Advanced Accounting

Thirteenth Edition, Global Edition

Chapter 7
Intercompany Profit
Transactions – Bonds

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Intercompany Profit Transactions - Bonds:
Objectives
7.1 Differentiate between intercompany receivables and
payables, and assets or liabilities of the consolidated
reporting entity.
7.2 Demonstrate how a consolidated reporting entity
constructively retires debt.
7.3 Defer unrealized gains/losses and later recognize
realized gains/losses on bond transfers between
parent and subsidiary.
7.4 Calculate noncontrolling interest share in the
presence of intercompany gains/losses on debt
transfers.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

7.1: Intercompany Receivables and
Payables
Intercompany Profit Transactions – Bonds

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Intercompany Payables and Receivables
Remove intercompany
– Payables and interest expense
– Receivables and interest income

Loans directly between affiliates generally pose no

special problems.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Retirement of Debt
– Issuing firm uses own resources to retire its own
bonds – no intercompany (IC) issues
– Issuing firm borrows from unaffiliated entity and
uses funds to retire its own debt – no IC
– Issuing firm borrows from affiliate and uses funds
to retire its own debt – simple IC loan
– Non-issuing firm purchases debt securities of an
affiliate resulting in constructive retirement – IC
constructive retirement

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

7.2: Constructive Retirement of Debt
Intercompany Profit Transactions – Bonds

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Constructive Retirement
One company purchases debt instruments of an
affiliate from outside entities.
Constructive gains and losses on bonds are:
1. Realized gains and losses from the
consolidated viewpoint
2. Those that arise when a company purchases
the bonds of an affiliate
3. From other entities
4. At a price other than the book value of the
bonds.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Agency Theory
Agency theory
– Assigns gain or loss to the issuing firm
– Conceptually superior than other methods
Text:
– Follows agency theory
– Simplifies discussion using straight line
amortization of premiums & discounts
Other methods
– Assign gain or loss to affiliates based on the par
value of the bonds – par value theory
– Assign all gain or loss to the parent

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

7.3: Defer Unrealized Gains and Losses
on Bond Transfers
Intercompany Profit Transactions – Bonds

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Parent is Issuer
● At constructive retirement
– Remove Investment in Bonds
– Remove proportionate share of bonds payable
and unamortized premium or discount
– Realize a gain or loss
● The gain or loss at constructive retirement is
recognized over the life of the bonds.
● Gain or loss is attributed solely to the parent.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Subsidiary Acquires Parent Bonds
● Pam owns 70% of Sun, acquired at book value.
Sun's net income for 2010 is $220.
● On 1/1/17, Pam has $10,000 bonds outstanding
with unamortized premium of $100. Bonds mature
in 5 years. Straight-line amortization. Interest is
10%, payable semi-annually.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Subsidiary Acquires Parent Bonds
(continued)

● On 1/1/17, Sun acquires $1,000 of Pam's bonds on

the open market at $950. Straight line.
– Portion of bonds retired: 1,000/10,000 = 10%
– Gain on retirement: 10%(10,100) – 950 = $60
– Pam's Investment in Sun:
70%(220) + 60 – 12 = $202
– Noncontrolling interest share: 30%(220) = $66

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Amortizations and Interest (1 of 4)
Book Fiscal Book Fiscal Book
value Year value Year value
 PAM’S BOOKS 1/1/17 2017 12/31/17 2018 12/31/18
Bonds payable $10,100 -$20 $10,080 -$20 $10,060
Retired 10% $1,010  blank $1,008  blank $1,006
500+500-20 500+500-20
Interest expense  blank  blank  blank
=$980 =$980

Retired 10%  blank $98  blank $98  blank

SUN'S BOOKS  blank  blank  blank  blank  blank
Investment in $950 +$10 $960 +$10 $970
bonds
50+50+10 50+50+10
Interest income  blank  blank  blank
=$110 =$110

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Worksheet Entries for Bonds
Entries for 2017 worksheet.
Bonds payable (-L) 1,008 blank
Investment in bonds (-A) blank 960
Gain on retirement of bonds (Ga, +SE) blank 48
Interest income (-R, -SE) 110 blank
Interest expense (-E, +SE) blank 98
Gain on retirement of bonds (Ga, +SE) blank 12
Interest payable (-L) 50 blank
Interest receivable (-A) blank 50

Had a consolidated balance sheet been prepared on 1/1/2017, the date

of the retirement, the first entry would have recorded amounts at
$1010, $950, and $60, respectively. There would be no interest.
One entry could have been used above, with a gain of $60.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Piecemeal Recognition
– The constructive gain of $60 is recognized in 2017
when the bonds are constructively retired.
– The difference between interest income $98 and
interest expense on the retired bonds $110 is $12.
– This $12 is an adjustment to investment income.
– Pam is the issuer, so the full $12 is attributed to
Pam.
– If Sun was the issuer, the $12 would be shared
among the controlling and noncontrolling interests.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Amortizations and Interest (2 of 4)
Book Fiscal Book Fiscal Book
value Year value Year value
PAM’S BOOKS 1/1/17 2017 12/31/17 2018 12/31/18
Bonds payable $10,100 -$20 $10,080 -$20 $10,060
Retired 10% $1,010 blank  $1,008 blank  $1,006
500+500-20 500+500-20
Interest expense blank  blank  blank 
=$980 =$980
Retired 10% blank  $98 blank  $98 blank 
SUN'S BOOKS blank  blank  blank  blank  blank 
Investment in $950 +$10 $960 +$10 $970
bonds
50+50+10 50+50+10
Interest income blank  blank  blank 
=$110 =$110

