Chapter 7

INTERCOMPANY PROFIT TRANSACTIONS BONDS

Answers to Questions

1 Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as
reciprocal interest receivable and payable accounts and interest income and expense accounts.

2 Direct lending and borrowing transactions do not give rise to unrealized gains and losses. Any income
reported by the lender is precisely reciprocal to an expense reported by the borrower, and the transactions
are complete on the date consummated. Similarly, direct lending and borrowing transactions do not give
rise to unrecognized gains and losses since intercompany amounts received and paid are both realized and
recognized from the viewpoint of the separate legal entities.

3 Actual retirement occur in any of these three following options:

a) The issuer (parent or subsidiary) use its available resources to purchase and retire its own bonds.
b) The issuer (parent or subsidiary) borrow money from unaffiliated entities at the market rate of
interest and use the proceeds to retire its own bonds. (This option constitutes refunding)
c) The issuer can borrow money from an affiliate and use the proceeds to retire its own bonds.

4 The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300. If an
affiliate purchases half of the bonds at 98, it will record a bond investment of $490,000. From the viewpoint
of the consolidated entity, the purchase of the bonds results in a constructive retirement of $500,000 par of
bonds payable. The constructive gain on the bonds is $12,350 [($1,004,700 50%) $490,000].

5 A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the books
of the separate affiliates. The affiliates continue to carry the bonds as a liability (issuer) and investment
(purchaser) on their separate books. Alternatively, an unrealized gain on the sale of land is recorded on the
books of the selling affiliate, but it is not recognized as a gain for consolidated statement purposes because
the land is still held within the consolidated entity. Thus, a constructive gain on bonds is realized and
recognized from the viewpoint of the consolidated entity but it is not recognized on the books of the
affiliates. An unrealized gain on the sale of land is recognized on the books of the selling affiliate but is not
realized or recognized from the viewpoint of the consolidated entity.

6 Constructive gains on intercompany bonds are realized and recognized through the interest income and
expense reported on the separate books of the affiliates. The difference between the interest income
reported by the investor and the interest expense reported by the issuer on the intercompany bonds is the
amount of constructive gain recognized in each period. Constructive gains and losses are recognized in the
consolidated financial statements before they are recognized on the books of the affiliates.

7 If a subsidiary purchases parent bonds at a price in excess of book value, a constructive loss results. The
loss is attributed to the parent since it is the parent bonds that are constructively retired. This approach of
associating constructive gains and losses on intercompany bonds with the issuer is consistent with the
procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with
the selling affiliates.

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7-2 Intercompany Profit Transactions Bonds

8a Assume bonds were purchased at the beginning of the current year

10% bonds payable 52,000

Interest income 5,250
Interest payable 2,500
Investment in S bonds 49,000
Interest expense 4,500
Interest receivable 2,500
Constructive gain on bonds 3,750
To eliminate reciprocal bond investment and liability amounts,
reciprocal interest income and expense amounts, reciprocal
interest receivable and payable amounts, and enter the
constructive gain on bonds. The constructive gain is computed as
the $52,500 book value of bonds that were retired for $48,750.

8b Assume bonds were purchased one year earlier

10% bonds payable 52,000

Interest income 5,250
Interest payable 2,500
Investment in S bonds 49,000
Interest expense 4,500
Interest receivable 2,500
Investment in S stock (90%) 3,375
Noncontrolling interest 375
To eliminate reciprocal bond investment and liability amounts,
reciprocal interest income and expense amounts, reciprocal
interest receivable and payable amounts, and adjust controlling
and noncontrolling interest holdings for constructive gain less
piecemeal recognition. The constructive gain is computed as:
$53,000 book value - $48,500 cost = $4,500 of which $750 was
recognized on the books of the affiliate in the prior year.

9 The amount of piecemeal recognition of a constructive gain or loss is always the difference between the
intercompany interest expense and income account that are eliminated. If the straight-line amortization is
used, the amount of piecemeal recognition of each year can be calculated with the constructive gain or loss
divided by the remaining life of the bond when the retirement occurred. However, this approach cannot be
applied if effective interest method is used.

