Advanced Accounting Chapter 07 2021

Chapter 7:
Intercompany Profit
Transactions –
Bonds
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright ©2012 Pearson Education,

7-1
Inc. Publishing as Prentice Hall
Intercompany Profits on Bonds: Objectives
1. Differentiate between intercompany
receivables and payables, and assets or
liabilities of the consolidated reporting entity.
2. Demonstrate how a consolidated reporting
entity constructively retires debt.
3. Defer unrealized gains/losses and later
recognize realized gains/losses on bond
transfers between parent and subsidiary.
4. Adjust calculation of noncontrolling interest
share amounts in the presence of
intercompany gains/losses on debt transfers.
7-2
Intercompany Profit Transactions – Bonds
1: INTERCOMPANY
RECEIVABLES AND
PAYABLES

7-3
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.
8-4
Intercompany Debt Transactions (1 of 2)
Figure 8-1 (a)
8-5
Intercompany Debt Transactions (2 of 2)
Figure 8-1 (b)
8-6
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.
8-7
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.
8-8
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:
 When a note or bond payable is sold directly to an
affiliate at par value, the entries recorded by the
investor and the issuer should be mirror images of
each other.
8-9
Intercompany Payables and Receivables
Remove intercompany:
 Payables and interest expense
 Receivables and interest income
Loans directly between affiliates generally
pose no special problems

7-10
Transfer at Par Value
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 × 0.12), 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 worksheet to remove the effects of
the intercompany indebtedness:
Eliminate Intercorporate Bond Holdings:
Bonds Payable 100,000
Investment in Special Foods Bonds 100,000
Eliminate Intercompany Interest:

Interest Income 12,000
Interest Expense 12,000
These entries have no effect on consolidated net income because they

reduce interest income and interest expense by the same amount.
8-11
Transfer at a Discount or Premium
(1 of 7)
When the coupon or nominal interest rate on a

bond is different from the yield demanded by those
who lend funds, a bond sells at a discount or
premium.
Bond interest income or expense recorded does
not equal cash interest payments.
Interest income and expense amounts are
adjusted for the amortization of the discount or
premium.
8-12
(2 of 7)
On January 1, 20X1, Peerless Products purchases $100,000 par value, 12 percent, 10-year
bonds from Special Foods when the market interest rate is 13 percent. In order to yield a 13
percent return, Special Foods issues the bonds at a discount for $94,490.75. 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 period based on effective
interest amortization of the discount over the life of the bonds can be summarized as follows:
8-13
(3 of 7)
Entries by the debtor

January 1, 20X1
Cash 94,491
Discount on Bonds Payable 5,509
Issue bonds to Peerless Products.
July 1, 20X1
Discount on Bonds Payable 142
Cash 6,000
Pay semiannual interest payment.
December 31, 20X1

Interest Payable 6,000
Accrue interest expense at year-end.
8-14
(4 of 7)
Entries by the bond investor
January 1, 20X1
Cash 94,491
Purchase bonds from Special Foods.
July 1, 20X1
Cash 6,000
Investment in Special Foods Bonds 142
Receive interest on bond investment.
December 31, 20X1

Interest Receivable 6,000
Accrue interest income at year-end.
8-15
(5 of 7)
Consolidation entries at year-end:

The December 31, 20X1, bond-related amounts taken
from the books of Peerless Products and Special Foods
and the appropriate consolidated amounts are as follows:
Peerless Special Unadjusted Consolidated

Item Products + Foods = Totals ≠ Amounts
Bonds Payable 0 $(100,000) $ (100,000) 0
Discount on Bonds Payable 0 $5,216 5,216 0
Interest Payable 0 (6,000) (6,000) 0
Investment in Bonds $ 94,784 0 94,784 0
Interest Receivable 6,000 0 6,000 0
Interest Expense 0 $ 12,293 $ 12,293 0
Interest Income $ (12,293) 0 (12,293) 0
8-16
(6 of 7)

All account balances relating to the intercorporate bond holdings
must be eliminated in the preparation of consolidated financial
statements.
Toward that end, the consolidation worksheet prepared on December
31, 20X1, includes the following consolidation entries related to the
intercompany bond holdings:


Eliminate Intercompany Interest Receivable/Payable:

