Analyzing and Interpreting Disclosures on Equity Method Investments Cummins, Inc. (CMI) reports investments in affiliated companies, consisting mainly of investments in nine manufacturing joint ventures. Cummins reports those investments on its balance sheet at $734 million, and provides the following financial information of its investee companies in a footnote to its 10-K report:

	As of and for the years ended December 31,
(in millions)	2010	2009	2008
Net sales	$ 7,107	$ 5,554	$ 6,610
Gross margin	1,651	1,365	1,509
Net income	668	427	498
Cummins share of net income	$ 321	$ 196	$ 231
Royalty and interest income	30	18	22
Total equity, royalty and interest income from investees	$ 351	$ 214	$ 253
Current assets	$ 2,741	$ 2,005
Noncurrent assets	1,253	1,123
Current liabilities	(1,837)	(1,406)
Noncurrent liabilities	(499)	(390)
Net assets	$ 1,658	$ 1,332
Cummins share of net assets	$ 734	$ 587

(a) What assets and liabilities of unconsolidated affiliates are included on Cummins's balance sheet as a result of the equity method of accounting for those investments?

AssetsAnswer($ millions) LiabilitiesAnswer($ millions) (b) Do the liabilities of the unconsolidated affiliates affect Cummins directly?

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

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

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

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

(c) How does the equity method impact Cummins's ROE and its RNOA components (net operating asset turnover and net operating profit margin)? (Select all that apply) There is no effect on Cummins's ROE and RNOA as a result of its use of the equity method. AnswerTrueFalse Because equity method investments are reported at market value, assets are likely overstated. 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 The equity method arguably omits assets and liabilities from Cummins'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