Effect of equity method versus consolidation. Exhibit 14.11
presents a spreadsheet that we
use to compare the effects of using the equity method with using
consolidated financial
statements. The Web site for this book contains an Excel
spreadsheet that duplicates the
one in Exhibit 14.11. Download this spreadsheet in preparing your
solution to this exercise.
You will change only the cell marked in yellow.
a. For this part, assume that Parent owns 80% of Sub. Respond to
the following questions:
(1) Why is net income the same independent of whether Parent uses
the equity method
or prepares consolidated financial statements with Sub?
(2) Why is the ratio of liabilities to assets higher if Parent
prepares consolidated financial
statements with Sub than when it uses the equity method?
b. For this part, change Parent’s ownership interest in Sub from
80% to 60%. Respond to
the following questions:
(1) Why does net income decrease for the change in ownership
percentage, independent
of whether Parent uses the equity method or prepares consolidated
financial
statements?
(2) Why do total assets using the equity method decrease but total
assets on the
consolidated balance sheet remain the same with the decrease in the
ownership
percentage?
(3) Why do total liabilities using the equity method remain the
same with the decrease
in the ownership percentage?
(4) Why do total liabilities on the consolidated balance sheet
remain the same with the
decrease in the ownership percentage?
(5) Why does total shareholders’ equity decrease using the equity
method but remain
the same on the consolidated balance sheet with the decrease?
(6) Why does the ratio of liabilities to assets on the consolidated
balance sheet remain
the same with the decrease in the ownership percentage?

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Question: Effect of equity method versus consolidation. Exhibit 14.11 presents a spreadsheet that we use to…
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Equity Method Contrast with
Consolidated Financial Statements
Total assets = 3,400 version
Exhibit 14.11 FACMU 14, 14.25 version, Exh 14.11
P S Allows changes in S’s income, while keeping S’s other assets
constant.
Increasing S’s earnings increase its assets and its retained
earnings.
To see how things change, alter this
number —–>
80.0% [Third column not meaningful unless ownership exceeds 50%.]
Equity Percent
Method Owned
Income Statement Parent Only Sub Consolidated
Revenues ………………………………… $1,000 $400 $1,400
Investment Income …………………. 80
Expenses ………………………………… (700) (300) (1,000)
Noncontrolling Interest [Note A]
…………………………
(20)
Net Income ………………………………… $380 $100 $380
Note A: Minority Owns (1 – Parent’s
Fraction)   =
20.0%
Balance Sheet
Assets, Other Than… $2,600 $2,000 $4,600
Investments …………………………. 400 –    –   
Total Assets ………………………….. $3,000 $2,000 $4,600
Liabilities …………………………….. $1,800 $1,500 $3,300
Noncontrolling Interest ……………………. –    –    100
Owners’ Equity ………………………. 1,200 500 1,200
Total Sources of Financing
……………………………..
$3,000 $2,000 $4,600
In General Electric’s Financials… 2nd Column 3rd Column 1st Column

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