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1. Pam Corporation has $108,000 income from its own operations for 2016, and $42,000 income from
Sun Corporation, its 70 percent–owned subsidiary. Sun’s net income of $60,000 consists of $66,000
operating income less $6,000 net-of-tax interest on its outstanding 10 percent convertib le
debentures. Throughout 2016, Pam has 100,000 shares of common stock outstanding, and Sun has
50,000 outstanding common shares.
Required:
1. Compute Pam’s diluted earnings per share for 2016, assuming that Sun’s bonds are convertib le
into 10,000 shares of Sun’s common stock.
2. Compute Pam’s diluted earnings per share for 2016, assuming that Sun’s bonds are convertib le
into 10,000 shares of Pam’s common stock.
2. Pam Corporation paid $1,155,000 cash for a 70 percent interest in Sun Corporation’s outstanding
common stock on January 2, 2016, when the equity of Sun consisted of $1,000,000 common stock
and $600,000 retained earnings. The excess fair value is due to goodwill.
In December 2016, Sun sold inventory items to Pam at a gross profit of $100,000 (selling price
$240,000 and cost $140,000), and all these items were included in Pam’s inventory at December
31, 2016.
Sun paid dividends of $100,000 in 2016, and an 80 percent dividends-received deduction
applies. A flat 34 percent income tax rate applies to both companies.
Separate pretax incomes of Pam and Sun for 2016 are as follows (in thousands):
Pam Sun
Sales $8,000 $2,000
Cost of sales (4,000) (1,100)
Operating expenses (3,000) (500)
Pretax income $ 1,000 $ 400
Questions
1. Determine 2016 income tax currently payable and income tax expense for Pam and Sun.
2. Calculate Pam’s income from Sun for 2016.
3. Prepare a consolidated income statement for Pam and Sun for 2016.
SOLUTION
1. Requirement 1 Requirement 2
Diluted Diluted
Sun’s EPS
Sun’s net income (equal to income to common
stockholders) $60 $60
Add: Net-of-tax interest on convertible bonds 6 -
Sun’s earnings = a $66 $60
2. Preliminary computations
Investment cost $1,155,000
Implied total fair value of Sun ($1,155,000 / 70%) $1,650,000
Less: Book value of Sun $1,600,000
Excess fair value over book value = Goodwill $ 50,000
Check:
Pam’s separate income ($1,000,000 - $349,424) $ 650,576
Income from Sun 138,600
Pam’s and Controlling share of NI $ 789,176