Question

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1. Choco owns 70% of Cake. On 1/1/2015, Cake issued $800,000 10 years bond at 6%. Cake issued the bond at $724,000, with effective interest of 7%. On 1/1/2016, Choco purchased all of Cake’s bond for $886,000 with effective interest at 5% and Cake’s bond has been effectively retired.

1. What is the book value of Cake’s bond as of 12/31/2015?

   Date	Cash Interest	Effective interest	Amortization of bond discount	BV
   01/01/2015
   12/31/2015
   12/31/2016

2. Calculate the amount of gain or loss from this transaction to be recognized in consolidated statements on 12/31/2016.

1. Make a journal entry that Choco will record regarding the 1/1/2016 investment on bond, and bond interest expense on 12/31/2016.

1/1/16
12/31/16

1. Prepare consolidation entry B on 12/31/2016.

Answer 1

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1. Calculation of book value of cakes bond

The bond discount of $76,000 must be amortized to Interest Expense over the life of the bond. We assume that interest payment is made twice a year so interest payment made is $24000 (800000*6/100*6/12)

The effective interest rate is the market interest rate on the date that the bonds were issued. In our case the market interest rate on January 1, 2015 was 3.5% per semiannual period for 20 semiannual periods.

Period	Cash Interest	Effective Interest	Amortisation	Bond Carrying Value
1/1/2015				(800000-76000) 724000
1/6/2015	24000	25340	1340	725340
31/12/2015	24000	25386.9	1386.9	726726.9

Loss of $2726.9 will be recorded in the books.