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Pesto Company possesses 80% of Salerno Company's outstanding voting stock. Pesto uses the intial value method...

Pesto Company possesses 80% of Salerno Company's outstanding voting stock. Pesto uses the intial value method to account for this investment. On January 1, 2014, Pesto sold 9% bonds payable with a $10 million face value (maturing in 20 years) on the open market at a premium of $600,000. On January 1, 2017, Salerno acquired 40% of these same bondsfrom an outside party at 96.6% of fave value. Both companies use the straigh-line method of amortization. For a 2018 consolidation, what adjustment should be made to Pesto's beginning Retained Earnings as a result of this bond acquisition?

A) $320,000 Increase

B) $326,000 Increase

C) $331,000 Increase

D) $340,000 Increase

Solutions

Expert Solution

Solution: $320,000 Increase

Working:

Cash Received

10,600,000

2014–2016 amortization ($600,000 /20 yrs. * 3 yrs.)

-90,000

Book value, January 1, 2017

10,510,000

%

40%

Book value of retired bonds

4,204,000

Cash received ($4,000,000 * 96.6%)

3,864,000

Gain earned

340,000

Interest Expense on Intra-Entity Debt - 2017

Cash interest expense (9% * $4,000,000)

360,000

Premium amortization ($30,000 * 40% retired portion of bonds)

-12,000

Interest expense on intra-entity debt

348,000

Interest Income on Intra-Entity Debt - 2017

Cash interest income (9% * $4,000,000)

360,000

Discount amortization (.034 * $4,000,000 / 17 years)

8,000

Interest income on intra-entity debt

368,000

Adjustment to 1/1/18 Retained Earnings

Recognition of 2017 gain on extinguishment of debt (computed above)

340,000

Elimination of 2017 intra-entity interest expense (computed above)

348,000

Elimination of 2017 intra-entity interest income (computed above)

-368,000

Increase in retained earnings, 1/1/18

320,000

ekkarill92 answered 2 years ago
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