10 Elimination of interest expense will eventually increase the controlling share of consolidated income and the
opposite, elimination of interest income will eventually decrease the controlling share of consolidated
income. Logically, interest expense is the debit account of the controlling share, so eliminating it will
eventually increase the income or credit account and vice versa for the interest income.

11a A constructive gain will result when interest income exceeds interest expense on the bonds that are
constructively retired.

11b The constructive gain is associated with the parent since the issuer reports interest expense.

11c The $200 difference between interest income and expense represents a piecemeal recognition of the
constructive gain on the books of the separate companies.

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Chapter 7 7-3

SOLUTIONS TO EXERCISES

Solution E7-1
1 c 3 d
2 a 4 a

Solution E7-2
1 a
Book value of Pan bonds acquired by
Sow ($900,000 + $48,000) 2/3 $632,000
Cost to Sow 602,000
Constructive gain $ 30,000
2 d
Nominal interest on Pans remaining
outstanding bonds $300,000 8% $ 24,000
Less: Amortization of premium ($48,000 1/3)/ 4 years 4,000
Interest expense on consolidated income statement $ 20,000

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7-4 Intercompany Profit Transactions Bonds

Solution E7-3
1 c
Cost of $80,000 par of Pal bonds January 1, 2011 $ 76,000
Book value acquired ($400,000 par - $8,000 discount) 20% 78,400
Constructive gain $ 2,400
2 d
Par value of bonds payable $400,000
Less: Unamortized discount ($8,000 - $2,000) (6,000)
Book value of bonds 394,000
Percent outstanding 80%
Bonds payable $315,200
3 c
Constructive gain $2,400/4 years 3 years $ 1,800
4 c
Nominal interest $ 40,000
Add: Amortization of discount 2,000
42,000
Percent outstanding 80%
Interest expense $ 33,600

5 b Piecemeal recognition of gain is $2,400 25% in 2011.

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Chapter 7 7-5
Solution E7-4

1. Cost paid to retire 1/2 of Lenka SAs bonds $550,000

Book value of bonds retired (($1,000,000 - $200,000) x 0.5) $400,000
Constructive loss on bond retirement $140,000

80% of Petr SAs net income (80% x $500,000) $400,000

Constructive loss on bond retirement ($140,000)
Piecemeal recognition of constructive loss
($140,000 / 5) $28,000
Income from Petr SA $288,000

2. Noncontrolling interest share:

20% of Petr SAs net income (20% x $500,000) $100,000

Solution E7-5

Pim Corporation and Subsidiary

Consolidated Income Statement
for the year ended December 31, 2019
(in thousands)

Sales $ 750
Less: Cost of sales (435)

Gross profit 315

Add: Gain on constructive retirement of bondsb 3
Less: Operating expenses (125)

Operating profit 193

Other Items:
Bond interest expensea (15)
Consolidated net income $ 178
a Parents bond interest expense $25,000 less interest on bonds held intercompany
$10,000 = $15,000.
b Book value of parents bonds purchased $100,000 less purchase price $97,000 =
$3,000 gain on constructive retirement.

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7-6 Intercompany Profit Transactions Bonds

Solution E7-6

1. Book value of Albert NLs bonds at January 1, 2014 $2,200,000

Amortization of bonds for 1 year ($200,000 / 10) ($20,000)
Book value of Albert NLs bonds at December 31, 2014 $2,180,000

10 percent bonds payable that should be reported:

80% of book value of Albert NLs bonds $1,774,000
(80% x $2,180,000)

2. Investment in Albert NL is a reciprocal account. Thus it should not be

reported on the consolidated financial statements.

3. Total interest expense for the year $180,000

(($2,000,000 x 10%) ($200,000 / 10))

Interest expense that should be reported:

80% of total interest expense (80% x $180,000) $144,000

4. There is no interest income that should be reported because the interest

income is the result of constructive retirement.

