Question

On January 1, Year 4, Place Inc. acquired an 80 percent interest in Setting Co. for $800,000 cash. At that time, Setting’s assets and liabilities had carrying amounts equal to fair values, except for the following:

Inventory	Undervalued by $75,000	Turns over 6 times a year
Planet and equipment	Undervalued by $50,000	Remaining useful life: 10 years
Bonds payable	Overvalued by $40,000	Maturity date: December 31, Year 8

The premium/discount on bonds payable is amortized on a straight-line basis.
At January 1, Year 4, Setting had 100,000 common shares outstanding with a carrying amount of $550,000 and retained earnings of $50,000.
The abbreviated financial statements of Place and Setting on December 31, Year 6, are as follows:

STATEMENTS OF FINANCIAL POSITION
		Place			Setting
Plant and equipment (net)	$	1,250,000		$	1,555,000
Investment in Setting		800,000			—
Current assets		950,000			800,000
	$	3,000,000		$	2,355,000
Common shares	$	1,000,000		$	550,000
Retained earnings		1,500,000			725,000
10% bonds payable		—			800,000
Current liabilities		500,000			280,000
	$	3,000,000		$	2,355,000

COMBINED INCOME AND RETAINED EARNINGS STATEMENTS
		Place			Setting
Sales	$	2,500,000		$	900,000
Cost of goods sold		1,200,000			330,000
Expenses		400,000			220,000
		1,600,000			550,000
Net operating income		900,000			350,000
Dividends received from Setting		100,000			—
Profit		1,000,000			350,000
Retained earnings, Jan. 1, Year 6		800,000			500,000
		1,800,000			850,000
Dividends declared and paid		300,000			125,000
Retained earnings, Dec. 31, Year 6	$	1,500,000		$	725,000

Which of the following is the correct adjustment to interest expense for the amortization of the bond fair value increment on Place’s consolidated income statement for the year ended December 31, Year 4?

Multiple Choice

• $8,000 increase.

• $6,400 increase.

• $8,000 decrease.

• $6,400 decrease.

Answer 1

Consolidation of an 80%-Owned Subsidiary—Direct Approach

Bond discount for consolidation, therefore increase to expenses over time

= $40,000 – $40,000*80%

= $40,000 - $32,000

= $8,000

Hence, $8,000 increase is the correct answer.