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Intercompany Profit
Transactions – Bonds
Chapter 7
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-1
Learning Objective 1
Differentiate between
intercompany receivables
and payables, and assets or
liabilities of the consolidated
reporting entity.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-2
Receivable and Payable Accounts
Companies
frequently hold
the debt
instruments of
affiliates.
Direct loans among
affiliates produce
reciprocal
receivable and
payable accounts.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-3
Receivable and Payable Accounts
Companies eliminate these reciprocal
accounts in preparing consolidated
financial statements.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-4
Learning Objective 2
Defer unrealized profits and later
recognize realized profits on bond
transfers between parent and
subsidiary companies.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-5
Intercompany Bond Transactions
At the time a company issues bonds,
its bond liability will reflect the
current market rate of interest.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-6
Intercompany Bond Transactions
If the market rate of interest increases…
– market value of the liability is less then book
value (a realized gain that is not recognized).
A decline in the market rate of interest gives
rise to a realized loss that is not recognized.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-7
Constructive Gains and Losses
on Intercompany Bonds
They are realized from the consolidated viewpoint.
They arise when a company purchases the bonds
of an affiliate from other entities at a price other
than the book value of the bonds.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-8
Acquisition of Parent
Company Bonds
Sugar Corporation is an 80%-owned
affiliate 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.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7-9
Acquisition of Parent
Company Bonds
Income from Sugar
4,500
Investment in Sugar
To adjust income from Sugar for the
constructive loss on bonds
4,500
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 10
Acquisition of Parent
Company Bonds
Loss on Constructive
Retirement of Bonds
4,500
10% Bonds Payable
100,000
Investment in Bonds
To enter loss and eliminate reciprocal
bond investment and liability amounts
104,500
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 11
Acquisition of Subsidiary Bonds
On January 2, 2006, Sugar sold $1,000,000
10% , 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.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 12
Acquisition of Subsidiary Bonds
Income from Sugar
Investment in Sugar
3,600
3,600
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 13
Learning Objective 3
Demonstrate how a consolidated
reporting entity constructively
retires debt.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 14
Parent Company Bonds
Purchased by a Subsidiary
A constructive retirement of parent
company bonds occurs when an
affiliate purchases the outstanding
bonds of the parent.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 15
Acquisition of Parent
Company 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 had
capital stock of $5,000,000 and
retained earnings of $3,000,000.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 16
Acquisition of Parent
Company Bonds
Pam has $10,000,000 par of 10% bonds
outstanding with a $100,000 unamortized
premium on January 1, 2005, at which time
Sue purchases $1,000,000 par of these bonds
for $950,000 from an investment broker.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 17
Acquisition of Parent
Company Bonds
Investment in Pam Bonds
950,000
Cash
950,000
To record acquisition of Pam bonds at 95
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 18
Acquisition of Parent
Company Bonds
10% Bonds Payable
1,010,000
Investment in Pam Bonds
950,000
Gain on Retirement of Bonds
60,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 19
Acquisition of Parent
Company Bonds
A piecemeal recognition occurred during
2005 as Pam amortized premium and
Sue amortized $10,000 discount on
bonds that were constructively retired.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 20
Acquisition of Parent
Company Bonds
10% Bonds Payable
1,008,000
Investment in Pam Bonds
960,000
Gain on Retirement of Bonds
48,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 21
Acquisition of Parent
Company Bonds
Interest Income
Interest Expense
Gain on Retirement of bonds
Interest Payable
Interest Receivable
110,000
98,000
12,000
50,000
50,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 22
Consolidation Working Papers for the
Year Ended December 31, 2005
Income Statement
Sales
Income from Sue
Gain on retirement
of bonds
Interest income
Expenses
Interest expense
Minority interest expense
Net income
Retained earnings – Pam
Retained earnings – Sue
Retained earnings 12/31/05
Pam
$4,000
202
(1,910)
(980)
$1,312
4,900
$6,212
Adjustments/ ConsolSue Eliminations idated
$2,000
$6,000
c 202
a 48
b 12
60
110 b 110
(1,890)
(3,800)
b 98
(882)
d 66
(66)
$ 220
$1,312
$4,900
4,000 e 4,000
$4,220
$6,212
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 23
Consolidation Working Papers for the
Year Ended DecemberAdjustments/
31, 2005ConsolBalance Sheet
Other assets
Interest receivable
Investment in Sue
Pam
Sue
Eliminations
$39,880 $19,100
50
f
50
6,502
c 202
e 6,300
Investment (Pam bonds)
960
a 960
$46,382 $20,110
Other liabilities
$ 9,590 $10,890
Interest payable
500
f
50
10% bond payable
10,080
a 1,008
Common stock
20,000
5,000 e 5,000
Retained earnings
6,212
4,220
Minority interest
d 66
e 2,700
$46,382 $20,110
idated
$58,980
$58,980
$20,480
450
9,072
20,000
6,212
2,766
$58,980
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 24
Subsidiary Bonds
Purchased by Parent
On December 31, 2003, Sky had $10,000,000
par 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.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 25
Subsidiary Bonds
Purchased by Parent
On January 2, 2004, Pro Corporation purchases
50% of Sky’s outstanding bonds for $5,150,000.
