Chapter 08

Intercompany Indebtedness
McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objective 1

Understand and explain concepts associated with intercompany debt transfers.

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Consolidation Overview A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party.
An indirect intercompany debt transfer involves the issuance of debt to an unrelated party and the subsequent purchase of the debt instrument by an affiliate of the issuer.
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Direct Intercompany Debt Transfer

8-4

Indirect Intercompany Debt Transfer

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Practice Quiz Question #1

Which of the following statements is true? a. A direct intercompany debt transfer always involves an unrelated party. b. An indirect intercompany debt transfer always involves a transfer directly to a related party. c. A direct intercompany debt transfer never involves an unrelated party. d. An indirect intercompany debt transfer is first transferred to an affiliated company with a subsequent transfer to an unrelated party.
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Practice Quiz Question #1 Solution

Which of the following statements is true? a. A direct intercompany debt transfer always involves an unrelated party. b. An indirect intercompany debt transfer always involves a transfer directly to a related party. c. A direct intercompany debt transfer never involves an unrelated party. d. An indirect intercompany debt transfer is first transferred to an affiliated company with a subsequent transfer to an unrelated party.
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Learning Objective 2

Prepare journal entries and elimination entries related to direct intercompany debt transfers.

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Bond Sale Directly to an Affiliate When one company sells bonds directly to an affiliate, all effects of the intercompany indebtedness must be eliminated in preparing consolidated financial statements. Transfer at par value
(example continues on next slide).

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Bond Sale Directly to an Affiliate

Assume that on January 1, 20X1, Special Foods borrows $100,000 from Peerless Products by issuing $100,000 par value, 12 percent, 10-year bonds. During 20X1, Special Foods records interest expense on the bonds of $12,000 ($100,000 x .12), and Peerless records an equal amount of interest income. In the preparation of consolidated financial statements for 20X1, two elimination entries are needed in the consolidation worksheet to remove the effects of the intercompany indebtedness:

Eliminate intercorporate bond holding:

Bonds Payable Investment in Special Foods Bonds 100,000 100,000

Eliminate intercompany interest:

Interest Income Interest Expense 100,000

100,000

These entries have no effect on consolidated net income because they reduce interest income and interest expense by the same amount.
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Bond Sale Directly to an Affiliate Transfer at a discount or premium

Bond interest income or expense recorded do not equal cash interest payments. Interest income/expense amounts are adjusted for the amortization of the discount or premium.

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Bond Sale Directly to an Affiliate

On January 1, 20X1, Peerless Products purchases $100,000 par value, 12 percent, 10-year bonds from Special Foods for $90,000. Interest on the bonds is payable on January 1 and July 1. The interest expense recognized by Special Foods and the interest income recognized by Peerless each year include straight-line amortization of the discount, as follows:

Cash interest ($100,000 x .12) Amortization of discount ($10,000 / 20 semiannual interest periods) x 2 periods Interest expense or income

$12,000 1,000 $13,000

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Bond Sale Directly to an Affiliate Entries by the debtor

January 1, 20X1

Cash Discount on Bonds Payable Bonds Payable Issue bonds to Peerless Products.
July 1, 20X1 Interest Expense Discount on Bonds Payable Cash Semiannual payment of interest. December 31, 20X1 Interest Expense Discount on Bonds Payable Interest Payable Accrue interest expense at year-end.

90,000 10,000
100,000

6,500 500 6,000

6,500 500 6,000

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Bond Sale Directly to an Affiliate Entries by the bond investor

January 1, 20X1

Investment in Special Foods Bonds Cash

Purchase of bonds from Special Foods. July 1, 20X1 Cash Investment in Special Foods Bonds Interest Income Receive interest on bond investment December 31, 20X1 Interest Receivable Investment in Special Foods Bonds Interest Income Accrue interest income at year-end.

