Practice Problem FRA because, accounting, interest, required, question

dandman

From Schweser Exam book 1 exam 2 question 83

What are the likely effects of the required change in accounting for SPE's on Samilski's:

Return on assets Return on Equity

A. Decrease Decrease
B. Decrease No Effect
C. No Effect Decrease

Background: Samilski will be required under new acconting rules to classify the SPE as variable interest entities and consolidate the entities on the balance sheet rather than report them using the equity method.

I see the answer as B because equity should be the same regardless of consolidation. but the answer key has A because they say equity will increase.

Can someone advise if I am missing something here?



Edited 1 time(s). Last edit at Friday, May 6, 2011 at 12:58AM by autocats15.

b_sea93

In consolidation you add minority interest to equity, so equity goes up.

Uranus08

yes dreary. Autocats- just think of the equation A=L+E, if they are consolidating/adding the SPE, assets go up, so equity must go up to balance. Does that make sense?

luda002

Thanks for the response Andrew & Dreary.....I understand assets going up on the consolidation....But Can you explain if anything was reported on the balance sheet under the original equity method?

Also looking at reading 23 page 170 &171 in the CFAI book the example shows the consolidated balance sheet to have the same equity value.

This is because an unconsolidated balance sheet reports a one line amount for the SPE in assets and the consolidated reported both assets and liabilities so the net equity will still be the same but both assets and liabilities will be higher.