ExxonMobil mini-case (equity method investments and consolidation) ExxonMobil maintains a number of investments in other entities that it owns between 20% and 50%. These investments are accounted for using the equity method: the prorata share of the investee’s operating results are incorporated into earnings and the book value of its investment account is equal to its prorate share of the investee company’s book value of stockholders’ equity plus unamortized goodwill incurred at the time of acquisition. This method is sometimes referred to as a “one-line consolidation” as the final bottom-line impact on the investor’s financial statements is identical whether the equity method or full consolidation is employed; only the amount of detail presented within the statements will differ. The use of the equity method by the investor is straightforward: the original cost of the investment is increased by the investor’s share of the investee’s earnings and is decreased by its share of investee losses and by dividends received. The investment account described above represents the proportionate share of the investee’s book value of stockholders’ equity. Neither the assets of the investee company, nor its liabilities, are reported on the investor’s books. This represents a potential problem for the decomposition of ROE into margin, turnover and leverage. Although the net profit margin is unaffected, the total asset turnover (sales/average total assets) is potentially overstated and the financial leverage (average total assets / average total stockholders’ equity) is understated both by the failure to include the assets of the investee. The use of the equity method obscures the amount of capital required in the business and the degree of financial leverage employed to achieve ROE. Analysts may, therefore, wish to adjust the financial statements of the investor company before computing ratios. This case is designed to give you insight into the types of adjustments an analyst might consider. We will use the 2000 annual report of ExxonMobil, selected portions of which follow. Please answer the following questions: 1. Compute the decomposition of ROE into profit margin, turnover and financial leverage for 2000 (use year-end figures rather than averages for the assets and liabilities). 2. ExxonMobil reports total investments of $12,618. Included in this amount is $6,864 representing its share of the book values of the stockholders’ equity of companies it owns a minority interest in that are accounted for using the equity method. These companies have total assets of $71,993 million and liabilities of $54,668 (see note 8). The first adjustment we will consider is to fully consolidate these investee’s with ExxonMobil. To do this, ExxonMobil would make journal entries that would have the following effects: Copyright © 2001 by Robert F. Halsey. All rights reserved. Beginning balance Elimination of investment account relating to affiliates Replace investment account with affiliate assets and liabilities Recognize claim on assets by outside shareholders Ending balance Assets 149,000 (6,864) Liabilities Equity 78,243 70,757 71,993 54,668 -0- (only ExxonMobil parent company equity will remain in consolidated totals) 10,461 214,129 143,372 70,757 Net assets, therefore, increase by $65,129 (71,993-6,864), and liabilities by 65,129. In addition, we need to add the sales of the investee’s ($81,371) to those of ExxonMobil as none of these revenues are reflected in ExxonMobil’s income statement. ExxonMobil’s net income, however, will remain the same as the income it reports from its equity investment (included in its net profit) is equal to the net income of the investee companies less the portion earned by the nonExxonMobil shareholders. Now, recompute the ROE decomposition using the full consolidation adjustments outlined above (use year-end figures rather than averages for the assets and liabilities in turnover and leverage ratios). 3. A second adjustment an analyst might consider is called proportionate consolidation. In this case we add only ExxonMobil’s proportionate share of the investee company assets as follows: Assets Liabilities Equity Beginning balance 149,000 78,243 70,757 Elimination of investment account (6,864) relating to affiliates Replace investment account with 28,191 21,327 -0- (only ExxonMobil parent EM’s proportionate share of company equity will remain in affiliate assets and liabilities consolidated totals) Ending balance 170,327 99,570 70,757 Net assets increase by $21,327 (28,191-6,864), as do liabilities. In addition, we need to increase ExxonMobil’s revenues by its proportionate share if the investee companies’ revenues of $32,452. Again, its net income will remain the same as currently reported. Now, recompute the ROE decomposition using the proportionate consolidation adjustments outlined above (use year-end figures rather than averages for the assets and liabilities in turnover and leverage ratios). 4. Evaluate your analysis under the three methods: as reported, full consolidation, and proportionate consolidation. Which do you think gives the most informative ROE decomposition? Under what circumstances might you consider full consolidation and proportionate consolidation adjustments? Copyright © 2001 by Robert F. Halsey. All rights reserved. 