Mylan Laboratories (Mylan) is a leading firm in the generic pharmaceutical industry. Generic drugs have chemical compositions similar to ethical drugs but sell for a significantly lower price. Once the patent period ends on an ethical drug, generic drug companies break down the drug into its basic chemical elements. They then submit an application to the Food and Drug Administration (FDA)
to sell a generic equivalent of the ethical drug. The ability to sell generic drugs at a lower price results from lower research and development, marketing, and other costs.
Mylan also plays a limited role in the ethical drug market with a long-term equity position in Somerset Pharmaceuticals (Somerset). The firm has held 50 percent of the common stock of Somerset for almost fifteen years. Somerset's only commercial product is the ethical drug Eldepryl, which is used for the treatment of patients with late-stage Parkinson's disease. Five years ago Somerset began the development of EMSAM (selegiline transdermal system), a product for the treatment of major depressive disorders. Unfortunately, the firm's research and development activities related to the product for Year 13 and Year 14 have been a significant drain on the firm's earnings, and to date it has not been successful in obtaining FDA approval for EMSAM.
Required
NOTE: The following additional information applies to completing parts a through i. Exhibit 9.15 presents financial statement data for Mylan for Year 5 through Year 8. During this period, Mylan accounted for its investment in Somerset using the equity method. Equity in earnings of Somerset includes Mylan's 50 percent share of Somerset's earnings minus amortization of intangible assets resulting from the acquisition of Somerset. Such intangible assets are amortized over fifteen years. Amortization expense for intangibles totaled $924,000 in each of Years 6 through 8. Additionally, Mylan charges Somerset a management services fee each year and includes it in the Equity in Earnings of Somerset account. Somerset records this fee as an expense in measuring earnings. Exhibit 9.16 presents financial statement data for Somerset.
a. Prepare an analysis of the changes in the shareholders' equity of Somerset for each of Years 6 through 8.
b. Prepare an analysis of the changes in the Investment in and Advances to Somerset account on Mylan's books for each of Years 6 through 8. Be sure to indicate the amounts for equity in earnings of Somerset, management fee, dividend received, and other cash payments received.
c. Does the equity method, proportionate consolidation method, or full consolidation method best reflect the operating relationships between Mylan and Somerset? Explain.
d. Prepare an income statement for Mylan and Somerset for Year 6, Year 7, and Year 8 using the proportionate consolidation method.
e. Repeat part d using the full consolidation method.
f. Compute the ratio of operating income before income taxes to sales for Year 6, Year 7, and Year 8 using the equity method, proportionate consolidation method, and full consolidation method.
g. Why do the ratios computed in part f differ across the three methods of accounting for the investment in Somerset?
h. Compute the effective tax rate (that is, income tax expense divided by income before income taxes) for Year 6, Year 7, and Year 8 using the equity method, proportionate consolidation method, and full consolidation method.
i. Why do the measures of the effective tax rate computed in part h differ across the
three methods of accounting for the investment in Somerset?
NOTE: The following additional information applies to completing parts j through 1 as related to Year 13 and Year 14.
Somerset reported a net loss of $7.1 million in Year 13 and $3.3 million in Year 14 resulting primarily from substantially higher research and development costs incurred in those

years related to EMSAM. Based on the reported losses for Year 13 and Year 14, and an assessment by Mylan that Somerset will not return to profitability in the near future, the firm decided at the end of Year 14 to completely write off its investment in Somerset. In addition, in accordance with APB Opinion No. 18, Mylan stated in a recent annual report that it will temporarily cease recording the net losses of its Somerset investment in Year 15 and beyond.
j. What amounts would Mylan report as "Equity in Earnings of Somerset" on its income statement for Year 13 and Year 14? Show your calculations.

k. Assuming Somerset reports a net loss in Year 15, why does APB Opinion No. 18 preclude Mylan from reporting its share of the loss on the firm's income statement for Year 15?
1. Mylan stated in a recent annual report: "As Somerset continues its research and development activities, including working with the FDA to obtain approval for EMSAM, its earnings may continue to be adversely affected." Given this, speculate on why Mylan continues to support the activities of Somerset.

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EXHIBIT 9.15 Mylan Laboratories Financial Statement Data (amounts in thousands) Problem 9.16) Year 5 Year 6 Year 7 Year 8 Balance Sheet Current Assets... Investment in and Advances to Somerset 94,502 $120,014 $180,482 $209,572 18,045 13,674 14,844 17,964 Total Asset.. $186,955 $226,720 $351.105 $403325 6,493 5,359 7,348 5,430 Total Liabilities and Shareholders' Equity $186955 $226720 $351105 $403,325 Year 6 Year 7 Year 8 Income Statement $131,936 $211964 $251,773 (135,759)(188,304) $ 31.478 76,205 63,469 18,66 21,136 23,596 S 50,142 $ 97341 $ 87,065 10.028)(26,720) (13,998) 5 40,114 70,621 73067 Year 8 Equity in Earnings of Somerset Year 6 Year 7 Cash Flow Statement Net Income 40,114 70,62 73,067 (18,664) (21,136) (23,596) 19,966 7,959 23,035 5,962 (4519) 20,676 14,690 9,073 49-80 $ 45.928 68337 35.633 EXHIBIT 9.16 Somerset Pharmaceuticals Financial Statement Data (amounts in thousands) (Problem 9.16) Year 5 Year 6 Year 7 Year 8 Balance Sheet Current Assets.. 2,8022.7912.670 6.04 Total Assets Current Liabilities $25,603 $27388 33079 S 33974 7.952 $15,413 20,675 14,918 1,002 642 1,490 975 1,796 808 3,302 70759510 .80017412 Total Liabilities and Shareholders' Equity$25,603 $27388 $33,079 33,974 Year 8 Year 6 Year 7 Income Statement Sales 93,513 $108,518 $111.970 (42,041) -(49,872) (50,465) $51,472 58,646 61,505 18,806) (21.789) 19.547) Income before Taxes Income Tax Expense Net Income $32.666 $36.8$41.98