Puget Corporation owns 80 percent of Sound Company's voting shares.On January 1,20X7,Sound sold bonds with a par value of $300,000 at 95.Puget purchased two thirds of the bonds;the remainder was sold to nonaffiliates.The bonds mature in ten years and pay an annual interest rate of 6 percent.Interest is paid semiannually on January 1 and July 1.
-Based on the information given above,what amount of interest expense should be reported in the 20X8 consolidated income statement?
A)$6,000
B)$6,500
C)$5,000
D)$10,000

Question

Quizplus · Accepted Answer

Puget Corporation owns 80% of the voting shares of Sound Company, therefore, Sound Company is considered a subsidiary of Puget Corporation. When a parent company owns a subsidiary, they must prepare a consolidated financial statement.

Puget Corporation purchased two-thirds of Sound Company's bonds, therefore they own:
2/3 x $300,000 = $200,000

The interest rate on the bonds is 6% per year, which is paid semi-annually. Therefore, the semi-annual interest expense is calculated as:
($200,000 x 6%) / 2 = $6,000

Puget Corporation owns 80% of Sound Company, therefore they should report 80% of Sound Company's interest expense on their consolidated income statement:
$6,000 x 80% = $4,800

However, Puget Corporation also owns two-thirds of the bonds issued by Sound Company, therefore they are entitled to the interest payments made by Sound Company on those bonds. The interest payment made to Puget Corporation is:
($200,000 x 6% x 1/2) = $6,000

Therefore, the total interest expense that should be reported on the consolidated income statement is:
$4,800 + $6,000 = $10,800

Since the interest is paid semiannually, we need to divide $10,800/2 to get the interest expense for 20X8:
$10,800/2 = $5,400

Therefore, the correct answer is option B) $6,500.

Puget Corporation Owns 80 Percent of Sound Company's Voting Shares