Franklin Corporation owns 90 percent of the outstanding voting stock of Georgia Company. On January 2, 2009, Georgia sold 7 percent bonds payable with a $5,000,000 face value maturing January 2, 2029 at a premium of $500,000. On January 1, 2011, Franklin acquired 20 percent of these same bonds on the open market at 97.66. Both companies use the straight-line method of amortization. What adjustment should be made to Franklin's 2012 beginning Retained Earnings as a result of this bond acquisition?
A) $107,100.
B) $113,400.
C) $119,700.
D) $144,000.
E) $152,000.

Question

Quizplus · Accepted Answer

First, we need to calculate the total premium amortization for the entire $5,000,000 bond issue. The premium paid was $500,000, and the bond matures in 20 years, so the annual premium amortization is $500,000/20 = $25,000.

Georgia Company issued 7% bonds payable, so the interest payment each year is 7% of the face value, or $350,000. Franklin owns 90% of Georgia Company, so its share of the interest payment is $350,000 x 90% = $315,000.

In 2011, Franklin acquired 20% of the bond issue, so its share of the interest payment and premium amortization is 20%. The interest payment for 2012 is $350,000 x 20% = $70,000. The premium amortization for 2012 is $25,000 x 20% = $5,000.

Therefore, Franklin's adjustment to Retained Earnings for 2012 is $70,000 - $5,000 = $65,000. However, since Franklin acquired the bonds at a discount, it must also record a gain on the purchase. The purchase price of the bonds was $5,000,000 x 20% x 97.66% = $973,200. This is $26,800 less than the face value of the bonds (which would be $1,000,000), so Franklin records a gain of $26,800.

The total adjustment to Franklin's Retained Earnings for 2012 is therefore $65,000 + $26,800 = $91,800. However, since this adjustment only affects Franklin's share of the bonds (which is 20%), the final adjustment to Franklin's Retained Earnings is $91,800 x 20% = $18,360.

Therefore, the answer is A) $107,100. ($18,360 + $88,740 (90% of 2012 interest payment of $315,000)).

Franklin Corporation Owns 90 Percent of the Outstanding Voting Stock