8-17
(7 of 7)
The consolidation elimination entries related to the bonds

at the end of 20X2 are as follows:


By the end of 20X2, the carrying value of the bond investment on Peerless’s books increases to
$95,116 (issue price $94,491 + discount amortization of $142 + $151 + $161 +$171).
8-18
(1 of 7)
Bond interest income or expense recorded does

not equal cash interest payments.
Interest income and expense amounts are
adjusted for the amortization of the discount or
premium.
8-19
(2 of 7)
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:
8-20
(3 of 7)
Entries by the debtor

January 1, 20X1
Cash 90,000
Issue bonds to Peerless Products.
July 1, 20X1
Cash 6,000
Semiannual interest payment.
December 31, 20X1
Accrue interest expense at year-end.
8-21
(4 of 7)
Entries by the bond investor

January 1, 20X1
Cash 90,000
Purchase of bonds from Special Foods.
July 1, 20X1
Cash 6,000
Receive interest on bond investment.
December 31, 20X1
Accrue interest income at year-end.
8-22
(5 of 7)

The December 31, 20X1, bond-related amounts taken
from the books of Peerless Products and Special Foods
and the appropriate consolidated amounts are as follows:
Peerless Special Unadjusted Consolidated

Item Products + Foods = Totals ≠ Amounts
Bonds Payable 0 $ (100,000) $ (100,000) 0
Discount on Bonds Payable 0 $9,000 9,000 0
Interest Payable 0 (6,000) (6,000) 0
Investment in Bonds $ 91,000 0 91,000 0
Interest Receivable 6,000 0 6,000 0
Interest Expense 0 $ 13,000 $ 13,000 0
Interest Income $ (13,000) 0 (13,000) 0
8-23
(6 of 7)

All account balances relating to the intercorporate bond
holdings must be eliminated in the preparation of consolidated
financial statements.
Toward that end, the consolidation worksheet prepared on
December 31, 20X1, includes the following elimination entries
related to the intercompany bond holdings:


8-24
(7 of 7)

 The consolidation elimination entries related to the bonds
at the end of 20X2 are as follows:


8-25
2: CONSTRUCTIVE
RETIREMENT OF DEBT

7-26
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 from outside entities resulting in constructive
retirement – IC constructive retirement

7-27
Bonds of Affiliate Purchased from a Nonaffiliate (1 of 2)
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 affiliate’s bonds retires the bonds at the time they are
purchased.
Acquisition of an affiliate’s bonds 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.
8-28
Bonds of Affiliate Purchased from a Nonaffiliate (2 of 2)
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 purchaser’s
investment in the bonds is reported in the consolidated
balance sheet because the bonds are no longer
considered outstanding.
8-29
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. 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.

7-30
Constructive Gains and Losses on
Intercompany Bonds
 If the price paid by one affiliate to acquire the debt of
another is less than the book value of the liability
(par value plus unamortized premium or less
unamortized discount and issuance costs) a
constructive gain on the retirement of debt occurs.
 Alternatively, if the price paid is greater than the
book value of the debt, a constructive loss on the
retirement of debt occurs.
 The gain or loss is called constructive because it is a
gain or loss that is realized and recognized from the
viewpoint of the consolidated entity, but is not
recorded on the separate books of the affiliates at
the time of purchase.
7-31
Agency Theory
Par value theory
 Assign gain or loss to affiliates based on the par value of the
bond. For example, if Parent pays $99,000 for $100,000 par of
Subsidiary’s outstanding bonds with $2,000 unamortized
premium, they would allocate the $3,000 gain ($102,000 less
$99,000) $1,000 to Parent and S2,000 to Subsidiary.
Agency theory
 Assigns gain or loss to the issuing firm. The $3,000 constructive gain will be
assigned to the Subsidiary (the issuer), and the consolidated statement effect is
the same as if subsidiary had purchased its own bonds
 Conceptually superior than other methods
Text:
 Follows agency theory
 Simplifies discussion using straight line amortization of premiums & discounts

7-32
3: PROFITS ON BONDS

7-33
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

7-34
An Example
Sun Corp. is an 80% owned affiliate of Pat
Corproration. Pat issues $1,000,000 par, 10%,
10-year bonds at par value on Dec 31, 2010.
Sun purchases $100,000 of Pat bonds for
$104,500 in the open market. A constructive
loss of $4,500 ($104,500 paid to retire bonds
with a book value of $100,000).
The entry on Pat book Dec 31, 2011 is :
Income from Sun 4,500
Investment in Sun 4,500

