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27 May, 00:36

Pesto Company possesses 80 percent of Salerno Company's outstanding voting stock. Pesto uses the initial value method to account for this investment. On January 1, 2010, Pesto sold 6 percent bonds payable with a $16.5 million face value (maturing in 20 years) on the open market at a premium of $750,000. On January 1, 2013, Salerno acquired 40 percent of these same bonds from an outside party at 96.6 percent of face value. Both companies use the straightline method of amortization. For a 2014 consolidation, what adjustment should be made to Pesto's beginning Retained Earnings as a result of this bond acquisition?

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  1. 27 May, 00:58
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    The retainesd earnings figure will increase by 464,400 dollars

    Explanation:

    Parent Company premium:

    Premium: 750,000 / 20 years = 37,500 depreciation per year

    unamortized portion at Dec 31th 2013:

    amortized: 750,000 - 37,500 x 4 years = 150,000

    unarmortized: 750,000 - 150,000 = 600,000

    We must reverse 40% of the premium as is within the same company:

    600,000 x 40% = 240,000

    Subsidiary Discount:

    16,500,000 X 40% = 6,600,000

    Purchase at 96.6

    Discount of 3.4 = 6,600,000 x 3.4% = 224,400

    We must reverse this as is part of the same company.

    In total retained earnings will increase by

    240,000 + 224,400 = 464,400 dollars
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