Question

Magna Company is the parent company that owns an 80% interest in Metros Company. The interest was purchased at book value, and the simple equity method is used to record the ownership interest. The trial balances of the two companies on December 31, 2016, were as follows:

	Magna Company	Metros Company
Cash	258,000	100,000
Other Current Assets	50,000	200,000
Investment in Metros	316,000
Plant and Equipment	800,000	500,000
Accumulated Depreciation	(300,000)	(200,000)
Current Liabilities	(40,000)	(5,000)
Bonds Payable		(200,000)
Common Stock (par)	(300,000)	(100,000)
Retained Earnings	(746,000)	(285,000)
Sales	(150,000)	(170,000)
Cost of Goods Sold	90,000	130,000
Expenses	30,000	10,000
Interest Expense		20,000
Subsidiary Income	(8,000)
Totals	0	0

As of December 31, 2016, Magna Company was considering acquiring the $200,000 of Metros’s 10% bonds from the current owner. Based on a 12% current interest rate for bonds of this risk, the purchase price of the bonds would be $185,000. There are two possible options as follows:

a. Magna could lend $185,000 to Metros at 8% annual interest. Metros would then use the funds to retire the bonds.

b. Magna could buy the bonds and hold them as an investment and enjoy the high interest rate.

Required

1. Prepare a pro forma consolidated income statement and balance sheet for 2016 assuming option (a) is used.

Answer 1

If option (a) is used, Metros would retire the bond, by paying cash $185,000.
Journal entry for retirement of bonds
Bonds Payable	$200,000
Cash		$185,000
Gain on retirement of bonds		$15,000
When the carrying value of bonds is more then the cash paid for retirement,
there is gain on retirement of Bonds
Proforma Consolidated Income statement and balance sheet for 2016
Income statement
Sales	($320,000)
Cost of Goods sold	$220,000
Gross profit	($100,000)
Operating Expenses	$40,000
Operating Income	($60,000)
Interest expenses	$20,000
Gain on retirement of Bonds	($15,000)
Net Income	($55,000)
Balance Sheet
Assets:
Cash	$173,000
Other current assets	$250,000
Plant and Equipment	$1,300,000
Accumulated Depreciation	($500,000)
Total Assets	$1,223,000
Liabilities:
Current Liabilities	$45,000
Non controlling interest	$82,000
Common Stock	$300,000
Retained Earnings	$796,000
Total Liabilities	$1,223,000
Working Notes:
Non Controlling Interest
Common stock	$100,000
Retained earnings	$285,000
Current year Income	$10,000
Gain on retirement of Bonds	$15,000
Total	$410,000
NCI - 20%	$82,000
Retained Earnings
Retained Earnings-Magna	$746,000
Current year income-Magna	$30,000
Retained Earnings-Magna	$776,000
Income from Metros
Current year Income - 80%	$8,000
Gain on retirement of Bonds - 80%	$12,000
Share of Magna	$20,000
Consolidated Retained Earnings	$796,000

Cash Balance

Magna's cash balance $258,000

Metros's Cash balance $100,000

Less: Cash paid on retirement of bonds -$185,000

Consolidated cash balance $173,000