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