Periods 454Interests Other than Investments in CommonStock 455Investments in Partnerships 455Nonequity Interests in Other Entities 458Summary of Key Concepts 458Key Terms 459Questions 459Cases 460Exercises 462Problems 469Chapter 10Additional Consolidation ReportingIssues 477Advanced Consolidation Issues at Google 477Consolidated Statement of Cash Flows 478Preparation of a Consolidated Cash Flow Statement 478Consolidated Cash Flow Statement Illustrated 478Consolidated Cash Flow Statement—Direct Method 480Consolidation Following an Interim Acquisition 481Parent Company Entries 483Consolidation Worksheet 483Consolidation Income Tax Issues 486Tax Allocation Procedures When Separate Tax ReturnsAre Filed 486Allocation of Tax Expense When a Consolidated ReturnIs Filed 487Tax Effects of Unrealized Intercompany ProfitEliminations 489Consolidated Earnings per Share 493Computation of Diluted Consolidated Earningsper Share 493Computation of Consolidated Earnings per ShareIllustrated 494Summary of Key Concepts 496Key Terms 497Questions 497Cases 498Exercises 499Problems 505Chapter 11Multinational Accounting: ForeignCurrency Transactions and FinancialInstruments 516Microsoft's Multinational Business 516Doing Business in a Global Market 517The Accounting Issues 518Foreign Currency Exchange Rates 519The Determination of Exchange Rates 519Direct versus Indirect Exchange Rates 519Changes in Exchange Rates 521Spot Rates versus Current Rates 524Forward Exchange Rates 524Foreign Currency Transactions 524Foreign Currency Import and ExportTransactions 526Managing International Currency Risk withForeign Currency Forward Exchange FinancialInstruments 529Derivatives Designated as Hedges 530Forward Exchange Contracts 532Case 1: Managing an Exposed Foreign Currency NetAsset or Liability Position: Not a DesignatedHedging Instrument 534Case 2: Hedging an Unrecognized Foreign CurrencyFirm Commitment: A Foreign Currency Fair ValueHedge 539Case 3: Hedging a Forecasted Foreign CurrencyTransaction: A Foreign Currency Cash FlowHedge 542Case 4: Speculation in Foreign CurrencyMarkets 546Foreign Exchange Matrix 548Additional Considerations 548A Note on Measuring Hedge Effectiveness 548
Table of Contents xxixInterperiod Tax Allocation for Foreign CurrencyGains (Losses) 549Hedges of a Net Investment in a Foreign Entity 549Summary of Key Concepts 549Key Terms 549APPENDIX 11AIllustration of Valuing Forward ExchangeContracts with Recognition for the Time Valueof Money 550APPENDIX 11BUse of Other Financial Instruments byMultinational Companies 553Questions 565Cases 566Exercises 568Problems 579Chapter 12Multinational Accounting: Issues inFinancial Reporting and Translation ofForeign Entity Statements 587McDonald's—The World's Fast FoodFavorite 587Differences in Accounting Principles 589Determining the Functional Currency 592Functional Currency Designation in HighlyInflationary Economies 594Translation versus Remeasurement of ForeignFinancial Statements 594Translation of Functional Currency Statements intothe Reporting Currency of the U.S. Company 596Financial Statement Presentation of TranslationAdjustment 597Illustration of Translation and Consolidation of aForeign Subsidiary 598Noncontrolling Interest of a Foreign Subsidiary 607Remeasurement of the Books of Record into theFunctional Currency 609Statement Presentation of Remeasurement Gainor Loss 610Illustration of Remeasurement of a ForeignSubsidiary 611Proof of Remeasurement Exchange Gain 612Remeasurement Case: Subsequent ConsolidationWorksheet 613Summary of Translation versus Remeasurement 616Additional Considerations in Accounting for ForeignOperations and Entities 616Foreign Investments and UnconsolidatedSubsidiaries 617Liquidation of a Foreign Investment 617Hedge of a Net Investment in a ForeignSubsidiary 618Disclosure Requirements 619Statement of Cash Flows 619Lower-of-Cost-or-Market Inventory Valuationunder Remeasurement 620Intercompany Transactions 620Income Taxes 622Translation When a Third Currency Is the FunctionalCurrency 622Summary of Key Concepts 622Key Terms 623Questions 623Cases 624Exercises 628Problems 637Chapter 13Segment and Interim Reporting 649Segment Reporting at Walmart 649Reporting for Segments 650 ,Segment Reporting Accounting Issues 650International Financial Reporting Standards forOperating Segments 651Information about Operating Segments 651Defining Reportable Segments 652Comprehensive Disclosure Test 657Reporting Segment Information 658 .Enterprisewide Disclosures 659Information about Products and Services 659Information about Geographic Areas 660Information about Major Customers 661Interim Financial Reporting 662The Format of the Quarterly Financial Report 662Accounting Issues 663Discrete versus Integral View of InterimReporting 663Accounting Pronouncements on InterimReporting 663International Financial Reporting Standards forInterim Reporting 664Reporting Standards for Interim IncomeStatements 664Revenue 664Cost of Goods Sold and Inventory 665All Other Costs and Expenses 669Accounting for Income Taxes in Interim Periods 670Disposal of a Component of the Entity or Extraordinary,Unusual, Infrequently Occurring, and Contingent. Items 675Accounting Changes in Interim Periods 675Change in an Accounting Principle (RetrospectiveApplication) 675Change in an Accounting Estimate (Current andProspective Application) 676
