Question

Assume the same facts as in E8-3 but prepare entries using straight-line amortization of bond discount or premium.

Purse Corporation owns 70 percent of Scarf Company’s voting shares. On January 1, 20X3, Scarf sold bonds with a par value of $600,000 at 98. Purse purchased $400,000 par value of the bonds; the remainder was sold to nonaffiliates. The bonds mature in five years and pay an annual interest rate of 8 percent. Interest is paid semiannually on January 1 and July 1.

Required

What amount of interest expense should be reported in the 20X4 consolidated income statement?

Give the journal entries Purse recorded during 20X4 with regard to its investment in Scarf bonds.

Give all worksheet consolidation entries needed to remove the effects of the intercorporate bond ownership in preparing consolidated financial statements for 20X4.

prepare entries using straight-line amortization of bond discount or premium.

Answer 1

The amount of interest expense to be reported in the 20X4 consolidated income statement is $16,800.

Interest expenditure is an important significant cost for firms and is shown as an operational item on the income statement. A firm financial performance can be impacted and interest costs could be much decreased if they are able to refinance their debt at a cheaper interest rate.

To calculate the amount of interest expense to be reported in the 20X4 consolidated income statement, we must first determine the total interest expense for Scarf Company on the bonds before we can prepare the journal entries.

The data are:

• The annual interest rate is 8 percent
• Bonds pay interest semiannually.
• The par value of the bonds is $600,000.

Annual interest rate = 8% = 0.08

Semiannual interest rate = 0.08 / 2 = 0.04

Semiannual interest payment = 0.04 * $600,000 = $24,000

Interest expense for Purse = (Semiannual interest payment) * (Purse's percentage ownership)

= $24,000 * 70%

= $16,800

Journal Entries for Purse Corporation in 20X4,

1. Debit: Interest Receivable $16,800

Credit: Interest Income $16,800

To record the semiannual interest income on Scarf bonds

2. Debit: Cash $16,800

Credit: Interest Receivable $16,800

To record the semiannual interest payment from Scarf Company.