Analyzing and Interpreting Disclosures on Equity Method Investments Assume Caterpillar, Inc. (CAT) reports investments in affiliated companies, consisting mainly of its 50% ownership of Shin Caterpillar Mitsubishi, Ltd. Caterpillar reports those investments on its balance sheet at $576 million, and provides the following footnote in its 10-K report. Investments in unconsolidated affiliated companies Our investments in affiliated companies accounted for by the equity method consist primarily of a 50% interest in Shin Caterpillar Mitsubishi Ltd. (SCM) located in Japan. Combined financial information of the unconsolidated affiliated companies accounted for by the equity method (generally on a three-month lag, e.g., SCM results reflect the periods ending September 30) was as follows

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Sales from SCM to Caterpillar of approximately $1.67 billion, $1.81 billion and $1.73 billion in 2011, 2010 and 2009 respectively, are included in the affiliated company sales. In addition, SCM purchased $268 million, $273 million and $282 million of products from Caterpillar in 2011, 2010 and 2009, respectively.

a) What assets and liabilities of unconsolidated affiliates are included on CAT's balance sheet as a result of the equity method of accounting for those investments? Assets________($ millions) Liabilities_________($ millions) (b) Do the liabilities of the unconsolidated affiliates affect CAT directly?

The liabilities of the investee company are liabilities for the investor.

The liabilities of the investor company are liabilities of the investee.

The liabilities of the investee company are not liabilities for the investor.

The creditors of the investee company have recourse to the assets of the investor in the event of default.

(c) How does the equity method impact CAT's ROE and its RNOA components (net operating asset turnover and net operating profit margin)? (Select all that apply) There is no effect on CAT's ROE and RNOA as a result of its use of the equity method. AnswerTrueFalse Net income and stockholders' equity are the same whether the equity method or consolidation is used, so ROE is the same. AnswerTrueFalse The equity method arguably omits assets and liabilities from CAT's balance sheet, and omits sales and expense from its income statement (compared with the assets, liabilities, sales and expenses that would be recorded with consolidation). Therefore, RNOA would be affected. AnswerTrueFalse The equity method arguably omits investee company liabilities from the balance sheet. As a result, ROE appears to be derived from operating activities when, in fact, it is due primarily to financial leverage. AnswerTrueFalse

Years Ended December 31 (Millions of Dollars) Results of operations: Sales Cost of sales Gross profit Profit Caterpillar's profit 2011 2010 2009 4,007 4,420 4,140 3,210 3,526 3,257 797 894 883 157 187 161 73 81 73