Refer to Question 10 in Chapter 17 of the textbook: How is the use of the equity

Refer to Question 10 in Chapter 17 of the textbook: How is the use of the equity method subject to manipulation? How might a financial statement reader detect such behavior? In addition, provide an example to prove how the equity method may result in manipulation of the financial results.
Participate in follow-up discussion by providing recommendations to classmates’ fact patterns on how a company could implement procedures to prevent manipulation of the use of the equity method.
Jereca McReynolds
Jul 8, 2023, 7:41 PM(edited)
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The equity method is required when an investor owns between 20%- 50% voting shares or has significant influence in a company. The equity method seems to be subject to manipulation in many different ways. One of the ways I see the equity method being subject to manipulation is just the fact that the people with significant influence that can sit on the board and make rules that would benefit whatever they would like to do. It seems like a huge conflict of interest. Young (2018) mentions ” Investors have sometimes manipulated their ownership percentages in other companies depending on whether the affiliates are reporting profits or losses.”. Based upon what I read it seems like companies manipulate things by either over reporting or under reporting. This would be detected by looking at the balance sheet however I am not completely sure exactly what the financial statement reader would see or should be looking for exactly to detect this. However, Young (2018) makes it clear that “The lesson for analysts is clear: year‐on‐year changes in ownership interests, and their effects on the financial statements, should be closely monitored. It should also be noted that manipulation can occur at the other end of the ownership spectrum. For example, companies can choose to consolidate an affiliate’s financial statements, or not, depending on whether the ownership interest is just above or just below the 50% threshold.”.
Young, S. D., Cohen, J., & Bens, D. A. (2018). Corporate financial reporting and analysis (4th ed.). Wiley.ISBN-13: 9781119494577
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