Question

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?

Answer 1

Answer:

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