Ponte Corporation owns 25 percent of the voting shares of Scala Corporation.In 20X8,Scala reported net income of $120,000 and paid dividends of $30,000.Ponte uses the equity method to account for this investment.Ponte reported taxable income of $160,000 on its separate operations and has an effective tax rate of 40 percent.There is an 80 percent exemption on intercompany dividends.
-Based on the preceding information,income tax expense for Ponte for the year 20X8 will be:
A)$67,000
B)$64,600
C)$64,000
D)$66,400

Question

Quizplus · Accepted Answer

Ponte's share of Scala's net income is 25% of $120,000 = $30,000. This increases Ponte's pre-tax income. Dividends received ($30,000) are 80% exempt from tax, so taxable portion of dividends = 20% of $30,000 = $6,000. Ponte's taxable income = $160,000 (own operations) + $30,000 (share of Scala's net income) - $6,000 (taxable portion of dividends) = $184,000. Tax expense = 40% of $184,000 = $73,600. However, the equity method already includes Ponte's share of Scala's net income in Ponte's income, so the correct calculation should not subtract dividends received again. The correct taxable income is $160,000 + $30,000 = $190,000. Tax expense = 40% of $190,000 = $76,000. The error in the initial calculation suggests a misunderstanding of the equity method's treatment of dividends and income recognition.

Ponte Corporation Owns 25 Percent of the Voting Shares of Scala