1

Baker / Lembke / King

Intercompany
Indebtedness
8
© The McGraw-Hill
© The McGraw-Hill
Irwin/McGraw-Hill Companies,
Companies,
Inc., 1999 Inc., 1999
 2
Direct Intercompany Debt Transfer

Peerless Special
Products Foods
Intercorporate
debt

Consolidated Entity
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 3
Indirect Intercompany Debt Transfer

Peerless Special Nonaffiliated

Products Foods Corporation
Issuance of
debt

Purchase of debt by
Peerless

Consolidated Entity
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
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Bond Sale Directly to an Affiliate

On January 1, 19X1, Special Foods borrows $100,000 from

Peerless Products by issuing to Peerless $100,000 par
value, 12 percent bonds.

Elimination Entries

Bonds Payable 100,000

Investment in Special Foods Bonds 100,000

Interest Income 12,000

Interest Expense 12,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

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Bond Sale Directly to an Affiliate

On January 1, 19X1, Peerless Products purchases

$100,000 par value, 12 percent, 10-year bonds from
Special Foods for $90,000.

Entries by Special Foods

Jan. 1 Cash 90,000

Discount on Bonds Payable 10,000
Bonds Payable 100,000
July 1 Interest Expense 6,500
Discount on Bonds Payable $10,000/20 500
Cash 6,000

Same entry on December 31,

except Interest Payable is $100,000 x .12 x 6/12
Irwin/McGraw-Hill credited for $6,000. © The McGraw-Hill Companies, Inc., 1999
 6
Bond Sale Directly to an Affiliate

On January 1, 19X1, Peerless Products purchases

$100,000 par value, 12 percent, 10-year bonds from
Special Foods for $90,000.

Entries by Peerless Products

Jan. 1 Investment in Special Foods Bonds 90,000

Cash 90,000
July 1 Cash 6,000
Investment in Special Foods Bonds 500
Interest Income 6,500

Same entry on December 31,

except Interest Receivable is
Irwin/McGraw-Hill
debited for $6,000. © The McGraw-Hill Companies, Inc., 1999
 7
Bond Related Amounts, December 31, 19X1

Peerless Special Unadjusted Consolidated

Item Products Foods Totals Amounts
Bonds Payable -0- $(100,000) $(100,000) -0-
Disc. on Bonds Pay. -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-

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

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Constructive Debt Retirement

January 1,
19X1
Issuance of
debt for
$102,000
Peerless Special Nonaffiliated
Products Foods Corporation

Purchase of debt by Peerless for

$91,000 on December 31, 19X1

Consolidated Entity
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
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Constructive Debt Retirement
On January 1, 19X1, Special Foods issues 10-year, 12
percent bond payable with a par value of $100,000; the
bonds are issued at 102. The bonds are purchased from
Special Foods by Nonaffiliated Corporation.

Entry by Special Foods

Jan. 1 Cash 102,000

Bonds Payable 100,000
Premium on Bonds Payable 2,000

Special Foods

$100,000

Special Foods

$100,000

Nonaffliliated
Special
Corporation
Foods
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Constructive Debt Retirement

On December 31, 19X1 Peerless Products records

the purchase of Special Foods’ bonds from
Nonaffiliated for $91,000.

Entry by Peerless Products

Dec. 31 Investment in Special Foods Bonds 91,000

Cash 91,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

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Constructive Debt Retirement

Computation of Gain on Constructive Retirement

Book value of Special Foods’ bonds,

December 31, 19X1 $101,800
Price paid by Peerless to purchase bonds (91,000)
Gain on constructive retirement of bonds $ 10,800

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

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Constructive Debt Retirement

On June 30, record payment of interest and

amortization of the bond premium.