90,000
90,000

6,000 500 6,500

6,000 500 6,500

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Bond Sale Directly to an Affiliate

Elimination Entries at Year-End20X1:
Eliminates the bonds payable and associated discount against the investment in bonds: Bonds Payable Investment in Special Foods Bonds Discount on Bonds Payable 100,000 91,000 9,000

Eliminates the bond interest income recognized by Peerless during 20X1 against the bond interest expense recognized by Special Foods: Interest Income Interest Expense 13,000

13,000

Eliminates the interest receivable against the interest payable. Interest Payable Interest Receivable 6,000 6,000
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Bond Sale Directly to an Affiliate

Elimination Entries at Year-End20X2:
Eliminates intercorporate bond holding.

Bonds Payable Investment in Special Foods Bonds Discount on Bonds Payable

Eliminates intercompany interest: Interest Income Interest Expense Eliminates intercompany interest receivable/payable. Interest Payable Interest Receivable

100,000
92,000 8,000

13,000 13,000

6,000 6,000

Consolidation at the end of 20X2 requires elimination entries similar to those at the end of 20X1. Because $1,000 of the discount is amortized each year, the bond investment balance on Peerless books increases to $92,000.
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Bonds of Affiliate Purchased from a Nonaffiliate

Scenario: Bonds that were issued to an unrelated party are acquired later by an affiliate of the issuer.

From the viewpoint of the consolidated entity, an acquisition of an affiliates bonds retires the bonds at the time they are purchased.

Acquisition of the bonds of an affiliate by another company within the consolidated entity is referred to as constructive retirement.

Although the bonds actually are not retired, they are treated as if they were retired in preparing consolidated financial statements.
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Bonds of Affiliate Purchased from a Nonaffiliate When a constructive retirement occurs:

The consolidated income statement for the period reports a gain or loss on debt retirement based on the difference between the carrying value of the bonds on the books of the debtor and the purchase price paid by the affiliate. Neither the bonds payable nor the purchasers investment in the bonds is reported in the consolidated balance sheet because the bonds are no longer considered outstanding.
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Practice Quiz Question #2

A constructive debt retirement is a. an acquisition of the bonds of an affiliate by another company within the consolidated entity. b. an acquisition of the bonds of an nonaffiliate by a company within a consolidated entity. c. a sale of the bonds of a non-affiliate by a company within a consolidated entity. d. a sale of the bonds of an affiliate to a company within a consolidated entity.
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Practice Quiz Question #2 Solution

A constructive debt retirement is a. an acquisition of the bonds of an affiliate by another company within the consolidated entity. b. an acquisition of the bonds of an nonaffiliate by a company within a consolidated entity. c. a sale of the bonds of a non-affiliate by a company within a consolidated entity. d. a sale of the bonds of an affiliate to a company within a consolidated entity.
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Learning Objective 3

Prepare journal entries and elimination entries related to debt purchased from a nonaffiliate to an amount less than book value.
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Bonds of Affiliate Purchased from a Nonaffiliate

Purchase at an amount less than book value:

When the price paid to acquire the bonds of an affiliate differs from the liability reported by the debtor, a gain or loss is reported in the consolidated income statement in the period of constructive retirement. The bond interest income and interest expense reported by the two affiliates subsequent to the purchase must be eliminated in preparing consolidated statements. Interest income reported by the investing affiliate and interest expense reported by the debtor are not equal in this case because of the different bond carrying amounts on the books of the two companies.
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Bonds of Affiliate Purchased from a Nonaffiliate: Illustration

Peerless Products Corporation acquires 80 percent of the common stock of Special Foods Inc. on December 31, 20X0, for its underlying book value of $240,000.
At that date, the fair value of the noncontrolling interest is equal to its book value of $60,000. Additionally: 1. On January 1, 20X1, Special Foods issues 10-year, 12 percent bonds payable with a par value of $100,000; the bonds are issued at 102. Nonaffiliated Corporation purchases the bonds from Special Foods. The bonds pay interest on June 30 and December 31. Both Peerless and Special amortize bond discount and premium using the straight-line method.

2. 3.

4.
5. 6.

