Part 1 - The Situation, Consolidation, and Interpretation
This is an unusual type of corporate relationship. The first set of questions will reinforce your understanding of the relationship and provide evidence on the pros and cons of consolidation.
Carefully reread the information provided about the corporate headquarters and the Development Agreement. Which company is actually performing the research and development activities? Pharmco
Justify your response.
Disco is obligated, via a “Development Agreement,” to engage Pharmco to perform all of Disco’s research, development, & clinical testing activities related to products under development.
2. Using the financial statements provided in Teaching Notes Exhibit 1, calculate the following ratios for Pharmco without consolidation of Disco and for the consolidated results. Exclude amounts allocated to the non-controlling interest. If the outcome is different, identify the cause(s) of the difference For the sake of simplicity, use December 31, 20X1 results when balance sheet data are required:
a. Return on equity (e.g., net income divided by shareholder’s equity) b. Profit margin (e.g., net income divided by total revenues) c. Return on assets (e.g., net income divided by total assets) d. Leverage (e.g., total liabilities divided by total assets)
Return on Equity
Return on Assets
Examine the consolidated totals carefully by comparing them to Pharmco’s unconsolidated amounts in the first column. Compare the two sets of ratios computed in Question 2.
How would consolidating Pharmco and Disco benefit Pharmco’s shareholders? It appears the only ratio that improves by consolidation is the leverage ratio. If they...
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