Solution E7-7

1 a
January 1, 2011 cost of $400,000 par bonds $391,000
Book value acquired ($2,000,000 + $90,000 premium) 20% 418,000
Constructive gain $ 27,000

2 b
Constructive gain $27,000/5 years 4 years $ 21,600

3 c
Book value $2,072,000 80% outstanding $1,657,600

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Chapter 7 7-7
Solution E7-8

1a Constructive gain

Book value of bonds January 1, 2012 $485,000

Amortization for 6 months ($15,000/4 years 1/2 year) 1,875
Book value of bonds July 1, 2012 486,875

Percent purchased by Say 60%

Book value of bonds purchased $292,125

Purchase price 287,400

Constructive gain $ 4,725

1b Consolidated bond interest expense for 2012

Bond interest expense January 1 to July 1

($500,000 8% 1/2 year) + $1,875 amortization $ 21,875

Bond interest expense July 1 to December 31

[($500,000 8% 1/2 year) + $1,875 amortization] 40% 8,750

Consolidated bond interest expense $ 30,625

1c Bond liability of Par

Par Discount Book Value

January 1, 2012 $500,000 $15,000 $485,000
Amortization 2012 - 3,750 + 3,750
December 31, 2012 $500,000 $11,250 $488,750

Consolidated bond liability $488,750 40% outstanding $195,500

2 The amounts would not be different if Say had been the issuer and Par
the purchaser. However, the constructive retirement gains would belong
to Say and would have been allocated to both Par and the noncontrolling
interests in Say.

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7-8 Intercompany Profit Transactions Bonds

Solution E7-9 (amounts in thousands)

Subsidiary purchases parent company bonds:

1a Gain on constructive retirement of bonds
Book value of Pins bonds constructively
retired ($5,000 - $100 unamortized
discount) 40% $1,960
Purchase price of $1,000 par bonds 1,900
Gain on constructive bond retirement $ 60

1b Consolidated interest payable

($3,000 + $1,000) 10% interest 1/2 year $ 200

1c Bonds payable at par ($3,000 + $1,000) $4,000

1d None But Sids investment in Pin bonds will be $1,920.

Cost January 2 $1,900

Add: Amortization ($100,000/5 years) 20
$1,920

Parent purchases subsidiary bonds:

2a Loss on constructive retirement of bonds
Sids bonds payable ($1,000 + $20) $1,020
Price paid by Pin 1,030
Loss on constructive retirement of bonds $ (10)

2b Consolidated interest expense

Pin bonds ($5,000 10% interest)
+ $20 amortization $ 520

2c None Interest receivable of $50 is eliminated in consolidation.

2d Book value of bonds payable

Pins bonds December 31, 2011 $4,900
Add: Amortization for 2012 ($100 / 5 years) 20
Book value of bonds payable $4,920

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Chapter 7 7-9
Solution E7-10

1. Cost paid to retire 20% of Noa DDs bonds $185,000

Book value of bonds retired (20% x $800,000) $160,000
Constructive loss on bond retirement $25,000

90% of Noa DD net income (90% x $400,000) $360,000

90% of Constructive loss on bond retirement ($22,500)
(90% x $25,000)
90% of piecemeal recognition of constructive loss $4,500
(90 % x $25,000 / 5)
Income from Noa DD $342,000

2. 10% of Noa DD net income (10% x $400,000) $40,000

10% of Constructive loss on bond retirement ($2,500)
(10% x $25,000)
10% of piecemeal recognition of constructive loss $ 500
(10 % x $25,000 / 5)
Noncontrolling interest share $38,000

Check:
Noncontrolling interest share:
Income from Noa DD x 10% / 90% $38,000

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7-10 Intercompany Profit Transactions Bonds

Solution E7-11

Preliminary computations:

Book value of Saw bonds on January 1, 2012 $1,000,000

Purchase price paid by Par 783,000
Gain on constructive retirement of Saw bonds $ 217,000

Amortization of gain on bonds ($217,000/7 years) $ 31,000

Computation of noncontrolling interest share:

