Referring to CFAI reading 24, practice problem 7:
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My question: Why are we not excluding the revenue (1,230x.2=246) from the numerator of the equation as well?
Beats me. The Investment Income from “Exotic Imports” must not be in the revenue line. Check to see if the Income Statement for Colorful Concepts is included in the question. If so, maybe there is an “Investment Income” line or something like that. If so, it is already excluded from “revenue”. If not, I’m with you, why is it not deducted?
Side note: You’d only deduct 20% of the Net income, not sales, assuming the investment was accounted for using the Equity Method.
Below is the info given. It does not constitute of a separate line for investment in Exotic Imports. With that said CFAI should stay consistent and deduct both Revenue and Assets if we want to exclude the effect of Investment in Assoc. However, I do know that Equity Method requires “one-line accounting” on both IS and BS. With that said only the NI of the associate would be included on the IS.
But it still bugs me that that NI reflects some degree of Revenue and since the questions asks to exclude it, that degree of Revenue should be subtracted when calculating the Asset TO.
Revenue - 7,049
EBIT - 865
Interest expense - 35
Income taxes - 302
Net income - 528
Average total assets - 3,844
Average total equity - 2,562
Lease expense - 406
Okay, I see. The income from the associate is assumed to be outside of ‘revenue’. The question could have been a little clearer if the full Income Statement was shown. At any rate Matt86, if you see this on the exam you’ll know how to deal with it.