On December 31, 20X1, Peerless purchases the bonds from Nonaffiliated for $91,000.
Special Foods reports net income of $50,000 for 20X1 and $75,000 for 20X2 and declares dividends of $30,000 in 20X1 and $40,000 in 20X2. Peerless earns $140,000 in 20X1 and $160,000 in 20X2 from its own separate operations. Peerless declares dividends of $60,000 in both 20X1 and 20X2.
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Bonds of Affiliate Purchased from a Nonaffiliate: Illustration

8-24

Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

Bond Liability Entries20X1 (Special Foods)
January 1, 20X1 Cash 102,000

Bonds Payable Premium on Bonds Payable

Sale of bonds to Nonaffiliated. June 30, 20X1 Interest Expense Premium on Bonds Payable Cash Semiannual payment of interest. December 31, 20X1 Interest Expense Premium on Bonds Payable Cash Semiannual payment of interest. 5,900 100 5,900 100

100,000 2,000

6,000

6,000

8-25

Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

Total interest expense for 20X1 is $11,800 ($5,900 x 2), and the book value of the bonds on December 31, 20X1, is as follows:
Book value of bonds at issuance Amortization of premium, 20X1 Book value of bonds, December 31, 20X1 $102,000) (200) $101,800)

Bond Investment Entry20X1 (Peerless)

December 13, 20X1 Investment in Special Foods Bonds Cash 91,000

91,000

Purchase of Special Foods bonds from Nonaffiliated Corporation.

Computation of Gain on Constructive Retirement of Bonds

Book value of Special Foods bonds, December 31, 20X1 Price paid by Peerless to purchase bonds Gain on constructive retirement of bonds $101,800 ) (91,000) $10,800 )

This gain is included in the consolidated income statement as a gain on the retirement of bonds.

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Bonds of Affiliate Purchased from a Nonaffiliate: Illustration Assignment of gain: constructive retirement

Four approaches have been used:

1. The affiliate issuing the bonds 2. The affiliate purchasing the bonds

3. The parent company

4. The issuing and purchasing companies, based on the difference between the carrying amounts of the bonds on their books at the date of purchase and the par value of the bonds

8-27

Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

Fully Adjusted Equity-Method Entries20X1: In addition to recording the bond investment with entry, Peerless records the following equity-method entries during 20X1 to account for its investment in Special Foods stock:
Investment in Special Foods Stock Income from Special Foods
Record equity-method income: $50,000 x 0.80. Cash Investment in Special Foods Stock Record dividends from Special Foods: $30,000 x 0.80. Investment in Special Foods Stock Income from Special Foods 8,640 8,640 24,000 24,000

40,000
40,000

Record Peerless 80% share of the gain on the constructive retirement of Special Foods bonds.
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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

These entries result in a $264,640 balance in the investment account at the end of 20X1 as shown: Investment in Special Foods Acq. 240,000 80% NI 40,000 8,640 EB 264,640 Income from Special Foods 40,000 80% NI

24,000 80% Dividends 80% of Bond Retirement Gain

8,640 48,640 EB

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

In preparing a consolidation worksheet prepared at the end of 20X1, the first two elimination entries are the same as we prepared in Chapter 3 with one minor exception. While the analysis of the book value portion of the investment account is the same, in preparing the basic elimination entry, we increase the amounts in Peerless Income from Special Foods and Investment in Special Foods Stock accounts by Peerless share of the gain on bond retirement, $8,640 ($10,800 x 0.80). We also increase the NCI in Net Income of Special Foods and NCI in Net Assets of Special Foods by the NCI share of the deferral, $2,160 ($10,800 x 0.20).