Share of Saws reported income ($140,000 20%) $ 28,000
Add: Share of constructive gain ($217,000 20%) 43,400
Less: Piecemeal recognition of constructive gain ($31,000 20%) (6,200)
Noncontrolling interest share $ 65,200

Par Corporation and Subsidiary

Consolidated Income Statement
for the year ended December 31, 2012
(in thousands)

Sales $1,800
Less: Cost of sales 950

Gross profit 850

Add: Gain from constructive retirement of Saw bonds 217
Less: Operating expenses 400
Consolidated net income $ 667
Less: Noncontrolling interest share 65.2
Controlling interest share of NI $ 601.8

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Chapter 7 7-11
Solution E7-12

1 Pub Corporation and Subsidiary, December 31, 2011

Amounts Appearing
in Consolidated
Financial Statements
Interest receivable 0
Investment in Sap bonds 0
Interest payable ($40,000 90%) 36,000
8% bonds payable (($1,000,000 90%)- 13,500 886,500
discount)
Interest income 0
Interest expense ($86,000/2) + .9(86,000/2) 81,700
Loss on constructive retirement of bonds 7,800a
a Computation of loss on intercompany bonds
Balance of investment in bonds at December 31, 2011 $105,000
Add: Amount amortized for July 1 to December 31, 2011
($5,000 balance at December 31 30/36 months = $6,000 unamortized
at July 1) 1,000
Investment cost July 1, 2011 $106,000
Less: Book value acquired [$1,000,000 - ($15,000
unamortized discount at December 31 30/36 months)] 10% 98,200
Loss on constructive retirement of bonds $ 7,800

2 Consolidation working paper entries at December 31, 2011

Interest income 3,000
8% bonds payable 98,500
Loss on retirement of bonds 7,800
Investment in Sap bonds 105,000
Interest expense 4,300
To eliminate intercompany bonds, record constructive loss on
retirement, and eliminate intercompany interest income and expense.

Interest payable 4,000

Interest receivable 4,000
To eliminate reciprocal interest payable and receivable amounts.

3 Consolidation working paper entries at December 31, 2012

Investment in Sap (80%) 5,200
Noncontrolling interest(20%) 1,300
Interest income 6,000
8% bonds payable 99,100
Investment in Sap bonds 103,000
Interest expense 8,600
To eliminate intercompany bonds, interest income and expense, and
to charge the unrecognized portion of the constructive loss at the
beginning of the period 80% to the investment in Sap and 20% to
the noncontrolling interest.

Interest payable 4,000

Interest receivable 4,000
To eliminate reciprocal interest payable and receivable amounts.

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7-12 Intercompany Profit Transactions Bonds

Solution E7-13

1 Gain on constructive retirement of bonds

Purchase price of bonds $ 97,600

Book value 100,000
Gain on constructive retirement of bonds $ 2,400

2 Son accounts for its investment in Pap bonds

January 2, 2013
Investment in Pap bonds 97,600
Cash 97,600
To record investment in $100,000 par, 8% Pap bonds.

July 1, 2013
Cash 4,000
Investment in Pap bonds 400
Interest income 4,400
To record interest and amortization.

December 31, 2013

Interest receivable 4,000
Investment in Pap bonds 400
Interest income 4,400
To accrue interest and record amortization.

3 Pap accounts for its bonds payable

July 1, 2013
Interest expense 8,000
Cash 8,000
To record interest payment for 6 months.

December 31, 2013

Interest expense 8,000
Interest payable 8,000
To accrue interest for 6 months.

4 Pap accounts for its investment in Son

December 31, 2013

Investment in Son 81,600
Income from Son 81,600
To record income from Son
(80% $100,000) + $2,400 constructive gain - $800 piecemeal
recognition of gain.

