Question

Paulina, Incorporated, owns 90 percent of Southport Company. On January 1, 2021, Paulina acquires half of Southport’s $560,000 outstanding 13-year bonds. These bonds had been sold on the open market on January 1, 2018, at a 12 percent effective rate. The bonds pay a cash interest rate of 10 percent every December 31 and are scheduled to come due on December 31, 2030. Southport issued this debt originally for $488,056. Paulina paid $317,576 for this investment, indicating an 8 percent effective yield.

1. Assuming that both parties use the effective rate method, what gain or loss from the retirement of this debt should be reported on the consolidated income statement for 2020?

2. Assuming that both parties use the effective rate method, what balances should appear in the Investment in Southport Bonds account on Paulina’s records and the Bonds Payable account of Southport as of December 31, 2021?

3. Assuming that both parties use the straight-line method, what consolidation entry would be required on December 31, 2021, because of these bonds? Assume that the parent is not applying the equity method.

Answer 1

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1) Assuming that both parties use the effective rate method, what gain or loss from the retirement of this debt should be reported on the consolidated income statement for 2020?

Ans :

DATE	Book value	effective interest	cash interest	Amortization	Yr end Book value
	a	B = a * 8%	c = ORIGINAL PRICE * .10	d = b - c	a + d
2018	488056	58567	56000	2567	490623
2019	490623	58875	56000	2875	493497
2020	493497	59220	56000	3220	496717
				8661

Loss on retirement is calculated as below
Partucular		Amount ($)
Acquisition Price of Bonds		317576
Less: Book Value of Bonds Payable		248359
Loss on Retirement		69217

2) Assuming that both parties use the effective rate method, what balances should appear in the Investment in Southport Bonds account on Paulina’s records and the Bonds Payable account of Southport as of December 31, 2021?

Ans :

Balance of Investments in bonds and bond payable
Investments in bonds
Particulars	Amount (in $)	Amount (in $)
Acquisition Price of Bonds (01/01/2021)		317576
Cash Interest	28000
Less: Effective Interest Income ( Acq price * 0.08)	25406
Amortization		2594
Balance of   Bonds as on 12/13/2021	314982

Bonds Payable
Particulars	Amount (in $)	Amount (in $)
Book Value (01/01/2021)		496717
Cash Interest	56000
Less: Effective Interest Income 496717 * .12	59606
Amortization		-3606
Bonds PAYABLE as on 12/13/2021		500323

Balance of Investment in Bonds and Bonds Payable are    314982 And 500323.

3) Assuming that both parties use the straight-line method, what consolidation entry would be required on December 31, 2021, because of these bonds? Assume that the parent is not applying the equity method.

Ans : As Company uses straight-line method of amortization, the loss on retirement is computed again

Loss on Retirement
Particulars	Amount (in $)
Original Issue Price	488056
Add: discount amortisation (2018- 2020)	19621
Book Value as on 12/31/2020	507677
Acquisition Price of Bonds	317576
Less: Intra-entity portion of Bonds Payable	253839
Loss on retirement	63737

Investment in Bonds
Particulars		Amount (in $)
Acquisition Price of Bonds	317576
Less: Premium Amortization (2018 - 21 )	26007
Book Value as on 12/31/2021	291569

Interest Income
Particulars	Amount (in $)
Cash Interest	28000
Less: Premium Amortization (2018 – 21	26007
Intra-entity interest Income	1993

Bonds Payable
Particulars	Amount (in $)
Original Price(1/1/18)	488056
Add: discount amortisation (2018- 2020)	26161
Book Value as on 31/12/2020	514217
Outside Ownership	0.5
Intra-entity Portion as on 31/12/2020	257109

9. Interest Expense
Particulars	Amount (in $)
Cash Interest	28000
Add: discount amortisation (2015- 2018)	3270
Intra-entity interest expense	31270

General Journal
Bonds payable		257108.7
Retained earnings		63737
Interest income		1993
Investment in bloom bonds		291569
Interest expense			31270