7-35
Workpaper entry
The $4,500 constructive loss appears in
consolidated income statement of Pat and
subsidiary for 2011, and the 10 percent bond
issue is reported at $900,000 in the
consolidated balance sheet at December 31,
2011.
Elimination entry for 2011 Worksheet
Dec. 31,2011
10% bonds payable 100,000
Loss on constructive retirement of
4,500
bonds
Investment in Pam Inc. bonds
Publishing as Prentice Hall 104,5006-36
Subsidiary Acquires Parent Bonds
Pam owns 70% of Sue, acquired at fair value equal to its
($6,300,000) book value on December 31,2011, when Sue
had capital stock of $5,000,000 and retained earnings of
$4,000,000. Sue's net income for 2012 is $220,000.
On 1/1/12, Pam has $10,000,000 bonds outstanding with
unamortized premium of $100,000. Bonds mature in 5
years. Straight line amortization. Interest is 10%, payable
semi-annually (January 1 and July 1).
On 1/1/12, Sue acquires $1,000,000 of Pam's bonds on the
open market at $950,000. The purchase results in a
constructive retirement of 10 percent of bonds and a
$60,000 constructive gain.

7-37
Subsidiary Acquires Parent Bonds
 Portion of bonds retired: 1,000,000/10,000,000 = 10%

Constructive gain is computed as follows:
Book value of bonds purchased $1,010,000
10% * ($10,000,000 par +$100,000 premium)
Purchase price 950,000
 Gain on retirement: 10%(10,100) – 950 = $ 60,000
The only entry Sue makes when purchasing Pam bonds is:
Investment in Pam bonds 950,000

Cash 950,000

7-38
Workpaper entry
If we prepare consolidated financial statements
immediately after the constructive retirement,
the workpaper entry to eliminate intercompany
bond investment and liability balances
includes the $60,000 gain as follows:
Jan. 1,2012
10% bonds payable 1,010,000
Investment in Pam bonds 950,000
Gain on retirement of bonds 60,000

6-39
Interest and Amortization Entries 2012
Pam books:
July 1 Interest expense 500,000
Cash 500,000
($10,000,000 * 10% * ½)
Dec. 31 Interest expense 500,000
Interest payable
500,000
Dec. 31 Premium on bonds 20,000
Interest expense 20,000
amortization of premium
on bonds (100,000/5 years)
7-40
Sue books:
July 1 Cash 50,000
Interest income 50,000
($1,000,000 * 10% * ½)
Dec. 31 Interest receivable 50,000
Dec. 31 Investment in Pam
bonds 10,000
amortization of discount
on bonds (50,000/5)
7-41
Amortizations and Interest
Book
value Fiscal Year Book value Fiscal Year Book value
PAM’S BOOKS: 1/1/2012 2012 12/31/ 2012 2013 12/31/ 2013
Bonds payable $10,100 -$20 $10,080 -$20 $10,060
Retired 10% $1,010 $1,008 $1,006
500+500-20 500+500-20
Interest expense =$980 =$980
Retired 10% $98 $98

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

7-42
Worksheet Entries for Bonds
Entries for 2012 worksheet.
Bonds payable (-L) 1,008
Investment in bonds (-A) 960
Gain on retirement of bonds (Ga, +SE) 48
Interest income (-R, -SE) 110
Interest expense (-E, +SE) 98
Interest payable (-L) 50
Interest receivable (-A) 50
Had a consolidated balance sheet been prepared on 1/1/2012, 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.
7-43
Piecemeal Recognition
 The constructive gain of $60 is recognized in 2012
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 Sue was the issuer, the $12 would be shared among
the controlling and noncontrolling interests.

