7 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Intercompany Profit Transactions – Bonds
Chapter 7
7 - 2©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 1
Differentiate between
intercompany receivables
and payables, and assets or
liabilities of the consolidated
reporting entity.
7 - 3©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Companiesfrequently hold
the debtinstruments of
affiliates.
Direct loans amongaffiliates produce
reciprocalreceivable and
payable accounts.
Receivable and Payable Accounts
7 - 4©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Companies eliminate these reciprocalaccounts in preparing consolidated
financial statements.
Receivable and Payable Accounts
7 - 5©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 2
Defer unrealized profits and later
recognize realized profits on bond
transfers between parent and
subsidiary companies.
7 - 6©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
At the time a company issues bonds,its bond liability will reflect thecurrent market rate of interest.
Intercompany Bond Transactions
7 - 7©2003 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 givesrise to a realized loss that is not recognized.
7 - 8©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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.
7 - 9©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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.
7 - 10©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
Income from Sugar 4,500Investment in Sugar 4,500
To adjust income from Sugar for theconstructive loss on bonds
7 - 11©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany 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
7 - 12©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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.
7 - 13©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of Subsidiary Bonds
Income from Sugar 3,600Investment in Sugar 3,600
7 - 14©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 3
Demonstrate how a consolidated
reporting entity constructively
retires debt.
7 - 15©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
A constructive retirement of parentcompany bonds occurs when an
affiliate purchases the outstandingbonds of the parent.
Parent Company BondsPurchased by a Subsidiary
7 - 16©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
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.
7 - 17©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
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.
7 - 18©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
Investment in Pam Bonds 950,000Cash 950,000
To record acquisition of Pam bonds at 95
7 - 19©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
10% Bonds Payable 1,010,000Investment in Pam Bonds 950,000Gain on Retirement of Bonds 60,000
7 - 20©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
A piecemeal recognition occurred during2005 as Pam amortized premium andSue amortized $10,000 discount on
bonds that were constructively retired.
7 - 21©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
10% Bonds Payable 1,008,000Investment in Pam Bonds 960,000Gain on Retirement of Bonds 48,000
7 - 22©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Acquisition of ParentCompany Bonds
Interest Income 110,000Interest Expense 98,000Gain on Retirement of bonds 12,000
Interest Payable 50,000Interest Receivable 50,000
7 - 23©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
7 - 24©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Consolidation Working Papers for the
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
7 - 25©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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.
7 - 26©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Subsidiary BondsPurchased by Parent
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.
7 - 27©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Subsidiary BondsPurchased by Parent
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.
7 - 28©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Subsidiary BondsPurchased by Parent
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
7 - 29©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Subsidiary BondsPurchased by Parent
Investment in Sky 675,000Income from Sky 675,000
To record 90% of Sky’s reported income for 2004
7 - 30©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Subsidiary BondsPurchased by Parent
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
7 - 31©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Subsidiary BondsPurchased by Parent
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
7 - 32©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 4
Adjust calculations of minority
interest amounts in the
presence of intercompany
profits on debt transfers.
7 - 33©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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.
7 - 34©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
7 - 35©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
7 - 36©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Consolidation Working Papers for the
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
7 - 37©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Consolidation Working Papers for the
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
7 - 38©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
7 - 39©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
7 - 40©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
7 - 41©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
7 - 42©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
End of Chapter 7