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Carter Schmitz, Inc. (Schmitz) purchased 200 shares of Intelismart at $21 a share in June
2006 and classifies 80 shares as fair value through profit or loss securities and holds the
remaining 120 shares as classified as fair value through OCI. Intelismart's closing price was
$26 on December 31, 2006, and Schmitz did not sell any of its shares.
What amount should Schmitz report on this investment under the income statement?
A) $400.
B) $600.
C) $1,000.
Rocky Mountain Air Cargo is a privately held commercial aviation company serving the
western United States. It publishes financial statements in accordance with U.S. GAAP and
uses a fiscal year that matches the calendar year.
Rocky Mountain was in good financial shape heading into 2003, with assets of $50 million at
the beginning of the fiscal year. That year, it earned $3 million in net income and was easily
able to maintain its traditional 50% dividend payout ratio. However, Rocky Mountain had a
very difficult year in 2004, reporting a loss of $800,000. It managed to pay $1 million in
dividends, but the decision to pay dividends in such a weak financial year further
undermined the company's fiscal stability.
Flitenight Air Lines, a publicly-traded aviation firm serving the central and Midwestern
United States, wanted to expand its range of service by coordinating its flight schedule with
airlines serving different geographic regions of North America. One of these airlines was
Rocky Mountain Air Cargo.
To cement the relationship, Flitenight's CEO, John "Bulldog" Basten, decided to make a
significant investment in Rocky Mountain Air Cargo. He was easily able to convince both
boards of the wisdom of the deal, and, in his usual brash style, personally negotiated the
terms with his counterpart at Rocky Mountain, Buck Matthews. Flitenight Air Lines acquired
a 20% stake in Rocky Mountain Air Cargo (with an option to purchase 40% more) for $10
million cash. The deal closed on January 1, 2003 and Flitenight accounted for the investment
using the equity method.
Basten was not happy to find that he had invested right at the peak of Rocky Mountain's
profitability and wound up with a money-losing airline. He had a difficult conversation with
Matthews in early 2005, complaining about the impact of the Rocky Mountain investment on
Flitenight's financials. Basten pointed out that he had a loss on his books: the original $10
million investment in Rocky Mountain was carried at only $9,940,000 on Flitenight's
December 31, 2004 balance sheet. Matthews countered that this was just an accounting
entry: on a cash basis, Flitenight had a gain of 5% on its investment over the two years.
Matthews' insistence that the investment had earned money for Flitenight did not sit well
with Basten. Basten decided that Rocky Mountain was clearly being mismanaged and
concluded it was time to gain control of the company.
Basten notified Matthews and Rocky Mountain's board that Flitenight intended to exercise
its option. At the direction of Basten and Glenn, Flitenight purchased the additional shares
for cash and gained control of Rocky Mountain on December 31, 2004.