7 - 1 ©2003 prentice hall business publishing, advanced accounting 8/e,...

7 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Intercompany Profit Transactions – Bonds

Chapter 7


Learning Objective 1

Differentiate between

intercompany receivables

and payables, and assets or

liabilities of the consolidated

reporting entity.


Companiesfrequently hold

the debtinstruments of

affiliates.

Direct loans amongaffiliates produce

reciprocalreceivable and

payable accounts.

Receivable and Payable Accounts


Companies eliminate these reciprocalaccounts in preparing consolidated

financial statements.

Receivable and Payable Accounts



Defer unrealized profits and later

recognize realized profits on bond

transfers between parent and

subsidiary companies.


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

Intercompany Bond Transactions


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 givesrise to a realized loss that is not recognized.


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.


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, Sugarpurchases $100,000 of these

outstanding bonds for $104,500.



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

To adjust income from Sugar for theconstructive loss on bonds



Loss on Constructive Retirement of Bonds 4,50010% Bonds Payable 100,000

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


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.


Acquisition of Subsidiary Bonds

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



Demonstrate how a consolidated

reporting entity constructively

retires debt.


A constructive retirement of parentcompany bonds occurs when an

affiliate purchases the outstandingbonds of the parent.

Parent Company BondsPurchased by a Subsidiary



Sue is a 70%-owned subsidiary of Pam,acquired at its $5,600,000 book value

on December 31, 2003.

At the time of acquisition Sue hadcapital stock of $5,000,000 andretained earnings of $3,000,000.



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.



Investment in Pam Bonds 950,000Cash 950,000

To record acquisition of Pam bonds at 95



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



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

bonds that were constructively retired.



10% Bonds Payable 1,008,000Investment in Pam Bonds 960,000Gain on Retirement of Bonds 48,000



Interest Income 110,000Interest Expense 98,000Gain on Retirement of bonds 12,000

Interest Payable 50,000Interest Receivable 50,000


Consolidation Working Papers for the

Year Ended December 31, 2005 Adjustments/ Consol- Pam Sue Eliminations idated

SalesIncome from SueGain on retirementof bondsInterest incomeExpensesInterest expenseMinority interest expenseNet incomeRetained earnings – PamRetained earnings – SueRetained earnings 12/31/05

$4,000 202

(1,910)(980)

$1,312 4,900

$6,212

$2,000

110(1,890)

$ 220

4,000$4,220

c 202a 48b 12

b 110

b 98d 66

e 4,000

$6,000

60

(3,800) (882) (66)$1,312$4,900

$6,212

Income Statement



Year Ended December 31, 2005Other assetsInterest receivableInvestment in Sue

Investment (Pam bonds)

Other liabilitiesInterest payable10% bond payableCommon stockRetained earningsMinority interest

$39,880

6,502

$46,382$ 9,590 500 10,080 20,000 6,212

$46,382

$19,100 50

960$20,110$10,890

5,000 4,220

$20,110

f 50 c 202 e 6,300 a 960

f 50a 1,008e 5,000

d 66 e 2,700

$58,980

$58,980$20,480 450 9,072 20,000 6,212

2,766$58,980

Balance Sheet Adjustments/ Consol-

Pam Sue Eliminations idated


Subsidiary BondsPurchased by Parent

On December 31, 2003, Sky had $10,000,000par of 10% bonds outstanding with an

unamortized discount of $300,000.

The bonds pay interest on January 1 and July 1.

They mature in five years on January 1, 2009.



On January 2, 2004, Pro Corporation purchases50% of Sky’s 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.



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 investmentin bonds during 2004 of $470,000.

At December 31, 2004, their books do not showthe $240,000 of the constructive loss.



90% of Sky’s $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



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

To record 90% of Sky’s reported income for 2004



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

To adjust investment income from Sky for 90%of the loss on the retirement of Sky’s 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



Investment in Sky 01/01/04 ($11,259,000 × 90%) $10,125,000Add: Income from Sky 459,000Investment in Sky 12/31/04 $10,584,000



Adjust calculations of minority

interest amounts in the

presence of intercompany

profits on debt transfers.


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.


Minority Interest

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


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



Year Ended December 31, 2004 Adjustments/ Consol- Pro Sky Eliminations idated

SalesIncome from SkyInterest incomeExpensesInterest expenseLoss on bond retirement

Minority interest expenseNet incomeRetained earnings – ProRetained earnings – SkyRetained earnings 12/31/04

$25,750 459 470(21,679)

$ 5,000 13,000

$18,000

$14,250

(12,440) (1,060)

$ 750

1,250$2,000

c 459b 470

b 530a 240b 60c 51

e 1,250

$40,000

(34,119) (530) (300) (51)$ 5,000$13,000

$18,000

Income Statement



Year Ended December 31, 2004Other assetsInterest receivableInvestment in Sky

Investment in Sky bonds

Other liabilitiesInterest payable10% bonds payableCapital stockRetained earningsMinority interest

$34,046 250 10,584

5,120$50,000$12,000

20,000 18,000

$50,000

$25,000

$25,000$ 2,740 500 9,760 10,000 2,000

$25,000

e 250 c 459 d 10,125 a 5,120

e 250a 4,880e 10,000

c 51 d 1,125

$59,046

$59,046$14,740 250 4,880 20,000 18,000

1,176$59,046

Balance Sheet Adjustments/ Consol-

Pro Sky Eliminations idated


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


Minority Interest

Increased by:Elimination of interest expense $530,000Decreased 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


Summary of Intercompany BondAccount Balances on Separate

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

Sky’s 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


Summary of ConsolidationWorking Paper Adjustments

December 31, 2005 2006 2007 2008DebitsInvestment 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


End of Chapter 7

7 - 1 ©2003 prentice hall business publishing, advanced accounting 8/e,...

Documents