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

2018 Worksheet Entries (1 of 2)
Entries for 2018 worksheet, assuming that Pam
has not yet paid the second interest payment:
Bonds payable (-L) 1,006 blank
Interest income (-R, -SE) 110 blank
Investment in bonds (-A) blank 970
Interest expense (-E, +SE) blank 98
Investment in Sun (-A) blank 48
Interest payable (-L) 50 blank
Interest receivable (-A) blank 50

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Subsequent Worksheet Entries
– Notice that there is no gain in subsequent
years.
– The $60 “gain” is amortized each year by $12,
so the Investment account is increased by $48
in 2018.
– The Investment in Sun account will be credited
by $36 in 2016, by $24 in 2017, and so forth.
– Had Sun been the issuer, the $48 credit for
2017 would be shared between:
● Investment in Sun and
● Noncontrolling Interest

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

7.4: Calculate NonControlling Interest
Share
Intercompany Profit Transactions – Bonds

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Subsidiary Issuer with Gain
Constructive gain
– Purchase price of the debt is less than the book
value.
– Share gain between CI and NCI in year of
retirement.
● Increase Income from subsidiary
● Increase Noncontrolling interest share
– In current and subsequent years, use piecemeal
recognition.
● Reduce Income from subsidiary
● Reduce Noncontrolling interest share
Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.
Subsidiary Issuer with Loss
Constructive loss
– Purchase price of the debt is greater than the
book value.
– Share loss between CI and NCI in year of
retirement.
● Reduce Income from subsidiary
● Reduce Noncontrolling interest share
– In current and subsequent years, use piecemeal
recognition.
● Increase Income from subsidiary
● Increase Noncontrolling interest share
Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.
Parent Acquires Subsidiary Bonds
● Panda owns 80% of Salty, acquired at book value.
Salty's net income for 2017 is $500.
● On 1/1/17, Salty has $5,000, bonds outstanding
with unamortized discount of $200. Bonds mature
in 8 years. Straight line amortization. Interest is
10% payable semi-annually. Interest expense =
$525

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Parent Acquires Subsidiary Bonds
(continued)

● On 1/1/17, Panda acquires $2,000 of Salty's bonds

on the open market at $2,040. Straight line.
Interest income = $195
– Portion of bonds retired: 2,000/5,000 = 40%
– Loss on retirement:
40%(4,800) – 2,040 = -$120
– Panda's Investment in Salty:
80%(500 – 120 + 210 - 195) = $316
– Noncontrolling interest share:
20%(500 – 120 + 210 - 195) = $79

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Amortizations and Interest (3 of 4)
Book Fiscal Book Fiscal Book
SALTY'S value Year value Year value
BOOKS 1/1/17 2017  12/31/17 2018 12/31/18
Bonds payable $4,800 +$25 $4,825 +$25 $4,850
Retired 40% $1,920 blank  $1,930 blank  $1,940
Interest blank 
250+250+25
blank 
250+250+25
blank 
expense =$525 =$525
Retired 40% blank  $210 blank  $210 blank 
PANDA'S blank  blank  blank  blank  blank 
BOOKS
Investment in $2,040 -$5 $2,035 -$5 $2,030
bonds
100+100-5 100+100-5
Interest income blank  blank  blank 
=$195 =$195

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

2017 Entries with Loss
Entries for 2017 worksheet, assuming the second
interest payment has not yet been paid:
Bonds payable (-L) 1,930 blank
Interest income (-R, -SE) 195 blank
Loss on retirement of bonds (Lo, -SE) 120 blank
Interest expense (-E, +SE) blank 210
Investment in bonds (-A) blank 2,035
Interest payable (-L) 100 blank
Interest receivable (-A) blank 100

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Amortizations and Interest (4 of 4)
Book Fiscal Book Fiscal Book
SALTY'S value Year value Year value
BOOKS 1/1/17 2017  12/31/17 2018 12/31/18
Bonds payable $4,800 +$25 $4,825 +$25 $4,850
Retired 40% $1,920 blank $1,930 blank $1,940
250+250+25 250+250+25
Interest expense blank blank blank
=$525 =$525
Retired 40% blank $210 blank $210 blank

PANDA'S
BOOKS
blank blank blank blank blank
Investment in $2,040 -$5 $2,035 -$5 $2,030
bonds
100+100-5 100+100-5
Interest income blank blank blank
=$195 =$195

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

2018 Worksheet Entries (2 of 2)
Entries for 2018 worksheet, assuming that Salty
has not yet paid the second interest payment:
Bonds payable (-L) 1,940 blank
Interest income (-R, -SE) 195 blank
Investment in Salty (+A) 105 blank
Investment in bonds (-A) blank 2,030
Interest expense (-E, +SE) blank 210
Interest payable (-L) 100 blank
Interest receivable (-A) blank 100

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.