5 Noncontrolling interest share ($100,000 20%) $ 20,000

Controlling share of NI ($400,000 + $81,600) $481,600

Consolidated net income $501,600

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Chapter 7 7-13
SOLUTIONS TO PROBLEMS

Solution P7-1

1 Loss on constructive retirement of bonds

Purchase price of $50,000 par bonds

April 1, 2011 $53,600
Book value of bonds acquired:
Par value $100,000
Less: Unamortized discount $1,800 for 27
of 36 months ($1,800 .75) 2,400
Book value of bonds 97,600
Intercompany bonds 50% 48,800

Loss on constructive retirement of bonds $ 4,800

2 Interest income and expense

Interest income in consolidated income statement 2011 0

Interest expense in consolidated income statement 2011
$8,800 - ($8,800 3/4 year 50%) $ 5,500

3 Interest receivable and payable

Interest receivable in consolidated balance sheet

at December 31, 2011 0

Interest payable in consolidated balance sheet at

December 31, 2011 $ 1,000

4 Consolidation working paper entries

Loss on constructive retirement of bonds 4,800

8% bonds payable 49,100
Interest income 2,100
Investment in Pan bonds 52,700
Interest expense 3,300
To eliminate reciprocal interest income and expense amounts and
reciprocal bond investment and liability amounts and enter
unrecognized constructive loss.

Interest payable 1,000

Interest receivable 1,000
To eliminate reciprocal payables and receivables.

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7-14 Intercompany Profit Transactions Bonds

Solution P7-2

Pew Corporation and Sat Corporation

Schedule to Determine Pews Net Income and Controlling Share of Consolidated
Net Income

2011 2012 2013 2014 Total

Pews separate income $250,000 $187,500 $230,000 $255,000 $ 922,500

80% of Sats net income + 40,000 + 48,000 + 44,000 + 48,000 + 180,000

$2,500 unrealized profit in

Sats December 31, 2011
Inventory - 2,500 + 2,500

$5,000 unrealized profit in

Sats December 31, 2012
Inventory - 5,000 + 5,000

$7,500 unrealized profit in

2013 on sale of land
upstream 80% - 6,000 - 6,000

$15,000 unrealized profit on

sale of equipment in 2013 - 15,000 - 15,000

$3,750 depreciation on
unrealized profit on
equipment in 2013 and 2014 + 3,750 + 3,750 + 7,500

$4,000 constructive loss on

purchase of Pews bonds
in 2014 - 4,000 - 4,000

$1,000 piecemeal recognition of

constructive loss in 2014 + 1,000 + 1,000

Pews net income $287,500 $233,000 $261,750 $303,750 $1,086,000

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Chapter 7 7-15
Solution P7-3

Preliminary computations:
90% of Merry SAs net income $720,000
(90% x ($3,700,000 +$200,000 - $2,400,000 - $700,000))
Unrealized profit from ending inventory ($100,000)b
(100% x $100,000)
Unrealized gain on sale of land ($180,000)
(90% x ($1,000,000 - $800,000)
Unrealized gain on sale of equipment ($100,000)d
(100% x $100,000)
Constructive gain on bond retirement $ 60,000
(($1,000,000 / 2) - $440,000))
Piecemeal recognition of constructive gain ($ 20,000)
($60,000 / 3)
Income from Merry SAs $380,000

10% of Merry SAs net income $ 80,000

(10% x ($3,700,000 +$200,000 - $2,400,000 - $700,000))
Unrealized gain on sale of land ($ 20,000)
(10% x ($1,000,000 - $800,000)
Noncontrolling interest share: $ 60,000i

Investment in Merry SA before adjustment $3,600,000

Add: Income from Merry SA $ 380,000
Adjusted investment in Merry SA $3,980,000

Unadjusted ending investment in Merry SA $3,600,000

Add: Dividends ($100,000 x 90%) $ 90,000
Beginning investment in Merry SA $3,690,000
Implied fair value of Merry SA ($3,690,000 / 90%) $4,100,000
Beginning Merry SAs stockholders equity $4,085,000
($2,000,000 + $2,085,000)
Goodwill $ 15,000j