xxxTable of ContentsChange in a Reporting Entity (RetrospectiveApplication) 676International Financial Reporting Standards forAccounting Changes 676Summary of Key Concepts 677Key Terms 677Questions 677Cases 678' 'Exercises 682Problems 692Chapter 14SEC Reporting 699The Genesis of Securities Regulation 699International Harmonization of Accounting Standardsfor Public Offerings 700Securities and Exchange Commission 701Organizational Structure of the Commission 701Laws Administered by the SEC 702The Regulatory Structure 702Issuing Securities: The Registration Process 705The Registration Statement 706SEC Review and Public Offering 706Accountants 'Legal Liability in the RegistrationProcess 707Periodic Reporting Requirements 707Accountants 'Legal Liability in Periodic Reporting 710Electronic Data Gathering, Analysis, and Retrieval(EDGAR) System 710Foreign Corrupt Practices Act of 1977 711Sarbanes-Oxley Act of 2002 711Title I: Public Company Accounting OversightBoard 711Title II: Auditor Independence 712Title III: Corporate Responsibility 712Title IV: Enhanced Financial Disclosures 713Title V: Analyst Conflicts of Interest 713Title VI: Commission Resources and Authority 713Title VII: Studies and Reports 713Title VIII: Corporate and Criminal FraudAccountability 714Title IX: White-Collar Crime PenaltyEnhancements 714Title X: Sense of Congress Regarding Corporate TaxReturns 714Title XI: Corporate Fraud and Accountability 714Disclosure Requirements 714Management Discussion and Analysis 714Pro Forma Disclosures 716Summary of Key Concepts 716Key Terms 716Questions 716Cases 717Exercises 720Chapter 15Partnerships: Formation, Operation, andChanges in Membership 727The Evolution of PricewaterhouseCoopers (PwC) 727The Nature of the Partnership Entity 728Legal Regulation of Partnerships 728Definition of a Partnership 729Formation of a Partnership 729Other Major Characteristics of Partnerships 730Accounting and Financial Reporting Requirementsfor Partnerships 732International Financial Reporting Standards forSmall and Medium-Sized Entities and JointVentures 733Accounting for the Formation of a Partnership 733Illustration of Accounting for PartnershipFormation 734Accounting for the Operations of aPartnership 735Partners 'Accounts 735Allocating Profit or Loss to Partners 736Illustrations of Profit Allocation 737Multiple Bases of Profit Allocation 740Special Profit Allocation Methods 741Partnership Financial Statements 741Changes in Membership 742General Concepts to Account for a Change inMembership in the Partnership 742New Partner Purchases an Interest 744New Partner Invests in Partnership 746Determining a New Partner s Investment Cost 759Dissociation of a Partner from the Partnership 759Summary of Key Concepts 762Key Terms 762APPENDIX 15ATax Aspects of a Partnership 762APPENDIX 15BJoint Ventures 764Questions 766Cases 766Exercises 769Problems 775Chapter 16Partnerships: Liquidation 782The Demise of Laventhol & Horwath 782Overview of Partnership Liquidations 783Dissociation, Dissolution, Winding Up, and Liquidationof a Partnership 783Lump-Sum Liquidations 785Realization of Assets 785Expenses of Liquidation 785Illustration of Lump-Sum Liquidation 785
Table of Contents xxxiInstallment Liquidations 790Illustration of Installment Liquidation 791Cash Distribution Plan 794Additional Considerations 797Incorporation of a Partnership 797Summary of Key Concepts 798Key Terms 799APPENDIX 16APartners' Personal Financial StatementsQuestions 802Cases 803Exercises 805Problems 814799Chapter 17Governmental Entities: Introduction andGeneral Fund Accounting 820Accounting for the Bustling City of San Diego 820Differences between Governmental and Private SectorAccounting 821History of Governmental Accounting 822Major Concepts of Governmental Accounting 823Elements of Financial Statements 823Expendability of Resources versus Capital MaintenanceObjectives 824Definitions and Types of Funds 824Financial Reporting of Governmental Entities 826Fund-Based Financial Statements: GovernmentalFunds 827Measurement Focus and Basis of Accounting(MFBA) 830Basis of Accounting—Governmental Funds 831Basis of Accounting—Proprie
Advanced Financial Accounting Ninth Edition Richard E. Baker Northern Illinois University Theodore E. Christensen Brigham Young University David M. Cottrell Brigham Young University With contributions from: Valdean C. Lembke Professor Emeritus Thomas E. King Professor Emeritus Southern Illi
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