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 will be eliminated in the preparation of the 20X8 consolidated financial statements?
A)$13,000
B)$13,500
C)$10,000
D)$15,000

Question

Quizplus · Accepted Answer

Puget owns 80% of Sound's voting shares, which means it has significant influence over Sound and must consolidate Sound's financial statements with its own. Puget also purchased two thirds of Sound's bonds, which means it has a direct financial relationship with Sound.

To eliminate the intercompany interest expense, we need to calculate the total interest paid by Sound to all bondholders, and then eliminate the portion of that interest paid to Puget.

Sound's total interest expense for the year will be:
($300,000 x 0.95) x 0.06 = $17,100

Puget owns two thirds of the bonds, so it is entitled to two thirds of the interest payments:
$17,100 x (2/3) = $11,400

Therefore, the amount of interest expense eliminated in the preparation of the 20X8 consolidated financial statements will be the portion of interest paid to Puget:
$11,400 x 80% = $9,120

Since interest is paid semiannually, we need to divide by 2 to get the interest eliminated for the year:
$9,120 / 2 = $4,560

And since this question is asking for the amount eliminated in the preparation of the 20X8 consolidated financial statements, we need to double this amount to find the total for the year:
$4,560 x 2 = $9,120

Therefore, the answer is A) $13,000, since that is the closest option to our calculated amount of $13,680 ($17,100 - $9,120).

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