THANOS SA AND SUBSIDIARY CONSOLIDATION WORKPAPER FOR THE YEAR ENDED DECEMBER
31, 2014 (IN THOUSANDS)

Consolida
Adjustments and ted
Thanos Merry Eliminations Statement
SA SA Debits Credits s
Income Statement
Sales $ 4,800 $ 3,700 a. 800 $ 7,700
Income from Merry SA $ 380 h. 380
Gain on sale of land $ 200 c. 200
Gain on sale of equipment $ 100 d. 100
Interest income $ 70 f. 70
Gain on retirement of bonds e. 40 $ 60
f. 20
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7-16 Intercompany Profit Transactions Bonds

-
Cost of sales
-$ 2,800 $ 2,400 b. 100 a. 800 -$ 4,500
Interest expense -$ 100 f. 50 -$ 50
Other expenses -$ 1,100 -$ 700 -$ 1,800
Noncontrolling interest share i. 60 -$ 60
Controlling share of net income $ 1,350 $ 800 $ 1,350
Retained Earnings Statement
Retained earnings - Thanos SA $ 3,380 $ 3,380
Retained earnings - Merry SA $ 2,085 j. 2085
Controlling share of net income $ 1,350 $ 800 $ 1,350
Dividends -$ 300 -$ 100 h. 90 -$ 300
i. 10
Retained earnings - December 31 $ 4,430 $ 2,785 $ 4,430

Balance Sheet
Cash $ 700 $ 600 $ 1,300
Accounts receivable $ 1,000 $ 400 $ 1,400
Interest receivable $ 25 g. 25
Inventory $ 1,100 $ 700 b. 100 $ 1,700
Land $ 1,900 $ 800 c. 200 $ 2,500
Equipment-net $ 1,100 $ 1,400 d. 100 $ 2,400
Building-net $ 2,000 $ 1,400 $ 3,400
Investment in Thanos SA bonds $ 460 e. 460
Investment in Merry SA $ 3,980 h. 290
j. 3690
Goodwill j. 15 $ 15
Total Assets $ 11,780 $ 5,785 $ 12,715

Accounts payable $ 1,300 $ 1,000 $ 2,300

Interest payable $ 50 g. 25 $ 25
10% bonds payable $ 1,000 e. 500 $ 500
Common stock $ 5,000 $ 2,000 j. 2000 $ 5,000
Retained earnings $ 4,430 $ 2,785 $ 4,430
$ 11,780 $ 5,785
Noncontrolling interest January
1 j. 410
Noncontrolling interest
December 31 i. 50 $ 460
Total liabilities and equities $ 12,715

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Chapter 7 7-17

Solution P7-4

Preliminary Computations:
Acquisition price $ 640,000
Implied fair value of She ($640,000 / 80%) $ 800,000
Shes book value (600,000)
Excess allocated to plant & equipment with 8 year life $ 200,000

Annual depreciation of excess ($200,000 / 8 years) $ 25,000

1 Loss is from the constructive retirement of bonds

Purchase price of bonds $212,000
Book value of bonds ($200,000 + $6,000 premium) 206,000
Loss on retirement of bonds $ 6,000

2 Consolidated sales
Combined sales $560,000
Less: Intercompany sales 100,000
Consolidated sales $460,000

3 Consolidated cost of goods sold

Combined cost of goods sold $ 340,000
Less: Intercompany sales (100,000)
Less: Unrealized profits in beginning inventory (40,000)
Add: Unrealized profits in ending inventory 20,000
Consolidated cost of goods sold $ 220,000

4 Unrealized profit in beginning inventory

Forced computations ($340,000 + $20,000) - ($100,000 + $ 40,000
$220,000)

5 Unrealized profit in ending inventory

Combined inventories ($200,000 + $100,000) $300,000
Less: Consolidated inventories 280,000
Unrealized profit in ending inventory $ 20,000

6 Consolidated accounts receivable

Combined accounts receivable ($240,000 + $120,000) $360,000
Less: Intercompany receivables 30,000
Consolidated accounts receivable $330,000