Book Value Calculations:

NCI + 20% 60,000) 10,000) (6,000) 64,000)
200,000 100,000 48,640 12,160 30,000 264,640 66,160

Original Book Value + Net Income Dividends

Ending Book Value
Common Stock Retained Earnings Income from Special Foods NCI in NI of Special Foods Dividends Declared Investment in Special Foods Stock NCI in NA of Special Foods

Peerless = 80% 240,000) 40,000) (24,000) 256,000)

Common Stock 200,000

Retained Earnings 100,000) 50,000) (30,000) 120,000)

200,000

Basic Investment Account Elimination Entry:

Original amount invested (100%) Beg. RE from trial balance Peerless % of NI + 80% Ret. Gain NCI share of NI + 20% Ret. Gain 100% of Subs dividends Net BV + 80% Ret. Gain NCI share of BV + 20% Ret. Gain

8-30

Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

The amounts related to the bonds from the books of Peerless and Special Foods and the appropriate consolidated amounts are shown below along with entry to eliminate intercompany bond holdings:
Item Peerless Products Special Foods Unadjusted Totals Consolidated Amounts

Bonds Payable
Premium on Bonds Payable Investment in Bonds Interest Expense Interest Income Gain on Bond Retirement

0)
0) $91,000) 0) 0) 0)

$(100,000)
(1,800) 0) $11,800) 0) 0)

$(100,000)
(1,800) 91,000) $11,800) 0) 0)

0)
0) 0) $11,800) 0) (10,800)

Worksheet entry to eliminate intercompany bond holdings:

Bonds Payable Premium on Bonds Payable Investment in Special Foods Bonds Gain on Bond Retirement

100,000 1,800
91,000 10,800
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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

The impact of the constructive gain on the beginning noncontrolling interest balance and on the beginning consolidated retained earnings balance is reflected in the entry to eliminate intercompany bond holdings.
The entry to eliminate intercompany bond holdings also eliminates all aspects of the intercorporate bond holdings, including:

Peerless investment in bonds

Special Foods bonds payable and the associated premium

Peerless bond interest income

Special Foods bond interest expense
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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

The optional accumulated depreciation entry can be made by netting the accumulated depreciation at the time of acquisition against the cost as shown:
300,000 300,000 Original depreciation at the time of the acquisition netted against cost

Optional accumulated depreciation elimination entry:

Accumulated Depreciation Building and Equipment

The consolidation worksheet prepared for December 31, 20X1, is presented on the next slide (Figure 82 in the text).
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Consolidation Worksheet at December 31, 20X2

Peerless Products Special Foods Elimination Entries DR CR Consolidated 600,000 (285,000) (70,000) (23,200) (31,800) 0 10,800 200,800 (12,160) 188,640 300,000 188,640 (60,000) 428,640 246,800 125,000 175,000 0 0 215,000 1,100,000 (470,000) 1,394,800 200,000 200,000 0 500,000 428,640 66,160 1,394,800 Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Less: Interest Expense Income from Special Foods Gain from Bond Retirement Consolidated Net Income NCI in Net Income Controlling Interest Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Inventory Investment in Special Foods Stock Investment in Special Foods Bonds Land Building and Equipment Less: Accumulated Depreciation Total Assets Accounts Payable Bonds Payable Premium on Bonds Payable Common Stock Retained Earnings NCI in NA of Special Foods Total Liabilities & Equity 400,000 (170,000) (50,000) (20,000) (20,000) 48,640 188,640 188,640 300,000 188,640 (60,000) 428,640 173,000 75,000 100,000 264,640 91,000 175,000 800,000 (450,000) 1,228,640 100,000 200,000 500,000 428,640 1,228,640 200,000 (115,000) (20,000) (3,200) (11,800) 48,640 50,000 50,000 100,000 50,000 (30,000) 120,000 76,800 50,000 75,000 264,640 91,000 40,000 600,000 (320,000) 521,800 100,000 100,000 1,800 200,000 120,000 521,800 300,000 300,000 300,000 100,000 1,800 200,000 160,800 462,600 655,640 48,640 12,160 60,800 100,000 60,800 160,800 10,800 10,800 10,800

10,800 30,000 40,800

40,800 66,160 106,960

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 1

Consolidated Net Income20X1

Noncontrolling InterestDecember 31, 20X1

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

Bond Liability Entries20X2 (Special Foods)
June 30, 20X2 Interest Expense Premium on Bonds Payable Cash Semiannual payment of interest. December 31, 20X2 5,900 100

6,000

Interest Expense Premium on Bonds Payable Cash Semiannual payment of interest.

