Question #15
Reading: Reading 12 Evaluating Quality of Financial Reports
PDF File: Reading 12 Evaluating Quality of Financial Reports.pdf
Page: 10
Status: Incorrect
Correct Answer: A
Your Answer: C
Question
Asma Pharma has made several strategic investments in other pharmaceutical companies. In each instance, Asma has kept its stake just below 50% so it can account for the investment using the equity method of consolidation. Asma's balance sheet quality can be most accurately characterized as:
Answer Choices:
A. High-quality due to compliance with local GAAP
B. Low-quality due to lack of completeness
C. Low-quality due to bias in measurement
Explanation
One-line consolidation under the equity method obscures the components of balance
sheet and artificially boosts certain profitability ratios (e.g., return on assets or profit
margin). This reduces the completeness and quality of the firm's balance sheet.
Compliance with GAAP is a necessary but not sufficient condition for evaluating quality of
financial statements. Equity method of accounting does not by itself lead to measurement
bias.