Pay Corporation purchased 60 percent of Set Corporation’s outstanding preferred stock for $6,500,000 and 70 percent of its outstanding common stock for $35,000,000 on January 1, 2012. Set’s stockholders’ equity on December 31, 2011, consisted of the following (in thousands):
10% cumulative, $100 par, preferred stock, callable
at $105 (100,000 shares issued and outstanding with
one year’s dividends in arrears) ........... $10,000
Common stock, $10 par ................... 30,000
Other paid-in capital .................... 5,000
Retained earnings ...................... 15,000
Total stockholders’ equity ................ $60,000

REQUIRED
1. Determine the fair value/book value differentials from Pay’s investments in Set.
2. Without bias on your part, assume that the fair value/book value differential applicable to the preferred investment is a negative $400,000. Describe the accounting treatment of the preferred differential if the preferred investment is treated as a constructive retirement for consolidation purposes.