Question

Martin has a controlling interest in Rowen's outstanding stock. At the current year-end, the following information has been accumulated for these two companies:

Separate Operating Income Dividends Paid
Martin $565,000 $105,000
(includes a $162,000 net gross profit in intra-entity ending inventory)
Rowen 300,000 75,000

Martin uses the initial value method to account for the investment in Rowen. The separate operating income figures just presented include neither dividend nor other investment income. The effective tax rate for both companies is 21 percent.

Required:
a. Assume that Martin owns 100 percent of Rowen's voting stock and is filing a consolidated tax return. What income tax amount does this affiliated group pay for the current period?
b. Assume that Martin owns 92 percent of Rowen's voting stock and is filing a consolidated tax return. What amount of income taxes does this affiliated group pay for the current period?
c. Assume that Martin owns 65 percent of Rowen's voting stock, but the companies elect to file separate tax returns. What is the total amount of income taxes that these two companies pay for the current period?

Answer 1

a. The income tax amount that the affiliated group (Martin owning 100% of Rowen) would pay for the current period is $147,630.

Income tax = $147,630 ($565,000 - $162,000 + $300,000) x 21%

b.  The income tax amount that the affiliated group (Martin owning 92% of Rowen) would pay for the current period is $150,352.

Income tax = $150,352 ($565,000 + $300,000 - $149,040) x 21%

c.  The income tax amount that the affiliated group (Martin owning 65% of Rowen) would pay for the current period is $159,537.

Income tax = $159,537 ($565,000 + $300,000 - $105,300) x 21%

What is intra-entity profit?

An intra-entity profit arises when profits have not been unrealized because the assets are not consumed by or sold to any outside party. Such profits must be eliminated from the consolidated tax returns and financial statements.

Data and Calculations:

                              Separate            Dividends

                       Operating Income         Paid

Martin                    $565,000           $105,000

(includes a $162,000 net gross profit in intra-entity ending inventory)

Rowen                    300,000               75,000

Income tax rate = 21%

Intra-entity gross profit to be eliminated:

a. 100% ownership = $162,000

b. 92% ownership = $149,040 ($162,000 x 92%)

c. 65% ownership = $105,300 ($162,000 x 65%)

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