Bond Investment Entries20X2 (Peerless) June 30, 20X2 Cash Investment in Special Foods Bonds Interest Income Record receipt of bond interest. December 31, 20X2 Cash Investment in Special Foods Bonds Interest Income Record receipt of bond interest.

5,900 100
6,000

6,000 500 6,500

6,000 500

6,500
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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2 Subsequent recognition of gain on constructive retirement

In 20X1, the entire $10,800 gain on the retirement was recognized in the consolidated income statement but not on the books of either Peerless or Special Foods
$9,000 1,800
$10,800

Peerless discount on bond investment Special Foods premium on bond liability

Total gain on constructive retirement of bonds

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

This can be visualized as in the following figure:

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

In each year subsequent to 20X1, both Peerless and Special Foods recognize a portion of the constructive gain as they amortize the discount on the bond investment and the premium on the bond liability:

Peerless amortization of discount on bond investment ($9,000 9 years) Special Foods amortization of premium on bonds payable ($1,800 9 years)
Annual increase in combined incomes of separate companies

$1,000 200 $1,200

8-39

Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

Fully Adjusted Equity-Method Entries20X2

Investment in Special Foods Stock Income from Special Foods Record equity-method income: $75,000 x 0.80. Cash
Investment in Special Foods Stock Record dividends from Special Foods: $40,000 x 0.80.

60,000
60,000

32,000
32,000

Income from Special Foods Investment in Special Foods Stock Record dividends from Special Foods: $40,000 x 0.80.

960
960

Whereas neither Peerless nor Special Foods recognized any of the gain from the constructive bond retirement on its separate books in 20X1, Peerless adjusts its equity method income from Special Foods for its 80 percent share of the $10,800 gain, $8,640. Therefore, as Peerless and Special Foods recognize the gain over the remaining term of the bonds, Peerless must reverse its 20X1 equity-method entry for its share of the gain amortization each year. Thus, the original adjustment of $8,640 is reversed by $960 ($8,640 9 years) each year.

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

Book Value Calculations:
NCI 20% Beginning Book Value + Net Income Dividends Ending Book Value
Basic Elimination Entry
Common Stock 200,000 Retained Earnings 120,000 Income from Special Foods 59,040 NCI in NI of Special Foods 14,760 Dividends Declared 40,000 Investment in Special Foods Stock 283,040 NCI in NA of Special Foods 70,760 Original amount invested (100%) Beg. RE from trial balance % of NI 80% Gain Rec. NCI % of NI 20% 20X2 Gain Rec. 100% of Subs dividends Net BV 80% 20X2 Gain Rec. NCI % of BV 20% Gain Rec.
+

Peerless 80% 256,000) 60,000) (32,000)

Common Stock 200,000

Retained Earnings 120,000) 75,000) (40,000) 155,000)

64,000) 15,000) (8,000)

71,000) 284,000)

200,000

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

The amounts related to the bonds from the books of Peerless and Special Foods and the appropriate consolidated amounts are shown below along with entry to eliminate intercompany bond holdings:

Item
Bonds Payable Premium on Bonds Payable Investment in Bonds Interest Expense

Peerless Products 0) 0) $92,000) 0)

Special Foods $(100,000) (1,600) 0) $11,800)

Unadjusted Totals $(100,000) (1,600) 92,000) $11,800)

Consolidated Amounts 0) 0) 0) 0)

Interest Income

$(13,000)

0)

(13,000))

0)

This analysis leads to the following worksheet entry to eliminate intercompany bond holdings.

