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Pesto Company possesses 80 percent of Salerno Company's outstanding voting stock. Pesto uses the initial value...

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, 2014, Pesto sold 6 percent bonds payable with a $14.0 million face value (maturing in 20 years) on the open market at a premium of $1,070,000. On January 1, 2017, Salerno acquired 40 percent of these same bonds from an outside party at 96.6 percent of face value. Both companies use the straight-line method of amortization. For a 2018 consolidation, what adjustment should be made to Pesto's beginning Retained Earnings as a result of this bond acquisition?

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Answer #1

Book Value = 14000000 + 1070000 = 15070000

Amortization = 1070000/20 x 3 = 160500

Cash Received = 14000000 x 40% x 96.6%= 5409600

Book Value = 15070000-160500 = 14909500

Book Value of Retired Bonds = 14909500*40%= 5963800

Cash Received = 5409600

Gain on Retirement of bonds = 5963800-5409600= 554200

Cash Interest Expense = 14000000 x 40% x 6% = 336000

Premium Amortization = 1070000/20 x 40% = 21400

Interest Expense = 336000 - 21400 = 314600

Discount amortization = 14000000 x 40%/20 - 3 Years x (100% - 96.6%)= 12000

=336000 + 12000 = 348000

Adjustment = 554200 + 314600 - 348000

=520800

So retained earnings should increase by 520800

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