Vontkins Inc. owned all of Quasimota Co. The subsidiary had bonds payable outstanding on January 1, 2010, with a book value of $265,000. The parent acquired the bonds on that date for $288,000. Subsequently, Vontkins reported interest income of $25,000 in 2010 while Quasimota reported interest expense of $29,000. Consolidated financial statements were prepared for 2011. What adjustment would have been required for the retained earnings balance as of January 1, 2011?
A) reduction of $27,000.
B) reduction of $4,000.
C) reduction of $19,000.
D) reduction of $30,000.
E) reduction of $20,000.

Question

Quizplus · Accepted Answer

The difference between the interest income earned by Vontkins and the interest expense recorded by Quasimota ($25,000 - $29,000 = -$4,000) needs to be eliminated in the consolidation process. Since Vontkins owned the bonds at the beginning of 2010, it recorded the interest income of $25,000 for the year. However, Quasimota's interest expense of $29,000 should not be included in the consolidated financial statements since the bonds were owned by Vontkins. Therefore, a net adjustment of $4,000 ($29,000 - $25,000) is needed to reduce the subsidiary's interest expense and increase the parent's interest income. This adjustment would reduce the consolidated retained earnings balance as of January 1, 2011, by $19,000 ($4,000 x 0.80, since 80% of the subsidiary's earnings belong to the parent).