BCLAA8e Ab.az.Chapter 07

8/13/2019 BCLAA8e Ab.az.Chapter 07

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7 - 12003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Intercompany ProfitTransactions Bonds

Chapter 7


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Learning Objective 1

Differentiate between

intercompany receivablesand payables, and assets or

liabilities of the consolidatedreporting entity.


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Companiesfrequently hold

the debt

instruments ofaffiliates.

Direct loans amongaffiliates produce

reciprocal

receivable and payable accounts.

Receivable and Payable Accounts


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Companies eliminate these reciprocalaccounts in preparing consolidated

financial statements.

Receivable and Payable Accounts


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Defer unrealized profits and laterrecognize realized profits on bond

transfers between parent andsubsidiary companies.


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At the time a company issues bonds,its bond liability will reflect thecurrent market rate of interest.

Intercompany Bond Transactions


7/427 - 72003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

If the market rate of interest increases

market value of the liability is less then bookvalue (a realized gain that is not recognized ).

Intercompany Bond Transactions

A decline in the market rate of interest gives

rise to a realized loss that is not recognized .


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Constructive Gains and Losseson Intercompany Bonds

They are realized from the consolidated viewpoint.

They arise when a company purchases the bondsof an affiliate from other entities at a price other

than the book value of the bonds.


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Acquisition of ParentCompany Bonds

Sugar Corporation is an 80%-ownedaffiliate of Peach Corporation.

On January 2, 2006, Peach sells$1,000,000 10% , 10-year bonds at par.

On December 31, 2006, Sugar purchases $100,000 of these

outstanding bonds for $104,500.


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Income from Sugar 4,500Investment in Sugar 4,500

To adjust income from Sugar for theconstructive loss on bonds


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Loss on ConstructiveRetirement of Bonds 4,500

10% Bonds Payable 100,000

Investment in Bonds 104,500To enter loss and eliminate reciprocal bond investment and liability amounts


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Acquisition of Subsidiary Bonds

On January 2, 2006, Sugar sold $1,000,00010% , 10-year bonds at par to the public.On December 31, 2006, Peach purchases

$100,000 of these outstanding bonds for $104,500.Peach owns 80% of Sugar.


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Acquisition of Subsidiary Bonds

Income from Sugar 3,600Investment in Sugar 3,600


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Demonstrate how a consolidatedreporting entity constructively

retires debt.


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A constructive retirement of parentcompany bonds occurs when an

affiliate purchases the outstanding

bonds of the parent.

Parent Company BondsPurchased by a Subsidiary


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Sue is a 70%-owned subsidiary of Pam,

acquired at its $5,600,000 book valueon December 31, 2003.At the time of acquisition Sue had

capital stock of $5,000,000 andretained earnings of $3,000,000.


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Pam has $10,000,000 par of 10% bondsoutstanding with a $100,000 unamortized

premium on January 1, 2005, at which timeSue purchases $1,000,000 par of these bonds

for $950,000 from an investment broker.


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Investment in Pam Bonds 950,000Cash 950,000

To record acquisition of Pam bonds at 95


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10% Bonds Payable 1,010,000Investment in Pam Bonds 950,000Gain on Retirement of Bonds 60,000


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A piecemeal recognition occurred during2005 as Pam amortized premium andSue amortized $10,000 discount on

bonds that were constructively retired.


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10% Bonds Payable 1,008,000Investment in Pam Bonds 960,000

Gain on Retirement of Bonds 48,000


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Interest Income 110,000

Interest Expense 98,000Gain on Retirement of bonds 12,000

Interest Payable 50,000Interest Receivable 50,000


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Consolidation Working Papers for theYear Ended December 31, 2005

Adjustments/ Consol-Pam Sue Eliminations idated

SalesIncome from SueGain on retirementof bondsInterest incomeExpensesInterest expense

Minority interest expenseNet incomeRetained earnings PamRetained earnings SueRetained earnings 12/31/05

$4,000202

(1,910)(980)

$1,3124,900

$6,212

$2,000

110(1,890)

$ 220

4,000$4,220

c 202a 48b 12

b 110

b 98

d 66

e 4,000

$6,000

60

(3,800)(882)

(66)$1,312$4,900

$6,212

Income Statement


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Other assetsInterest receivableInvestment in Sue

Investment (Pam bonds)

Other liabilitiesInterest payable10% bond payableCommon stockRetained earningsMinority interest

$39,880

6,502

$46,382$ 9,590

50010,08020,000

6,212

$46,382

$19,10050

960$20,110$10,890

5,0004,220

$20,110

f 50c 202e 6,300a 960

f 50 a 1,008 e 5,000

d 66e 2,700

$58,980

$58,980$20,480

4509,072

20,0006,212

2,766$58,980

Balance SheetAdjustments/ Consol-

Pam Sue Eliminations idated


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Subsidiary BondsPurchased by Parent

On December 31, 2003, Sky had $10,000,000

par of 10% bonds outstanding with anunamortized discount of $300,000.The bonds pay interest on January 1 and July 1.