7-44
Pam ‘s Investment Income
Sue’s reported income: $220,000
Pam’s invested income is calculated as follows:
70% of Sue’s reported income $154,000
Add: constructive gain on bonds 60,000
Less: piecemeal recognition of gain
(60,000/5 years) 12,000
Income from Sue $202,000
 Noncontrolling interest share: 30%(220,000) = $66,000

7-45
Entries On Pam’s Books
Dec 31, 2012
1. Investment in Sue 154,000
Income from Sue 154,000
record investment income
(22,000 *70%)
2. Investment in Sue 60,000
To adjust income from Sue for 100% of
the $60,000 constructive gain on bonds
3. Income from Sue 12,000
Investment in Sue 12,000
Either 60,000gain/5 years or$110,000
interest income - $98,000 interest expense
7-46
Book
PAM’S BOOKS: 1/1/2012 2012 12/31/ 2012 2013 12/31/ 2013
Bonds payable $10,100 -$20 $10,080 -$20 $10,060
Retired 10% $1,010 $1,008 $1,006
500+500-20 500+500-20
Retired 10% $98 $98

SUE'S BOOKS:
Investment in $950 +$10 $960 +$10 $970
bonds
50+50+10 50+50+10

7-47
aBonds payable (-L) 1,008
bInterest income (-R, -SE) 110

cIncome from Sue (-R,-SE) 202

Investment in Sue(-A) 202

7-48
d Noncontrolling interest share (-SE) 66
Noncntrolling interest (+SE) 66
e Retained earnings--Sue (-SE) 4,000

Common stock—Sue (-SE) 5,000
Investment in Sue—(-A) 6,300
Noncontrolling interest Jan 1, 2012 2,700
f Interest payable (-L) 50

Interest receivable(-A) 50

7-49
Pam's 2012 Worksheet
Year ended 12/31/2012 Pam Sue DR CR Consol
Income statement:
Sales $4,000 $2,000 $6,000
Income from Sue 202 c 202
a48
Gain on retirement of bonds b12 60
Interest income 110 b110
Expenses (1,910) (1,890) (3,800)
Interest expense (980) b98 (882)
Noncontrolling interest share d66 (66)
Net income/ Controlling share $1,312 $220 $1,312
Statement of retained earnings:
Beginning retained earnings $4,900 $4,000 e4,000 $4,900
Add net income 1,312 220 1312

Ending retained earnings $6,212 $4,220 $6,212

4-50
Balance sheet, 12/31/2012: Pak San DR CR Consol
Other assets $39,880 $19,100 $58,980
Interest receivable 50 f50 40
Investment in Sue 6,502 c202 0.0
e6,300
Investment in Pam bonds 960 a960
Total $46,382 20,110 $58,980
Liabilities $9,590 $10,890 $20,480
Interest payable 500 f50 450
10% bonds payable 10,080 a1,008 9,072
Common stock 20,000 5,000 e5,000 20,000
Retained earnings 6,212 4,220 6,212
$46,382 $20,110
Noncontrolling interest, Jan.1 d66
Noncontrolling interest, Dec. 31 e2,700 2,767
$58,980
4-51
2013 Worksheet Entries
Entries for 2013 worksheet, assuming that Pam
has not yet paid the second interest payment.
Investment in Sue (-A) 48

7-52
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 2013.
 The Investment in Sue account will be credited by $36
in 2014, by $24 in 2015, and so forth.
 Had Sue been the issuer, the $48 credit for 2012 would
be shared between:
 Investment in Sue and
 Noncontrolling Interest

7-53
4: EFFECT ON
NONCONTROLLING
INTEREST

7-54
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

7-55
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

7-56
Parent Acquires Subsidiary Bonds
Pro owns 90% of Sky, acquired at book value. Sky's net
income for 2012 is $750,000.
On 1/1/12, Sky has $10,000,000 bonds outstanding with
unamortized discount of $300,000. Bonds mature in 5
years. Straight line amortization. Interest is 10%
payable semi-annually. Interest expense = $1,060,000.
On 1/1/12, Pro acquires $5,000,000 of Sky's bonds on
the open market at $5,150,000. Straight line. Interest
income = $470,000.
 Portion of bonds retired: 5,000/10,000 = 50%
 Loss on retirement: 50%(9,700) – 5,150 = -$300
 Pine's Investment in Sky: 90%(750 – 300 + 530 - 470) = $459
 Noncontrolling interest share: 10%(750 – 300 + 530 - 470) = $51
7-57

Constructive loss is computed as follows:
50% ($10,000,000 par - $300,000)
Purchase price 5,150,000
 Loss on retirement: 50%(9,700) – 5,150 = $ 300,000
The only entry Pro makes when purchasing Sky bonds is:
Investment in Scent bonds 5,150,000

