Detecting Accounting Fraud 1st Edition by Cecil Jackson

Exercise 25

Power Company acquires 80 percent of the shares (80 shares) in Emperor Company for $20 million on January 1, 2012. On December 31, 2012, Power Company forms an unconsolidated partnership named P2 and issues 1,000 Power Company shares to P2 for a 90 percent share in P2. The CFO of Power Company buys the remaining equity interest in P2 with cash loaned to him by Power.
On December 31, 2012, Power Company sells 10 percent of its stake in Emperor to P2 for $4 million. Using this sale as evidence of the market value of its investment in Emperor, Power Company revalues the remainder of its holdings in Emperor, recognizing the alleged appreciation in value as current income. Power does not consolidate P2 into its consolidated financial statements.
Required
a. Calculate the amount of pretax income that Power Company recognizes in its income statement for the year ended December 31, 2012, if it accounts for the revaluation on the basis described above.
b. How much pretax income would Power recognize on the sale of 10 percent of its stake in Emperor to P2?