Q24. If Prudhomme Inc. follows Sanscartier’s recommendation and classifies its shares of Quality as be trading securities, what

     would be the effect of its ownership of Quality on Prudhomme’s income statement for fiscal year 2004?

A)   +$30,000.

B)   −$70,000.

C)   −$100,000.

Q25. If Prudhomme Inc. acts on Xavier Prudhomme’s recommended investment and accounts for this investment using the equity

     method, what is the value of Quality on the balance sheet of Prudhomme as of December 31, 2004?

A)   $1,500,000.

B)   $1,425,000.

C)  $1,250,000.

Correct answer is B)

Q26. If Prudhomme Inc. acts on Xavier Prudhomme’s recommended investment and considers its shares of Quality to be trading

   securities, what is the effect of its ownership of Quality on Prudhomme’s income statement for FY2004?

A)   +$150,000.

B)   −$175,000.

C)   −$100,000.

答案和详解如下：

Q24. If Prudhomme Inc. follows Sanscartier’s recommendation and classifies its shares of Quality as be trading securities, what

     would be the effect of its ownership of Quality on Prudhomme’s income statement for fiscal year 2004?

A)   +$30,000.

B)   −$70,000.

C)   −$100,000.

Correct answer is B)

Sanscartier’s suggestion is to acquire only 10% of Quality. The value of a share dropped from $6 to $5, or $1 per share. Unrealized changes in the market value of trading securities are included in income. The income of Prudhomme is also increased by the dividend paid by Quality. We are told that Quality’s revenues are 1.5 times its assets of $2 million, so income is $3 million. Of this, 20% is profit, so profits are $600,000. Half of the profits are paid out as dividends. So:

[($5.00 − $6.00) × (100,000)] + [($300,000 / 1,000,000) × 100,000)] = −$70,000

Q25. If Prudhomme Inc. acts on Xavier Prudhomme’s recommended investment and accounts for this investment using the equity

     method, what is the value of Quality on the balance sheet of Prudhomme as of December 31, 2004?

A)   $1,500,000.

B)   $1,425,000.

C)  $1,250,000.

Correct answer is B)

Xavier Prudhomme recommended buying a 25% interest in Quality, which would be considered to give Prudhomme Inc. significant influence over Quality. The equity method is used when an investor has significant influence over an investee. Recall that he believed that this purchase could be made at a 10% discount from market value. Prudhomme’s actual dollar investment in Quality plus Prudhomme’s share of net income less Prudhomme’s share of dividends determines the carrying value of the acquired stock.

($6.00 × 250,000 × 0.9) + ($600,000 × 0.25) − ($300,000 × 0.25) = $1,425,000.

Xavier Prudhomme recommended buying a 25% interest in Quality, which would be considered to give Prudhomme Inc. significant influence over Quality. The equity method is used when an investor has significant influence over an investee. Recall that he believed that this purchase could be made at a 10% discount from market value. Prudhomme’s actual dollar investment in Quality plus Prudhomme’s share of net income less Prudhomme’s share of dividends determines the carrying value of the acquired stock.

($6.00 × 250,000 × 0.9) + ($600,000 × 0.25) − ($300,000 × 0.25) = $1,425,000.Q26. If Prudhomme Inc. acts on Xavier Prudhomme’s recommended investment and considers its shares of Quality to be trading

   securities, what is the effect of its ownership of Quality on Prudhomme’s income statement for FY2004?

A)   +$150,000.

B)   −$175,000.

C)   −$100,000.

Correct answer is A)

The equity method is used when an investor has significant influence over an investee, even if the company considers the investment trading securities. Prudhomme’s income will include 25% of Quality’s net income, or (0.25 × $600,000) = $150,000. In applying the equity method, dividends and changes in market value do not affect income.

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