Cash 5,150,000

7-58
Workpaper entry
includes the $300,000 loss as follows:
Jan. 1,2012
Loss on retirement of bond 300,000
Investment in Skybonds 5,150,000

6-59
Sky books:
Cash 500,000
($10,000,000 * 10% * ½)
Interest payable
500,000
Discount on bonds 60,000
on Copyright
bonds (300,000/5 years)
©2012 Pearson Education,
7-60
Pro books:
July 1 Cash 250,000
($10,000,000 * 50%)*10% * ½)
Dec. 31 Interest income 30,000
Investment in bonds 30,000

on bonds (150,000/5)
7-61
Book
Sky'S BOOKS: 1/1/2012 2012 12/31/2012 2013 12/31/2013
Bonds payable $9,700 +$60 $9,760 +$60 $9,820
Retired 50% $4.850 $4,880 $4,910
500+500+ 500+500+60
Interest expense 60=$1,060 =$1,060
Retired 50% $530 $530

Pro'S BOOKS:
Investment in $5,150 -$30 $5,120 -$30 $5,090
bonds
250+250-30 250+250-30

7-62
Entries On Pro Books
Dec 31, 2012
1. Investment in Sky 675,000
Income from Sky 675,000
(750,000 *90%)
2. Income from Sky 270,000
Investment in Sky 270,000
To adjust income from Scent for 90% of
the $300,000 constructive loss on bonds
3. Investment in Sky 54,000
Income from Sky 54,000
Either 90% (300,000 loss/5years) or $
470,000interest income - $530,000 interest expense
7-63
2012 Entries with Loss
Entries for 2012 worksheet, assuming the
second interest payment has not yet been paid.
Loss on retirement of bonds (Lo, -SE) 300
Investment in bonds (-A) 5,120

7-64
Book
Sky'S BOOKS: 1/1/2012 2012 12/31/2012 2013 12/31/2013
Bonds payable $9,700 +$60 $9,760 +$60 $9,820
Retired 50% $4,850 $4,880 $4,910
500+500+ 500+500+60
Retired 50% $530 $530

Pro'S BOOKS:
Investment in $5,150 -$30 $5,120 -$30 $5,090
bonds
250+250-30 250+250-30

7-65
Book
Sky'S BOOKS: 1/1/2014 2014 12/31/2014 2015 12/31/2015
Bonds payable $9,820 +$60 $9,880 +$60 $9,940
Retired 50% $4,910 $4,940 $4,970
500+500+ 500+500+60
Retired 50% $530 $530

Pro'S BOOKS:
Investment in $5,090 -$30 $5,060 -$30 $5,030
bonds
250+250-30 250+250-30

7-66
SUMMARY OF CONSOLIDATION
WORKPAPER ADJUSTMENTS
December 31 2013 2014 2015 2016
Debits
Investment in Sky $ 216 $ 162 $ 108 $ 54
(90%)
Noncontrolling 24 18 12 6
interest (10%)
Interest Income 470 470 470 470

10 % bonds 4,910 4,940 4,970 5,000
payable
Interest payable 250 250 250 250
Credits
Investment in Sky $5,090 $5,060 $5,030 $5,000
bonds
Interest expense 530 530 530 530
Interest receivable 250 250 250 250


7-67
Entries for 2013 worksheet, assuming that
Scent has not yet paid the second interest
payment.
Investment in Sky (+A) 216
Non controlling interest 24
7-68
Pine owns 80% of Scent, acquired at book value.
Scent's net income for 2012 is $500,000.
On 1/1/12, Scent has $5,000,000 bonds outstanding
with unamortized discount of $200,000. Bonds mature
in 8 years. Straight line amortization. Interest is 10%
payable semi-annually. Interest expense = $525,000.
On 1/1/12, Pine acquires $2,000,000 of Scent's bonds
on the open market at $2,040,000. Straight line.
Interest income = $195,000.
 Portion of bonds retired: 2,000/5,000 = 40%
 Loss on retirement: 40%(4,800) – 2,040 = -$120
 Pine's Investment in Scent: 80%(500 – 120 + 210 - 195) = $316
 Noncontrolling interest share: 20%(500 – 120 + 210 - 195) = $79
7-69