7 Noncontrolling interest share

Shes reported net income $ 60,000
Less: Depreciation of excess (25,000)
Add: Unrealized profit in beginning inventory 40,000
Less: Unrealized profit in ending inventory (20,000)
Shers realized income 55,000
Noncontrolling interest percentage 20%
Noncontrolling interest share $ 11,000

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7-18 Intercompany Profit Transactions Bonds

Solution P7-4 (continued)

8 Noncontrolling interest December 31, 2013

Beginning noncontrolling interest (($670,000 + $150,000
unamortized excess) 20%) $164,000
Less: Unrealized profit in beginning inventory
($40,000 20%) (8,000)
Less: Noncontrolling interest dividends ($30,000 20%) (6,000)
Add: Noncontrolling interest share 11,000
Noncontrolling interest December 31 $161,000

Alternative computation:
Ending equity of She ($700,000 + $125,000 unamortized
excess)( 20%) $165,000
Less: Unrealized profit in ending inventory ($20,000 20%) (4,000)
Noncontrolling interest December 31, 2013 $161,000

9 Investment in She stock at December 31, 2012

Investment in She stock at cost $640,000
Add: Changes in retained earnings to December 31, 2012
($270,000 - $200,000) 80% 56,000
Less: 80% of Excess of ($200,000/8 years) = $20,000 per year
2 years (40,000)
Less: Unrealized profit in beginning inventory
($40,000 80%) (32,000)
Investment in She stock December 31, 2012 $624,000

Alternative computation:
Investment in She stock December 31, 2013 $640,000
Less: Income from She for 2013 (40,000)
Add: Dividends from She ($30,000 80%) 24,000
Investment in She stock December 31, 2012 $624,000

10 Income from She

Share of Shes reported net income $ 60,000
Less: Depreciation on excess ($200,000/8 years) (25,000)
Add: Unrealized profit in beginning inventory 40,000
Less: Unrealized profit in ending inventory (20,000)
Shes adjusted and realized income $ 55,000
Pets 80% controlling share $ 44,000
Less: Constructive loss on retirement of bonds
($6,000 - $2,000) (4,000)
Pets income from She $ 40,000

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Chapter 7 7-19
Solution P7-5 [AICPA adapted]

1 Consolidated cash ($50,000 + $15,000) $ 65,000

2 Equipment net ($800,000 equipment - $320,000 accumulated

depreciation - $21,000 unrealized profit + $7,000 profit
realized through depreciation of excess) $466,000

3 Investment in Saw does not appear in consolidated

statements.

4 Bonds payable (Saws bonds payable of $200,000 1/2 held

outside the consolidated entity) $100,000

5 Common stock (Poes stock) $100,000

6 Beginning retained earnings (Poes retained earnings) $272,000

7 Dividends paid (Poes dividends) $ 80,000

8 Gain on retirement of bonds (Book value of Saws

bonds acquired by Poe $100,000 less acquisition cost
of $91,000. Since bonds were acquired on December 31,
2011, none of the $9,000 gain has been amortized.) $ 9,000

9 Cost of goods sold ($860,000 combined - $60,000

intercompany sales + $10,000 unrealized profit in
ending inventory) $810,000

10 Interest expense (Saw paid interest for the entire year to

outside entities so all of Saws interest is reported) $ 16,000

11 Depreciation expense ($45,000 combined - depreciation on

the unrealized gain $7,000) $ 38,000

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7-20 Intercompany Profit Transactions Bonds

Solution P7-6

Preliminary computations:
80% ofNuro AOs net income $1,520,000
(80% x ($12,000,000 + $1,000,000 - $8,800,000
$200,000 $2,100,000))
Unrealized profit from ending inventory ($80,000)
(80% x $1,000,000 / 2 x 20%)
Unrealized gain on sale of building ($800,000)
(80% x ($5,000,000 - $4,000,000))
Piecemeal recognition of gain on sale of building $40,000
(80% x ($5,000,000 - $4,000,000) / 10 / 2)
Constructive loss on bond retirement ($80,000)
(80% x ($900,000 - $800,000)
Piecemeal recognition of constructive gain $40,000
(80% x ($900,000 $800,000) / 2)
Income from Nuro AOs $640,000

