Question

Pepper Enterprises owns 95 percent of Salt Corporation. On January 1, 20X1, Salt issued $220,000 of five-year bonds at 115. Annual interest of 10 percent is paid semiannually on January 1 and July 1. Pepper purchased $120,000 of the bonds on August 31, 20X3, at par value. The following balances are taken from the separate 20X3 financial statements of the two companies: Note: Assume using straight-line amortization of bond discount or premium. Pepper Enterprises Salt Corporation Investment in Salt Corporation Bonds $ 125,700 Interest Income 4,367 Interest Receivable 6,000 Bonds Payable $ 220,000 Bond Premium 20,600 Interest Expense 15,400 Interest Payable 12,000
Required:
a. Compute the amount of interest expense that should be reported in the consolidated income statement for 20X3.
b. Compute the gain or loss on constructive bond retirement that should be reported in the 20X3 consolidated income statement.
c. Prepare the consolidation worksheet consolidation entry or entries as of December 31, 20X3, to remove the effects of the intercorporate bond ownership.

Answer 1

Solution :

a).

Par value of the bonds outstanding                   220,000

Annual interest rate                                              x 10%

Interest payment                                                 220,000

Amortization of the bonds premium                     6600     $\left( \frac{220,000 \times 15\%}{5}\right)$

Interest charged for full year                              15400

Less:interest on the bond purchased                  2567

by Online Enterprise (15400 x 1/2) x

(4 months / 12 months)

Interest expense included in the consolidated   12833

income statement

b).

Sale price of bonds, 1 Jan 20x1                           138,000

(120,000 x 115%)

Amortization of premium                                       9600    $\left(\frac{\ 120,000 \times 15\%}{5 \ yrs} \times 2\frac{2}{3}\right)$

Book value at time of purchase                         128,400

Purchase price                                                    120,000

Gain on bond retirement                                     8400

c).

Events   Accounts                               Debit            Credit

1           Bonds payable                       120,000

           Bonds premium                       6600

           interest income                        4367

          investment in Salt bonds                             120,000

          Interest expense                                           2567

          Gain on bond retirement                              8400

2      interest payable                            8100

      (4950+11900+8750)

      Interest receivable                                          8100