Constructive gain is computed as follows:
40% ($5,000,000 par - $200,000)
Purchase price 2,040,000
 Loss on retirement: 40%(4,800) – 2,040 = $ 120,000
The only entry Pine makes when purchasing Scent bonds is:

Cash 2,040,000

7-70
Workpaper entry
includes the $120,000 loss as follows:
Jan. 1,2012
Loss on retirement of bond 120,000

6-71
Scent books:
Cash 250,000
($5,000,000 * 10% * ½)
Interest payable
250,000
Discount on bonds 25,000
on Copyright
bonds (200,000/8 years)
©2012 Pearson Education,
7-72
Pine books:
July 1 Cash 100,000
($5,000,000 * 40%)*10% * ½)
Dec. 31 Interest income 5,000
Investment in bonds 5,000

on bonds (40,000/8)
7-73
Book
SCENT'S BOOKS: 1/1/2012 2012 12/31/2012 2013 12/31/2013
Bonds payable $4,800 +$25 $4,825 +$25 $4,850
Retired 40% $1,920 $1,930 $1,940
250+250+25 250+250+25
Retired 40% $210 $210

PINE'S BOOKS:
Investment in $2,040 -$5 $2,035 -$5 $2,030
bonds
100+100-5 100+100-5

7-74
Entries On Pines Books
Dec 31, 2012
1. Investment in Scent 400,000
Income from Scent 400,000
(500,000 *80%)
2. Income from Scent 96,000
Investment in Scent 96,000
To adjust income from Scent for 80% of
the $120,000 constructive loss on bonds
3. Investment in Scent 12,000
Either 80% (120,000 loss/8years) or $
195,000interest income - $210,000 interest expense
7-75
2012 Entries with Loss
Entries for 2012 worksheet, assuming the
second interest payment has not yet been paid.
Loss on retirement of bonds (Lo, -SE) 120

7-76
Book
SCENT'S BOOKS: 1/1/2012 2012 12/31/2012 2013 12/31/2013
Bonds payable $4,800 +$25 $4,825 +$25 $4,850
Retired 40% $1,920 $1,930 $1,940
250+250+25 250+250+25
Retired 40% $210 $210

PINE'S BOOKS:
Investment in $2,040 -$5 $2,035 -$5 $2,030
bonds
100+100-5 100+100-5

7-77
Entries for 2013 worksheet, assuming that
Scent has not yet paid the second interest
payment.
Investment in Scent (+A) 84
Noncontrooling interest 21
7-78
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Chapter 7:

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A direct intercompany debt transfer involves a

Which of the following statements is true?

Which of the following statements is true?

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Eliminate Intercompany Interest:

These entries have no effect on consolidated net income because they

When the coupon or nominal interest rate on a

Entries by the debtor

December 31, 20X1

Entries by the bond investor

December 31, 20X1

Consolidation entries at year-end:

Peerless Special Unadjusted Consolidated

Consolidation entries at year-end:

Eliminate Intercorporate Bond Holdings:

Eliminate Intercompany Interest:

Eliminate Intercompany Interest Receivable/Payable:

The consolidation elimination entries related to the bonds

Eliminate Intercompany Interest:

Eliminate Intercompany Interest Receivable/Payable:

Bond interest income or expense recorded does

On January 1, 20X1, Peerless Products purchases $100,000 par value, 12

Entries by the debtor

Entries by the bond investor

Consolidation entries at year-end:

Peerless Special Unadjusted Consolidated

Consolidation entries at year-end:

Eliminate Intercompany Interest:

Eliminate Intercompany Interest Receivable/Payable:

Consolidation entries at year-end:

Eliminate Intercompany Interest:

Eliminate Intercompany Interest Receivable/Payable:

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Scenario: Bonds that were issued to an

When a constructive retirement occurs,

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 Portion of bonds retired: 1,000,000/10,000,000 = 10%

Investment in Pam bonds 950,000

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 Noncontrolling interest share: 30%(220,000) = $66,000

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bInterest income (-R, -SE) 110

cIncome from Sue (-R,-SE) 202

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e Retained earnings--Sue (-SE) 4,000

f Interest payable (-L) 50

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Copyright ©2012 Pearson Education,