This transaction results in a loss of $300,000
from the viewpoint of the consolidated entity.
The entity retires a liability of $4,850,000
at a cost of $5,150,000.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 26
Subsidiary Bonds
Purchased by Parent
During 2004, Sky records interest expense
on 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.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 27
Subsidiary Bonds
Purchased by Parent
90% of Sky’s $750,000 reported income
$675,000
Deduct: $300,000 constructive loss × 90% –270,000
Add: $60,000 recognition of
54,000
constructive loss × 90%
Investment income from Sky
$459,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 28
Subsidiary Bonds
Purchased by Parent
Investment in Sky
675,000
Income from Sky
675,000
To record 90% of Sky’s reported income for 2004
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 29
Subsidiary Bonds
Purchased by Parent
Income from Sky
270,000
Investment 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
54,000
Income from Sky
54,000
To adjust investment income from Sky for 90%
of the $60,000 piecemeal recognition of the
constructive loss on Sky bonds during 2004
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 30
Subsidiary Bonds
Purchased by Parent
Investment in Sky 01/01/04
($11,259,000 × 90%)
Add: Income from Sky
Investment in Sky 12/31/04
$10,125,000
459,000
$10,584,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 31
Learning Objective 4
Adjust calculations of minority
interest amounts in the
presence of intercompany
profits on debt transfers.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 32
Minority Interest
Minority interest expense for 2004 is $51,000,
which is assigned to the constructive loss to Sky.
The constructive loss reduces consolidated
net income for 2004 by $216,000 which is
reflected in the consolidated income statement.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 33
Minority Interest
Decreased by:
Constructive loss
Elimination of interest income
Total decreases
Increased by:
Elimination of interest expense
Reduction of minority interest expense
Total increases
Effect on consolidated net income for 2004
$300,000
470,000
$770,000
$530,000
24,000
$554,000
$216,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 34
Minority Interest
Loss on Retirement of Bonds
Interest Income
10% Bonds Payable
Investment in Sky Bonds
Interest Expense
300,000
470,000
5,000,000
5,240,000
530,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 35
Consolidation Working Papers for the
Year Ended December 31, 2004
Income Statement
Sales
Income from Sky
Interest income
Expenses
Interest expense
Loss on bond retirement
Pro
Sky
Adjustments/ ConsolEliminations idated
$25,750 $14,250
459
c 459
470
b 470
(21,679) (12,440)
(1,060)
b 530
a 240
b 60
Minority interest expense
c 51
Net income
$ 5,000 $ 750
Retained earnings – Pro
13,000
Retained earnings – Sky
1,250 e 1,250
Retained earnings 12/31/04 $18,000 $2,000
$40,000
(34,119)
(530)
(300)
(51)
$ 5,000
$13,000
$18,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 36
Consolidation Working Papers for the
Year Ended December 31, 2004
Balance Sheet
Pro
Other assets
Interest receivable
Investment in Sky
$34,046
250
10,584
Investment in Sky bonds
5,120
$50,000
$12,000
Other liabilities
Interest payable
10% bonds payable
Capital stock
Retained earnings
Minority interest
20,000
18,000
Sky
Adjustments/ ConsolEliminations idated
$25,000
$59,046
e
250
c
459
d 10,125
a 5,120
$25,000
$ 2,740
500
9,760
10,000
2,000
$59,046
$14,740
250
4,880
20,000
18,000
e
250
a 4,880
e 10,000
c
51
d 1,125
$50,000
$25,000
1,176
$59,046
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 37
Minority Interest
Investment in Sky
Minority Interest
Interest Income
10% Bonds Payable
Investment in Sky Bonds
Interest Expense
216,000
24,000
470,000
5,000,000
5,180,000
530,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 38
Minority Interest
Increased by:
Elimination of interest expense
Decreased by:
Elimination of interest income
Increase in minority interest expense
($60,000 piecemeal recognition × 10%)
Total decreases
Annual effect on consolidated net income
$530,000
$470,000
6,000
$476,000
$ 54,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 39
Summary of Intercompany Bond
Account Balances on Separate Books
December 31,
Pro’s Books (000)
Investment in Sky bonds
Interest income
Interest receivable
2005
2006
2007
2008
$5,090 $5,060 $5,030 $ 5,000
470
470
470
470
250
250
250
250
Sky’s Books (000)
10% bonds payable
Interest expense
Interest payable
$9,820 $9,880 $9,940 $10,000
1,060 1,060 1,060
1,060
500
500
500
500
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 40
Summary of Consolidation
Working Paper Adjustments
December 31,
Debits
Investment in Sky (90%)
Minority interest (10%)
Interest income
10% bonds payable
Interest payable
2005
2006
2007
2008
$ 216 $ 162 $ 108 $ 54
24
18
12
6
470
470
470
470
4,910 4,940 4,970 5,000
250
250
250
250
Credits
Investment in Sky bonds
Interest expense
Interest receivable
$5,090 $5,060 $5,030 $5,000
530
530
530
530
250
250
250
250
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 41
End of Chapter 7
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
7 - 42
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