Bonds Payable Premium on Bonds Payable Interest Income Investment in Special Foods Bonds Interest Expense Investment in Special Foods Stock NCI in NA of Special Foods

100,000 1,600 13,000 92,000 11,800 8,640 2,160

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

The impact of the constructive gain on the beginning noncontrolling interest balance and on the beginning consolidated retained earnings balance is reflected in the entry to eliminate intercompany bond holdings.
The entry to eliminate intercompany bond holdings also eliminates all aspects of the intercorporate bond holdings, including:

Peerless investment in bonds

Special Foods bonds payable and the associated premium

Peerless bond interest income

Special Foods bond interest expense
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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2

The optional accumulated depreciation entry can be made by netting the accumulated depreciation at the time of acquisition against the cost as shown:
300,000 300,000 Original depreciation at the time of the acquisition netted against cost

Optional accumulated depreciation elimination entry:

Accumulated Depreciation Building and Equipment

The consolidation worksheet prepared for December 31, 20X2, is presented on the next slide (Figure 83 in the text).
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Consolidation Worksheet at December 31, 20X2

Peerless Products Special Foods Elimination Entries DR CR Consolidated Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Less: Interest Expense Interest Income Income from Special Foods Consolidated Net Income NCI in Net Income Controlling Interest Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Inventory Investment in Special Foods Stock Investment in Special Foods Bonds Land Building and Equipment Less: Accumulated Depreciation Total Assets Accounts Payable Bonds Payable Premium on Bonds Payable Common Stock Retained Earnings NCI in NA of Special Foods Total Liabilities & Equity 450,000 (180,000) (50,000) (40,000) (20,000) 13,000 59,040 232,040 232,040 428,640 232,040 (60,000) 600,680 212,000 150,000 180,000 291,680 92,000 175,000 800,000 (500,000) 1,400,680 100,000 200,000 500,000 600,680 300,000 (160,000) (20,000) (33,200) (11,800) 13,000 59,040 72,040 14,760 86,800 120,000 86,800 206,800 11,800 750,000 (340,000) (70,000) (73,200) (20,000) 0 0 246,800 (14,760) 232,040 428,640 232,040 (60,000) 600,680 298,600 230,000 270,000 0 0 215,000 1,100,000 (540,000) 1,573,600 200,000 200,000 500,000 600,680 72,920 1,573,600

75,000 75,000 120,000 75,000 (40,000) 155,000 86,600 80,000 90,000

11,800 11,800

11,800 40,000 51,800

283,040 8,640 92,000 40,000 600,000 (340,000) 556,600 100,000 100,000 1,600 200,000 155,000 300,000 300,000 300,000 100,000 1,600 200,000 206,800 683,680

1,400,680

556,600

508,400

51,800 70,760 2,160 122,560

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Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2 Consolidated Net Income20X2

8-46

Bonds of Affiliate Purchased from a Nonaffiliate: IllustrationYEAR 2 Noncontrolling InterestDecember 31, 20X2

8-47

Bonds of Affiliate Purchased from a Nonaffiliate: Illustration Bond elimination entry in subsequent years

In years after 20X2, the worksheet entry to eliminate the intercompany bonds and to adjust for the gain on constructive retirement of the bonds is similar to the entry to eliminate intercompany bond holdings.
The unamortized bond discount and premium decrease each year by $1,000 and $200, respectively.
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Bonds of Affiliate Purchased from a Nonaffiliate: Illustration

As of the beginning of 20X3, $9,600 of the gain on the constructive retirement of the bonds remains unrecognized by the affiliates:

8-49

Bonds of Affiliate Purchased from a Nonaffiliate: Illustration

In the bond elimination entry in the consolidation worksheet prepared at the end of 20X3, this amount is allocated between beginning retained earnings and the noncontrolling interest.
Eliminate intercompany bond holdings:
Bonds Payable Premium on Bonds Payable Interest Income Investment in Special Foods Bonds Interest Expense Investment in Special Foods Stock NCI in NA of Special Foods 100,000 1,400 13,000

93,000 11,800 7,680 1,920

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Practice Quiz Question #3

Which of the following statements is NOT true when affiliate bonds are purchased at an amount less than book value? a. When the price paid to acquire the bonds differs from the liability reported by the debtor, a gain or loss is reported. b. Bond interest income and interest expense reported by the two affiliates subsequent to the purchase must be eliminated. c. Interest income and interest expense reported affiliates are not equal because of the different bond carrying amounts on the companies books. d. Interest income and interest expense reported affiliates are always equal.
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Practice Quiz Question #3 Solution

