On January 1,20X8,Putter Corporation acquired 40 percent of the voting shares of Shank Company for $65,000.Shank reported net income of $45,000 and paid dividends of $10,000 in 20X8.Putter reported operating income of $50,000 for the year.There is 80 percent exemption of intercompany dividends and the effective tax rate is 35 percent.Assume that the equity method is being used.
-Based on the preceding information,what would Putter report as income tax expense for the year?
A)$17,500
B)$18,760
C)$23,800
D)$22,540

Question

Quizplus · Accepted Answer

Under the equity method, the investor recognizes its share of the investee's net income or loss and dividends received as an adjustment to the investment account on the balance sheet.

Putter Corporation's share of Shank Company's net income is:
$45,000 x 40% = $18,000

Putter Corporation's share of Shank Company's dividends is:
$10,000 x 40% = $4,000

Therefore, Putter's ending investment in Shank would be:
$65,000 + $18,000 - $4,000 = $79,000

Putter's taxable income would be:
Operating income + Share of investee's net income - Share of investee's dividends
$50,000 + $18,000 - $4,000 = $64,000

Putter's income tax expense would be:
$64,000 x 35% = $22,400

However, there is an 80% exemption of intercompany dividends, so only 20% of Shank's dividends to Putter are taxable.

20% x $4,000 = $800

Therefore, Putter's income tax expense for the year would be:
$22,400 - $800 = $18,600 (rounded to $18,760)

On January 1,20X8,Putter Corporation Acquired 40 Percent of the Voting