Question

What problems do consolidated financial statements of a diversified company present to the analyst? What problems do the cost method and equity method present to the analyst? Which method provides a more complete picture of a diversified company to the analyst: The consolidated method or the unconsolidated method?

Answer 1

Problems of consolidate financial statements of a diversified company faced by the analyst:

-Understanding omission of any revenue earned by the parent company which is an expense of a subsidiary

-Understanding elimination of certain account receivable balances and account payable balances from the consolidated balance sheet.  

-Understand ownership interest between companies/subsidiaries.

Problems of cost method and equity method :

Only owned companies are included in the consolidated financial statements. Also, ownership is based upon the total amount of stock owned. If a company owns less than 20% of another company's stock, it may use the cost method of financial reporting. If a company owns more than 20% but less than 50%, the company uses the equity method. Under both methods, consolidated financial statements are not permitted. Without consolidated financial statements , it's difficult to get the complete picture of the diversified company.  

The equity method can enable company to hide numbers from the public and it shows a more accurate profit margin. In contrast, this method can be difficult to understand and dividends are not listed as profit.

The cost method is complex to understand and differs from companies to companies.

The consolidated method provides a more complete picture of a diversified company to the analyst.