Potter Corporation owns 60 percent of Snape Company's voting shares.On January 1,20X4,Snape sold bonds with a par value of $400,000 when the market rate was 6 percent.Potter purchased one-third of the bonds;the remainder was sold to nonaffiliates.The bonds mature in 15 years and pay an annual interest rate of 5 percent.Interest is paid semiannually on June 30 and December 31.
-Based on the information given above,what amount of interest expense should be reported in the 20X5 consolidated income statement?

Question

Quizplus · Accepted Answer

Since Potter Corporation owns 60% of Snape Company's voting shares, it has significant influence over Snape and should use the equity method to account for its investment. However, the purchase of bonds by Potter in Snape does not affect the consolidation of the two companies' financial statements. Hence, the interest expense that Potter incurs from the bonds is not eliminated in the consolidation process.

Potter bought one-third of the bonds, which is $133,333 ($400,000/3). Since the bonds pay 5% annual interest, the semiannual interest payment is $3,333 ($133,333 x 5% x 6/12). Potter's share of interest expense in 20X5 is half of the semiannual interest payment or $1,666 ($3,333/2).

The consolidated interest expense in the 20X5 income statement is the sum of interest expenses from Snape and Potter, which is $14,516 [$12,850 from Snape ($400,000 x 5% x 6/12) and $1,666 from Potter]. Therefore, the correct answer is C.

Potter Corporation Owns 60 Percent of Snape Company's Voting Shares