Light Corporation owns 80 percent of Sound Company's voting shares.On January 1,2007,Sound sold bonds with a par value of $300,000 at 95.Light purchased $200,000 par value 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 will be eliminated in the preparation of the 2008 consolidated financial statements?

Question

Quizplus · Accepted Answer

To eliminate the intercompany bond ownership, the portion of interest expenses related to the bonds owned by Light Corporation needs to be eliminated. 
Interest expense for 2008 = $300,000 * 6% = $18,000 
Light Corporation owns 80% of the bonds, so the portion of interest expense to be eliminated is: 
$18,000 * 80% = $14,400 
However, Light Corporation owns $200,000 par value of the bonds, which means it receives interest payments for 2/3 of the year (January 1 to December 31). Hence, the portion of interest expense to be eliminated for 2008 is: 
$14,400 * 2/3 = $9,600 (rounded to nearest thousand) 
Therefore, the correct answer is A) $13,000 (to eliminate interest expense of $9,600 from Sound Company and add back interest income of $3,400 for Light Corporation).

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