Question

Lee, Inc. acquired 30% of Polk Corp.'s voting stock on January 1, Year 1 for $100,000. During Year 1, Polk earned $40,000 and paid dividends of $25,000. Lee's 30% interest in Polk gives Lee the ability to exercise significant influence over Polk's operating and financial policies. During Year 2, Polk earned $50,000 and paid dividends of $15,000 on April 1 and $15,000 on October 1. On July 1, Year 2, Lee sold half of its stock in Polk for $66,000 cash.

Answer 1

Question (continuation)

What should be the gain on sale of this investment in Lee's Year 2 income statement?

Answer:

The gain on sale is $12,250

Explanation:

Year 1:

Purchase Price for year 1 is $100,000

Year 1 Income: 30% of $40,000 = $12,000

Year 1 Dividend: 30% of $25,000 = $7,500 (Subtract)

Balance at the end of year 1 is $100,000 + $12,000 - $7,500 = $104,500

Year 2:

Year 2 income: ½ * 30% of $50,000 = $7,500 (For half a year)

Year 2 dividend: 30% of 15,000 = $4,500 (Subtract)

Balance at end of Year 2 = $104,500 + $7,500 - $4,500 = $107,500

Lee sold 50% of its stock = ½ of $107,500 = $53,750

Cost of half stock sold: $53,750

Selling price of: $66,000

Gain = $66,000 - $53,750 = $12,250