Decision-Making Across the Organization At the beginning of the question-and-ans

Question

Decision-Making Across the Organization

At the beginning of the question-and-answer portion of the annual stockholders' meeting of Neosho Corporation, stockholder John Linton asks, “Why did management sell the holdings in JMB Company at a loss when this company has been very profitable during the period Neosho held its stock?”

Since president Tony Cedeno has just concluded his speech on the recent success and bright future of Neosho, he is taken aback by this question and responds, “I remember we paid $1,300,000 for that stock some years ago. I am sure we sold that stock at a much higher price. You must be mistaken.”

Linton retorts, “Well, right here in footnote number 7 to the annual report it shows that 240,000 shares, a 30% interest in JMB, were sold on the last day of the year. Also, it states that JMB earned $520,000 this year and paid out $160,000 in cash dividends. Further, a summary statement indicates that in past years, while Neosho held JMB stock, JMB earned $1,240,000 and paid out $440,000 in dividends. Finally, the income statement for this year shows a loss on the sale of JMB stock of $180,000. So, I doubt that I am mistaken.”

Red-faced, president Cedeno turns to you.

Assignment - What dollar amount did Neosho receive upon the sale of the JMB stock? Explain why both stockholder Linton and President Cedeno are correct?

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Explanation / Answer

Solution:1

With a 30% ownership the investment in and earnings of JMB company were recorded using Equity method: Original investment= $1300000

Add: Earnings since acquisition(1240000+520000)= $1760000*30%= $528000

Less: Dividend received= (440000+160000)= $600000*30%= $180000

Net Investment at time of sale= $1648000

Proceeds from sale= $1468000

Loss on sale of JMB company= $180000 .

Solution:2

In this example, both President Cedeno and the stockholder John Linton are correct. Neosho Corporation did sell the stock for more than what they originally purchased it for. Therefore, President Cedeno is correct in his assumption that the stock was ultimately sold for more. John Linton is also correct that the JMB stock was sold for a loss. However, John Linton doesn’t account for the cash dividends that were paid out. The cash dividends equalled 180,000, which covers the perceived loss on the income statement

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