Each year, White Mountain Enterprises (WME) prepares a reconciliation schedule that compares its income statement with its statement of cash flows on both the direct and indirect method bases. In its 2018 income statement, WME reported $11,000 of interest expense on its outstanding bonds. During the year, WME paid its regular installments of $9,000 of interest in cash. In its reconciliation schedule, WME should:
A) Show a $2,000 positive adjustment to net income under the indirect method for the decrease in bond premium.
B) Show a $2,000 negative adjustment to net income under the indirect method for the decrease in bond premium.
C) Show a $2,000 positive adjustment to net income under the indirect method for the decrease in bond discount.
D) Show a $2,000 negative adjustment to net income under the indirect method for the decrease in bond discount.

Question

Quizplus · Accepted Answer

When interest expense exceeds the cash paid, the effective interest rate exceeds the stated interest rate; therefore, the bond was sold at a discount. The amortization of the discount was deducted from net income as interest expense but was not a cash outflow and therefore is added back to net income.

Each Year, White Mountain Enterprises (WME) Prepares a Reconciliation Schedule