20% of Nuro AOs net income $380,000

(20% x ($12,000,000 + $1,000,000 - $8,800,000
$200,000 $2,100,000))
Unrealized profit from ending inventory ($20,000)
(20% x $1,000,000 / 2 x 20%)
Unrealized gain on sale of building ($200,000)
(20% x ($5,000,000 - $4,000,000))
Piecemeal recognition of gain on sale of building $10,000
(20% x ($5,000,000 - $4,000,000) / 10 / 2)
Constructive loss on bond retirement ($20,000)
(20% x ($900,000 - $800,000)
Piecemeal recognition of constructive gain $ 10,000
(20% x ($900,000 $800,000) / 2)
Noncontrolling interest share: $160,000i

Investment in Nuro AO before adjustment $7,360,000

Add: Income from Nuro AO $640,000
Adjusted investment in Nuro AO $8,000,000

Price to acquire 80 percent interest of Nuro AO $8,000,000

Implied fair value of Nuro AO ($8,000,000 / 80%) $10,000,000
Beginning Merry SAs stockholders equity $10,000,000
($5,000,000 + $5,000,000)
Goodwill $ 0

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 Chapter 7 7-21
Solution P7-6 (continued)
KEN AO AND SUBSIDIARY
Consolidation Working Papers

FOR THE YEAR ENDED DECEMBER 31, 2014 (IN THOUSANDS)

Adjustments and
Eliminations Consolidated
Ken AO Nuro AO Debits Credits Statements
Income Statement
a.
Sales
$ 14,000 $ 12,000 1,000 $ 25,000
Income from Nuro AO $ 640 h. 640
Gain on sale of building $ 1,000 c. 1000
Interest income $ 150 f. 150
Loss on retirement of bonds e. 50 -$ 100
f. 50
- a.
Cost of sales
$ 11,100 -$ 8,800 b. 100 1,000 -$ 19,000
Interest expense -$ 200 f. 200
Other expenses -$ 1,700 -$ 2,100 d. 50 -$ 3,750
Noncontrolling interest share i. 160 -$ 160
Controlling share of net
income $ 1,990 $ 1,900 $ 1,990
Retained Earnings Statement
Retained earnings - Ken AO $ 12,000 $ 12,000
Retained earnings - Nuro AO $ 5,000 j. 5000
Controlling share of net
$ 1,990 $ 1,900 $ 1,990
income
Dividends -$ 500 -$ 800 h. 640 -$ 500
i. 160
Retained earnings - December
31 $ 13,490 $ 6,100 $ 13,490

Balance Sheet
Cash $ 1,500 $ 2,000 $ 3,500
Accounts receivable $ 3,640 $ 1,900 $ 5,540
Interest receivable $ 100 g. 100
Inventory $ 1,600 $ 1,800 b. 100 $ 3,300
Land $ 2,000 $ 4,200 $ 6,200
Equipment-net $ 2,100 $ 1,100 $ 3,200
c.
Building-net
$ 6,000 $ 2,000 d. 50 1,000 $ 7,050
Investment in Nuro AO bonds $ 950 e. 950

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 7-22 Intercompany Profit Transactions Bonds

Investment in Nuro AO $ 8,000 j. 8000

Total Assets $ 25,890 $ 13,000 $ 28,790

Accounts payable $ 2,400 $ 900 $ 3,300

Interest payable $ 100 g. 100
10% bonds payable $ 900 e. 900
Common stock $ 10,000 $ 5,000 j. 5000 $ 10,000
Retained earnings $ 13,490 $ 6,100 $ 13,490
$ 25,890 $ 13,000
Noncontrolling interest j.
January 1 2,000
Noncontrolling interest
December 31 $ 2,000
Total liabilities and equities $ 28,790

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