2000 1999 1998 ______________________________________________________________________________________________________________________ (millions of dollars) Revenue Sales and other operating revenue, including excise taxes Earnings from equity interests and other revenue Total revenue Costs and other deductions Crude oil and product purchases Operating expenses Selling, general and administrative expenses Depreciation and depletion Exploration expenses, including dry holes Merger related expenses Interest expense Excise taxes Other taxes and duties Income applicable to minority and preferred interests Total costs and other deductions Income before income taxes Income taxes Income before extraordinary item and cumulative effect of accounting change Extraordinary gain from required asset divestitures, net of income tax Cumulative effect of accounting change Net income Net income per common share (dollars) Copyright © 2001 by Robert F. Halsey. All rights reserved. $228,439 $182,529 $165,627 4,309 2,998 4,015 -------------------------$232,748 $185,527 $169,642 -------------------------$108,951 $ 77,011 $ 62,145 18,135 16,806 17,666 12,044 13,134 12,925 8,130 8,304 8,355 936 1,246 1,506 1,406 625 -589 695 568 22,356 21,646 20,926 32,708 34,765 33,203 412 145 265 -------------------------$205,667 $174,377 $157,559 -------------------------$ 27,081 $ 11,150 $ 12,083 11,091 3,240 3,939 -------------------------$ 15,990 $ 7,910 $ 8,144 1,730 ----(70) -------------------------$ 17,720 $ 7,910 $ 8,074 ========================== Dec. 31 Dec. 31 2000 1999 _____________________________________________________________________________________________________________________ (millions of dollars) Assets Current assets Cash and cash equivalents Other marketable securities Notes and accounts receivable, less estimated doubtful amounts Inventories Crude oil, products and merchandise Materials and supplies Prepaid taxes and expenses Total current assets Investments and advances Property, plant and equipment, at cost, less accumulated depreciation and depletion Other assets, including intangibles, net Total assets Liabilities Current liabilities Notes and loans payable Accounts payable and accrued liabilities Income taxes payable Total current liabilities Long-term debt Annuity reserves and accrued liabilities Deferred income tax liabilities Deferred credits Equity of minority and preferred shareholders in affiliated companies Total liabilities Shareholders' equity Benefit plan related balances Common stock without par value (4,500 million shares authorized) Earnings reinvested Accumulated other nonowner changes in equity Cumulative foreign exchange translation adjustment Minimum pension liability adjustment Unrealized gains/(losses) on stock investments Common stock held in treasury (545 million shares in 2000 and 533 million shares in 1999) Total shareholders' equity Total liabilities and shareholders' equity Copyright © 2001 by Robert F. Halsey. All rights reserved. $ 7,080 1 22,996 $ 1,688 73 19,155 7,244 7,370 1,060 1,122 2,018 1,733 ------------------$ 40,399 $ 31,141 12,618 14,544 89,829 94,043 6,154 4,793 ------------------$149,000 $ 144,521 =================== $ 6,161 $ 10,570 26,755 25,492 5,275 2,671 ------------------$ 38,191 $ 38,733 7,280 8,402 11,934 12,902 16,442 16,251 1,166 1,079 3,230 3,688 ------------------$ 78,243 $ 81,055 ------------------- $ (235) $ 3,661 86,652 (298) 3,403 75,055 (4,862) (2,300) (310) (299) (17) 31 (14,132) (12,126) ------------------$ 70,757 $ 63,466 ------------------$149,000 $ 144,521 =================== 8. Equity Company Information The summarized financial information below includes amounts related to certain less than majority owned companies and majority owned subsidiaries where minority shareholders possess the right to participate in significant management decisions (see note 1). These companies are primarily engaged in crude production, natural gas marketing and refining operations in North America; natural gas production, natural gas distribution, and downstream operations in Europe and crude production in Kazakhstan and the Middle East. Also included are several power generation, petrochemical/lubes manufacturing and chemical ventures; 1998 and 1999 included amounts related to Mobil's European Fuels joint venture which was divested as a condition of the Merger approval. 2000 1999 1998 _____________________________________________________ ExxonMobil ExxonMobil ExxonMobil Equity Company Financial Summary Total Share Total Share Total Share __________________________________________________________________________________________________________________________ (millions of dollars) Total revenues Percent of revenues from companies included in the ExxonMobil consolidation was 7% in 1998, 8% in 1999 and 11% in 2000 Income before income taxes Less: Related income taxes Net income Current assets Property, plant and equipment, less accumulated depreciation Other long-term assets Total assets Short-term debt Other current liabilities Long-term debt Other long-term liabilities Advances from shareholders Net assets Copyright © 2001 by Robert F. Halsey. All rights reserved. $81,371 $32,452 $94,534 $32,124 $76,552 $24,740 ----------------------------------------------------$ 7,632 $ 3,092 $ 4,100 $ 2,095 $ 4,104 $ 2,002 (1,382) (658) (734) (449) (1,071) (492) ----------------------------------------------------$ 6,250 $ 2,434 $ 3,366 $ 1,646 $ 3,033 $ 1,510 ===================================================== $28,784 $11,479 $21,518 $ 7,739 $19,037 $ 6,645 36,553 13,733 44,213 15,509 40,268 15,221 6,656 2,979 4,806 2,106 3,529 1,449 ----------------------------------------------------$71,993 $28,191 $70,537 $25,354 $62,834 $23,315 ----------------------------------------------------$ 2,636 $ 1,093 $ 2,856 $ 1,129 $ 2,628 $ 1,048 25,377 10,357 18,129 6,324 16,367 5,574 11,116 4,094 13,486 3,978 11,316 3,488 7,054 3,273 5,372 2,598 4,974 2,362 8,485 2,510 3,636 1,919 3,734 2,017 ----------------------------------------------------$17,325 $ 6,864 $27,058 $ 9,406 $23,815 $ 8,826 =====================================================