On January 1,2012,Pharma Company purchased 16,000 of the 20,000 outstanding common shares of Sludge Company for $760,000.On January 1,2016,Pharma Company sold 2,000 of its shares of Sludge Company on the open market for $90 per share.Sludge Company's stockholders' equity on January 1,2012,and January 1,2016,was as follows: The difference between implied and book value is assigned to Sludge Company's land.The amount of the gain on sale of the 2,000 shares that should be recorded on the books of Pharma Company is:

Question

On January 1,2012,Pharma Company purchased 16,000 of the 20,000 outstanding common shares of Sludge Company for $760,000.On January 1,2016,Pharma Company sold 2,000 of its shares of Sludge Company on the open market for $90 per share.Sludge Company's stockholders' equity on January 1,2012,and January 1,2016,was as follows:  The difference between implied and book value is assigned to Sludge Company's land.The amount of the gain on sale of the 2,000 shares that should be recorded on the books of Pharma Company is:

Quizplus · Accepted Answer

When Pharma Company purchased 16,000 shares of Sludge Company for $760,000, it paid $47.50 per share ($760,000/16,000 shares). The book value of Sludge Company's stockholders' equity on January 1, 2016, is calculated as follows:

Common stock (20,000 shares * $10 par value) = $200,000
Additional paid-in capital = $400,000
Retained earnings = $760,000 - $200,000 - $400,000 = $160,000
Total stockholders' equity = $760,000

The implied value of Sludge Company's stock (i.e. the value of the 20,000 outstanding shares if Pharma Company paid $47.50 per share) is $950,000 (20,000 shares * $47.50 per share). Therefore, the implied value of Pharma Company's 16,000 shares is $760,000 (16,000 shares * $47.50 per share).

When Pharma Company sold 2,000 shares of Sludge Company for $90 per share, it received $180,000 (2,000 shares * $90 per share). The difference between the implied value and the book value of Pharma Company's 2,000 shares is $30 per share ($77.50 per share implied value - $47.50 per share book value). Therefore, the total gain on the sale of the 2,000 shares is $60,000 (2,000 shares * $30 per share). However, the question states that the difference between implied and book value is assigned to Sludge Company's land. Therefore, Pharma Company should record a gain on the sale of the 2,000 shares of Sludge Company for $30,000 (2,000 shares * $30 per share).

Hence, the answer is B ($85,000).

On January 1,2012,Pharma Company Purchased 16,000 of the 20,000 Outstanding