Which of the following statements is NOT true when affiliate bonds are purchased at an amount less than book value? a. When the price paid to acquire the bonds differs from the liability reported by the debtor, a gain or loss is reported. b. Bond interest income and interest expense reported by the two affiliates subsequent to the purchase must be eliminated.

c. Interest income and interest expense reported affiliates are not equal because of the different bond carrying amounts on the companies books. d. Interest income and interest expense reported affiliates are always equal.
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Learning Objective 4

Prepare journal entries and elimination entries related to debt purchased from a nonaffiliate to an amount more than book value.
8-53

Bonds of Affiliate Purchased from a Nonaffiliate Purchase at an amount greater than book value

The consolidation procedures are virtually the same except that a loss is recognized on the constructive retirement of the debt

8-54

Bonds of Affiliate Purchased from a Nonaffiliate

Special Foods issues 10-year 12 percent bonds on January 1, 20X1, at par of $100,000. The bonds are purchased from Special Foods by Nonaffiliated Corporation, which sells the bonds to Peerless on December 31, 20X1, for $104,500. Special Foods recognizes $12,000 ($100,000 x .12) of interest expense each year. Peerless recognizes interest income of $11,500 in each year after 20X1:
Annual cash interest payment ($100,000 x .12) Less: Amortization of premium on bond investment ($4,500 9 years) Interest income $12,000) (500) $11,500)

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Bonds of Affiliate Purchased from a Nonaffiliate

Because the bonds were issued at par, the carrying amount on Special Foods books remains at $100,000. Thus, once Peerless purchases the bonds from Nonaffiliated Corporation for $104,500, a loss on the constructive retirement must be recognized in the consolidated income statement for $4,500. The bond elimination entry in the consolidation worksheet prepared at the end of 20X1 removes the bonds payable and the bond investment and recognizes the loss on the constructive retirement:
Eliminate intercorporate bond holdings:
Bonds Payable Loss on Bond Retirement Investment in Special Foods Bonds 100,000 4,500
104,500
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Bonds of Affiliate Purchased from a Nonaffiliate

The bond elimination entry needed in the consolidation worksheet prepared at the end of 20X2 is as follows: Eliminate intercorporate bond holdings:
Bonds Payable Interest Income Investment in Special Foods Stock NCI in NA of Special Foods Investment in Special Foods Bonds Interest Expense 100,000 11,500 3,600 900

104,000 12,000

$11,500 $3,600 $900 $104,000 $12,000

= = = = =

($100,000 x 0.12) $500 $4,500 x 0.80 $4,500 x 0.20 $104,500 $500 $10,000 x 0.12
8-57

Bonds of Affiliate Purchased from a Nonaffiliate

Similarly, the following entry is needed in the consolidation worksheet at the end of 20X3: Eliminate intercorporate bond holdings:
Bonds Payable Interest Income Investment in Special Foods Stock NCI in NA of Special Foods Investment in Special Foods Bonds Interest Expense 100,000 11,500 3,200 800

103,500 12,000

$3,200 = ($4,500 $500) x 0.80 $900 = ($4,500 $500) x 0.80 $103,500 = $104,500 $500 $500

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Practice Quiz Question #4

How do consolidation procedures when affiliate bonds are purchased at an amount greater than book value differ from when they are purchased at an amount less than book value? a. A constructive loss is reported instead of a constructive gain. b. The entries are identical. c. No consolidation entries are necessary. d. The constructive gain is ignored.
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Practice Quiz Question #4 Solution

How do consolidation procedures when affiliate bonds are purchased at an amount greater than book value differ from when they are purchased at an amount less than book value? a. A constructive loss is reported instead of a constructive gain. b. The entries are identical. c. No consolidation entries are necessary. d. The constructive gain is ignored.
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Conclusion

The End