On January 1,20X8,Pullman Company acquired 30 percent of Skate Company's common stock,at underlying book value of $100,000.Skate has 100,000 shares of $2 par value,5 percent cumulative preferred stock outstanding.No dividends are in arrears.Skate reported net income of $150,000 for 20X8 and paid total dividends of $72,000.Pullman uses the equity method to account for this investment.
-Based on the preceding information,what amount of investment income will Pullman Company report from its investment in Skate for the year?
A)$45,000
B)$42,000
C)$62,000
D)$35,000

Question

Quizplus · Accepted Answer

Under the equity method, Pullman would recognize its share of Skate's net income adjusted for dividends received. Skate's net income is $150,000. Pullman owns 30% of Skate, so its share of the net income is 30% of $150,000 = $45,000. However, dividends paid reduce the carrying amount of the investment. The $72,000 in dividends includes preferred dividends. The preferred dividends are 5% of the $100,000 par value of the preferred stock, which equals $5,000 (5% of $100,000). Since there are 100,000 shares at $2 par, the total par value is $200,000, making the calculation for preferred dividends $200,000 * 5% = $10,000, not $5,000 as previously misstated. The common dividends would be the total dividends minus the preferred dividends ($72,000 - $10,000 = $62,000). Pullman's share of the common dividends is 30% of $62,000 = $18,600. Therefore, the investment income recognized is $45,000 (share of net income) - $18,600 (share of dividends received) = $26,400. However, none of the provided choices match this calculation, indicating a mistake in the dividend calculation or the interpretation of the question's details. Reevaluating the correct approach: Pullman's share of Skate's net income is indeed 30% of $150,000, which is $45,000. The error lies in the misinterpretation of how dividends are treated under the equity method. Under the equity method, the investor's share of dividends is subtracted from the carrying value of the investment, not from the investment income recognized. Therefore, the correct answer should reflect only the share of net income attributable to Pullman, which is $45,000, without adjusting for dividends in the calculation of investment income. This reevaluation points out a mistake in the initial explanation and calculation regarding the treatment of dividends under the equity method and the calculation of preferred dividends. Given the error in the explanation and the provided choices, the correct answer based on the initial information should be focused on the share of net income attributable to Pullman, which is $45,000, as none of the calculations for dividends correctly align with the standard approach for reporting investment income under the equity method. This highlights a critical oversight in the initial response.

On January 1,20X8,Pullman Company Acquired 30 Percent of Skate Company's