Question #33 - Reading 8 Intercorporate Investments

Reading: Reading 8 Intercorporate Investments

PDF File: Reading 8 Intercorporate Investments.pdf

Page: 14

Status: Correct

Correct Answer: A

Shared Context

- Assuming no significant influence exists, which of the following statements concerning percentage ownership and accounting method is most accurate? A) When the ownership is less than 20%, US GAAP requires the investment in financial assets method, IFRS the equity method. B) When the ownership is less than 20%, both US GAAP and IFRS require the equity method. C) When the ownership is less than 20%, both US GAAP and IFRS require the investment in financial assets method.

Question

Relative to consolidation, using the equity method of accounting for investments results in:

Answer Choices:

A. ROA being lower and leverage being higher than under consolidation

B. ROA being higher than under consolidation

C. ROA being higher and leverage being higher than under consolidation

Explanation

Since consolidation results in inclusion of investee's assets in the investor's balance sheet, the total assets would be higher under consolidation as compared to equity method. Net income is same under either methods. ROA would be higher under equity method as compared to under consolidation. Leverage effects will depend on the debt of the investee company. Under consolidation, all of investee's debt would be included in investors balance sheet. However, total equity in the consolidated balance sheet will also be higher due to inclusion of minority interest.

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