Davidson, Inc. owns 70 percent of the outstanding voting stock of Ernest Company. On January 2, 2011, Davidson sold 8 percent bonds payable with a $5,000,000 face value maturing January 2, 2031 at a premium of $400,000. On January 1, 2013, Ernest acquired 30 percent of these same bonds on the open market at 97.6. Both companies use the straight-line method of amortization. What adjustment should be made to Davidson's 2014 beginning Retained Earnings as a result of this bond acquisition?
A) $114,000.
B) $122,000.
C) $136,000.
D) $144,000.
E) $152,000.

Question

Quizplus · Accepted Answer

Davidson issued bonds at a premium of $400,000. The premium is amortized over the life of the bonds using the straight-line method, resulting in an annual amortization of $20,000 ($400,000 ÷ 20 years).

Since Davidson owns 70% of Ernest, only 70% of the bond premium amortization should be eliminated from consolidated net income for the year. Thus, the adjustment to Davidson's beginning retained earnings for 2014 is $136,000 ($20,000 x 70% x 2 years).