They mature in five years on January 1, 2009.


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On January 2, 2004, Pro Corporation purchases

50% of Skys outstanding bonds for $5,150,000. This transaction results in a loss of $300,000from the viewpoint of the consolidated entity.

The entity retires a liability of $4,850,000at a cost of $5,150,000.


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During 2004, Sky records interest expenseon the bonds of $1,060,000 of which $530,000

relates to the intercompany bonds.Pro records interest income from its investment

in bonds during 2004 of $470,000.At December 31, 2004, their books do not show

the $240,000 of the constructive loss.


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90% of Skys $750,000 reported income $675,000Deduct: $300,000 constructive loss 90% 270,000Add: $60,000 recognition of 54,000

constructive loss 90%Investment income from Sky $459,000


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Investment in Sky 675,000Income from Sky 675,000

To record 90% of Skys reported income for 2004


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Income from Sky 270,000Investment in Sky 270,000

To adjust investment income from Sky for 90%of the loss on the retirement of Skys bonds

Investment in Sky 54,000Income from Sky 54,000

To adjust investment income from Sky for 90%of the $60,000 piecemeal recognition of theconstructive loss on Sky bonds during 2004


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Investment in Sky 01/01/04($11,259,000 90%) $10,125,000

Add: Income from Sky 459,000Investment in Sky 12/31/04 $10,584,000


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Adjust calculations of minorityinterest amounts in the

presence of intercompanyprofits on debt transfers.


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Minority Interest

Minority interest expense for 2004 is $51,000,

which is assigned to the constructive loss to Sky.The constructive loss reduces consolidatednet income for 2004 by $216,000 which is

reflected in the consolidated income statement.


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Minority Interest

Decreased by:Constructive loss $300,000Elimination of interest income 470,000Total decreases $770,000I ncreased by:Elimination of interest expense $530,000Reduction of minority interest expense 24,000Total increases $554,000Effect on consolidated net income for 2004 $216,000


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Minority Interest

Loss on Retirement of Bonds 300,000Interest Income 470,00010% Bonds Payable 5,000,000

Investment in Sky Bonds 5,240,000Interest Expense 530,000


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Other assetsInterest receivableInvestment in Sky

Investment in Sky bonds

Other liabilitiesInterest payable10% bonds payableCapital stockRetained earningsMinority interest

$34,046250

10,584

5,120$50,000$12,000

20,00018,000

$50,000

$25,000

$25,000$ 2,740

5009,760

10,0002,000

$25,000

e 250c 459

d 10,125a 5,120

e 250 a 4,880 e 10,000

c 51 d 1,125

$59,046

$59,046$14,740

2504,880

20,00018,000

1,176$59,046

Balance Sheet Adjustments/ Consol-Pro Sky Eliminations idated


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Minority Interest

Investment in Sky 216,000Minority Interest 24,000Interest Income 470,00010% Bonds Payable 5,000,000

Investment in Sky Bonds 5,180,000Interest Expense 530,000


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Minority Interest

Increased by:Elimination of interest expense $530,000

Decreased by:Elimination of interest income $470,000Increase in minority interest expense

($60,000 piecemeal recognition 10%) 6,000Total decreases $476,000Annual effect on consolidated net income $ 54,000

f d


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Summary of Intercompany BondAccount Balances on Separate Books

December 31, 2005 2006 2007 2008Pros Books (000) Investment in Sky bonds $5,090 $5,060 $5,030 $ 5,000Interest income 470 470 470 470Interest receivable 250 250 250 250

Skys Books (000) 10% bonds payable $9,820 $9,880 $9,940 $10,000Interest expense 1,060 1,060 1,060 1,060Interest payable 500 500 500 500

f l d


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Summary of ConsolidationWorking Paper Adjustments

December 31, 2005 2006 2007 2008 DebitsInvestment in Sky (90%) $ 216 $ 162 $ 108 $ 54Minority interest (10%) 24 18 12 6Interest income 470 470 470 47010% bonds payable 4,910 4,940 4,970 5,000Interest payable 250 250 250 250

CreditsInvestment in Sky bonds $5,090 $5,060 $5,030 $5,000Interest expense 530 530 530 530Interest receivable 250 250 250 250


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End of Chapter 7

BCLAA8e Ab.az.Chapter 07

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