Knight Co Owned 80% of the Common Stock of Stoop Co

question 43

Multiple Choice

Knight Co. owned 80% of the common stock of Stoop Co. Stoop had 50,000 shares of $5 par value common stock and 2,000 shares of preferred stock outstanding. Each preferred share received an annual per share dividend of $10 and is convertible into four shares of common stock. Knight did not own any of Stoop's preferred stock. Stoop also had 600 bonds outstanding, each of which is convertible into ten shares of common stock. Stoop's annual after-tax interest expense for the bonds was $22,000. Knight did not own any of Stoop's bonds. Stoop reported income of $300,000 for 2011.
-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.

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Definitions:

Internal Growth Rate

The rate at which a company can grow its sales and earnings without needing to borrow money or secure additional equity financing.

Profit Margin

A financial metric that measures the amount of profit made on a sale as a percentage of revenue, illustrating efficiency.

Retention Ratio

The retention ratio is a financial metric that measures the proportion of a company's earnings that are not distributed as dividends to shareholders but are instead reinvested in the business.

Debt-equity Ratio

A measure of a company's financial leverage calculated by dividing its total liabilities by its shareholder's equity.