Reading 22 EOC Q 7, 8

[bulu]

Q7: my answer is A, CFAI correct answer is B. I guess asset would remain the same in the BS , may be in the form of cash, if CC choose not to invest in Exotic. Income from the equity in exotic is not included in revenue, rather it is included in income as a seperate line in the IS. So it is included in EBIT.
For Q7, neither the numerator nor the denominator changes. My answer is A.
For Q8, for the same token, income from equity investment 21 (20% of 105) is included in EBIT, should be excluded before calculating interest coverage ratio. CC supposed to use equity method of accounting for investment in Exotic.
My answer is A. Am I missing something.?

 

[clangerh]

Q7) For Asset Turnover, it’s Revenue divided by average Assets. Revenue is only affected if you had a consolidated financial statement. For Investments in Associates (usually 20 to 50% voting shares held), you report the equity value of the investee as an Asset on your BS [N.B.: there’s generally no added liability to your BS with the Equity Method, you get a pure Asset only]. Here, since Revenue is untouched, you just remove the average of your equity investment on the two BS reporting dates, and recalculate. Same numerator and a lower denominator is a bigger fraction. You don’t even need to do the math except to double check.
Q8) For EBIT / Interest Expense, remember that, under the Equity Method, the only part of your IS that is affected is the bottom portion, comprehensive net income and other (post-tax) comprehensive income. Again, if this was a consolidated subsidiary, it would almost certainly be different (unless somehow parent and subsidiary had the same coverage ratio—ugh, I better remember that now). Here, both line items are untouched.