Entries by Special Foods

June 30 Interest Expense 5,900

Premium on Bonds Payable 100
Cash 6,000

$2,000 ÷ 20
This entry is repeated $100,000 x .12
on December 31 x 6/12

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

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Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Income from
Subsidiary 40,000

Dividends
Declared (60,000) (30,000)

Investment in
Special Foods 256,000

An entry is needed to eliminate the investment

account during 19X1, the parent’s share of the
subsidiary’s net income, and the dividends
recognized during the year.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
 14
Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Income from
Subsidiary 40,000 40,000

Dividends
Declared (60,000) (30,000) 24,000

Investment in
Special Foods 256,000 16,000

An entry is needed to eliminate the investment

account during 19X1, the parent’s share of the
subsidiary‘s net income, and the dividends
recognized during the year.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
 15
Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Income to
Noncontrolling
Interest

Dividends
Declared (60,000) (30,000) 24,000

Noncontrolling
Interest

Income of $12,160 is assigned to the noncontrolling interest:

Net income of Special Foods $50,000
Gain on constructive retirement of bonds 10,800
Realized net income of Special Foods $60,800
Noncontrolling stockholders’ share ($60,800 x.20) $12,160
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
 16
Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Income to
Noncontrolling
Interest 12,160

Dividends
Declared (60,000) (30,000) 24,000
6,000 (60,000)
Noncontrolling
Interest 6,160

Income of $12,160 is assigned to the noncontrolling interest:

Net income of Special Foods $50,000
Gain on constructive retirement of bonds 10,800
Realized net income of Special Foods $60,800
Noncontrolling stockholders’ share ($60,800 x.20) $12,160
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
 17
Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Retained Earn-
ings, Jan. 1 300,000 100,000
Investment in
Special Foods
Stock 256,000 16,000

Common Stock 500,000 200,000

Noncontrolling
Interest 6,160

An entry is necessary to eliminate Peerless’s investment

account and the stockholders’ equity balances of Special
Foods at the beginning of the year, and establish the amount
of the noncontrolling interest at the© beginning of the year.
Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 1999
 18
Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Retained Earn-
ings, Jan. 1 300,000 100,000 100,000 300,000
Investment in
Special Foods
Stock 256,000 16,000
240,000
Common Stock 500,000 200,000 200,000 500,000
Noncontrolling
Interest 6,160
60,000 66,160
An entry is necessary to eliminate Peerless’s investment
account and the stockholders’ equity balances of Special
Foods at the beginning of the year, and establish the amount
of the noncontrolling interest at the© beginning of the year.
Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 1999
 19
Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Gain on Bond
Retirement

Investment in
Special Foods
Bonds 91,000

Bonds Payable 200,000 100,000

Premium on
Bonds Payable 1,800

An entry is required to eliminate the

intercompany bond holdings and recognize the
gain on constructive retirement of the bonds.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
 20
Constructive Debt Retirement
19X1
Peerless Special Eliminations
Item Products Foods Debits Credits Consolidated
Gain on Bond
Retirement 10,800 10,800

Investment in
Special Foods
Bonds 91,000 91,000

Bonds Payable 200,000 100,000 100,000 200,000

Premium on
Bonds Payable 1,800 1,800

An entry is required to eliminate the

intercompany bond holdings and recognize the
gain on constructive retirement of the bonds.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999
 21
Constructive Debt Retirement

Peerless Special Unadjusted Consolidated

Item Products Foods Totals Amounts
Bonds Payable -0- $(100,000) $(100,000) -0-
Premium on
Bonds Payable -0- (1,800) (1,800) -0-
Investment
in Bonds $91,000 -0- 91,000 -0-
Interest Expense -0- $ 11,800 $ 11,800 $11,800
Interest Income -0- -0- -0- -0-
Gain on Bond
Retirement -0- -0- -0- (10,800)

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

 22
Constructive Debt Retirement

Peerless’s separate operating income $140,000

Peerless’s share of Special Foods’ income:
Special Foods’ net income $50,000
Gain on constructive retirement of bonds 10,800
Special Foods’ realized income $60,800
Peerless’s proportionate share x .80 48,640
Consolidated net income, 19X1 $188,640

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

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Constructive Debt Retirement

Book value of Special Foods, December 31, 19X1:

Common stock $200,000
Retained earnings 120,000
Total reported book value $320,000
Gain on constructive retirement of bonds 10,800
Realized book value of Special Foods $330,800
Noncontrolling stockholders’ share x .20
Noncontrolling interest, December 31, 19X1 $ 66,160

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999

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Chapter Eight

The
End

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999