1. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-1 Intercompany Indebtedness 8 Electronic Presentation by Douglas Cloud Pepperdine University Baker / Lembke / King

2. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-2 Bonds of Affiliate Purchased from a Non- affiliate Acquisition of bonds of an affiliate by another consolidated entity: Constructive retirement If the acquisition value is the same with liability reported by debtor (at book value), the elimination is the same with direct inter- corporate debt transfer Problems if purchase at other than book value (less than or more than book value)

3. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-3 Bonds of Affiliate Purchased from a Nonaffiliate PT Anak Consolidated Entity PT Induk January 1, 20X1 Issuance of debt for Rp102,000,000 PT Nonafiliasi Purchase of debt by PT Induk for Rp91,000,000 on December 31, 20X1 8-10

4. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-4 Entry by PT Anak (15) Jan. 1 Cash102,000,000 Bonds Payable100,000,000 Premium on Bonds Payable2,000,000 Sale of bonds to Nonaffiliated. On January 1, 20X1, PT Anak issues 10-year, 12 percent, semi annually bonds payable with a par value of Rp100,000,000; the bonds are issued at 102. The bonds are purchased from PT Anak by PT Nonafiliasi. PT Anak PT Nonafiliasi PT Anak Rp100,000, 000 PT Anak Rp100,000, 000 Bond Liability Entries--20X1

5. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-5 Entries by PT Anak (16) June 30Interest Expense5,900,000 Premium on Bonds Payable100,000 Cash6,000,000 Semiannual payment of interest. Bond Liability Entries--20X1 Rp2,000,000 ÷ 20 interest periods Rp100,000,000 x.12 x 6/12 (17)Dec. 31Interest Expense5,900,000 Premium on Bonds Payable100,000 Cash6,000,000 Semiannual payment of interest.

6. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-6 Entries by PT Induk Bond Investment Entry--20X1 (18) Dec. 31Investment in PT Anak Bonds91,000,000 Cash91,000,000 Purchase of PT Anak bonds from PT Nonafiliasi. This entry is the same as if the bonds purchased were those of an unrelated company.

7. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-7 Constructive Debt Retirement-20X1 Computation of Gain on Constructive Retirement Book value of PT Anak’ bonds, December 31, 20X1 Rp101,800,000 Price paid by PT Induk to purchase bonds -91,000,000 Gain on constructive retirement of bondsRp 10,800,000 Constructive gain or loss is assigned to the issuing company. It is shown only in consolidation process Constructive gain or loss is assigned to the issuing company. It is shown only in consolidation process

8. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-8 Entries by PT Induk Basic Equity-Method Entries--20X1 (20) Investment in PT Anak Bonds40,000,000 Income from Subsidiary40,000,000 Record equity-method income: Rp50,000,000 x.80 (19) Cash24,000,000 Investment in PT Anak Stock24,000,000 Record dividends from PT Anak: Rp30,000,000 x.80

9. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-9 PT Induk PT Anak Eliminations Item Debits Credits Consolidated An entry is needed to eliminate the investment account during 20X1, the parent’s share of the subsidiary’s net income, and the dividends recognized during the year. Constructive Debt Retirement--20X1 (in ‘000) Income from Subsidiary40,000 Dividends Declared(60,000(30,000) Investment in PT Anak Stock256,000 )

10. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-10 Income from Subsidiary40,000 40,000 Dividends Declared(60,000(30,000)24,000 Investment in PT Anak Stock256,000 16,000 Constructive Debt Retirement--20X1 (in ‘000) ) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

11. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-11 Noncontrolling Interest’s Share of Income Net income of PT AnakRp50,000,000 Gain on constructive retirement of bond10,800,000 Realized net income of PT AnakRp60,800,000 Noncontrolling stockholders’ sharex.20 Noncontrolling interest’s share of incomeRp12,160,000

12. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-12 Income to Noncontrolling Interest Dividends Declared(60,000)(30,000) (21) 24,000 Noncontrolling Interest Constructive Debt Retirement--20X1 (in ‘000) An entry is required eliminate the income from the subsidiary. PT Induk PT Anak Eliminations Item Debits Credits Consolidated

13. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-13 Income to Noncontrolling Interest (22) 12,160(12,160) Dividends Declared(60,000)(30,000) (21) 24,000 (22) 6,000(60,000) Noncontrolling Interest (22) 6,160 Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

14. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-14 Retained Earn- ings, Jan. 1300,000 100,000 Investment in PT Anak Stock256,000 (21) 16,000 Common Stock500,000200,000 Noncontrolling Interest (22) 6,160 An entry is necessary to eliminate PT Induk’s investment account and the stockholders’ equity balances of PT Anak at the beginning of the year, and establish the amount of the noncontrolling interest at the beginning of the year. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

15. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-15 Retained Earn- ings, Jan. 1300,000 100,000 (23) 100,000300,000 Investment in PT Anak Stock256,000 (21) 16,000 (23) 240,000 Common Stock500,000200,000 (23) 200,000500,000 Noncontrolling Interest6,160 (23) 60,00066,160 Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

16. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-16 Item PT Induk PT Anak Unadjusted Consolidated Totals Amounts Bonds Payable-0- Rp(100,000,000)Rp(100,000,000)-0- Premium on Bonds Payable-0- (1,800,000)(1,800,000)-0- Investment in BondsRp91,000,000 -0- 91,000,000 -0- Interest Expense-0- Rp 11,800,000 Rp 11,800,000 Rp11,800,000 Interest Income-0- -0- -0- -0- Gain on Bond Retirement-0- -0- -0- (10,800,000) Consolidated Balances--20X1

17. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-17 An entry is required to eliminate the intercompany bond holdings and recognize the gain on constructive retirement of the bonds. Gain on Bond Retirement Investment in PT Anak Bonds91,000 Bonds Payable200,000100,000 Premium on Bonds Payable1,800 Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

18. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-18 Gain on Bond Retirement (24) 10,80010,800 Investment in PT Anak Bonds91,000 (24) 91,000 Bonds Payable200,000100,000 (24) 100,000200,000 Premium on Bonds Payable1,800 (24) 1,800 Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

19. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-19 PT Induk’s separate operating incomeRp140,000,000 PT Induk’s share of PT Anak’ income: PT Anak’ net incomeRp50,000,000 Gain on constructive retirement of bonds10,800,000 PT Anak’ realized incomeRp60,800,000 PT Induk’s proportionate sharex.80 48,640,000 Consolidated net income, 20X1Rp188,640,000 Consolidated Net Income--20X1

20. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-20 Book value of PT Anak, December 31, 20X1: Common stockRp200,000,000 Retained earnings120,000,000 Total reported book valueRp320,000,000 Gain on constructive retirement of bonds 10,800,000 Realized book value of PT AnakRp330,800,000 Noncontrolling stockholders’ sharex.20 Noncontrolling interest, December 31, 20X1Rp 66,160,000 Noncontrolling Interest--20X1

21. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-21 Entries by PT Anak (25) June 30Interest Expense5,900,000 Premium on Bonds Payable100,000 Cash6,000,000 Semiannual payment of interest. Bond Liability Entries--20X2 Rp2,000,000 ÷ 20 interest periods Rp100,000,000 x.12 x 6/12 (26)Dec. 31Interest Expense5,900,000 Premium on Bonds Payable100,000 Cash6,000,000 Semiannual payment of interest.

22. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-22 Entries by PT Induk Bond Investment Entry--20X2 (27) June 30Cash6,000,000 Investment in PT Anak Bonds500,000 Interest Income6,500,000. (28) Dec 31Cash6,000,000 Investment in SF Bonds500,000 Interest Income6,500,000 Record receipt of Bond Interest. Amortization of discount recorded per year: (Rp100,000,000 - Rp91,000,000) / 9 = Rp1,000,000. Per semester = Rp1,000,000 / 2 = Rp500,000

23. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-23 Subsequent Recognition of Gain Bond premium Bond discount Rp1,800,000 Rp9,000,000 Issue Purchase by affiliate Constructive gain of Rp10,800,000 Carrying amount of bond investment Book value of bond liability Maturity Rp2,000,000 Rp100,000,000

24. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-24 Subsequent Recognition of Gain At Dec 20X1, Constructive Gain of Rp10,800,000 can be divided into: PT Induk’ discount on bond investment 9,000,000 PT Anak’s premium on bond liability 1,800,000 Total constructive gain on retirement 10,800,000 Subsequent recognition: PT Induk’discount amortization (9,000,000 / 9 years) 1,000,000 PT Anak’s premium amortization (1,800,000 / 9 years) 200,000 Annual increase each year 1,200,000

25. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-25 Investment Account--20X2 Investment in PT Anak Stock Original cost240,000,000 20X1 Equity accrual (Rp50,000,000 x.80) 40,000,000 Balance, 12/31/X1256,000,000 Equity accrual (Rp75,000,000 x.80) 60,000,000 Balance, 12/31/X2284,000,000 Dividends (Rp30,000,000 x.80)24,000,000 Dividends (Rp40,000,000 x.80)32,000,000

26. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-26 An entry is needed to eliminate the investment account during 20X2, the parent’s share of the subsidiary’s net income, and the dividends recognized during the year. Consolidation Workpaper--20X2 (in ‘000) Income from Subsidiary60,000 Dividends Declared(60,000(40,000) Investment in PT Anak Stock284,000 ) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

27. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-27 Consolidation Workpaper--20X2 (in ‘000) Income from Subsidiary60,000 (31) 60,000 Dividends Declared(60,000(40,000) (31) 32,000 Investment in PT Anak Stock284,000 (31) 28,000 ) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

28. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-28 Noncontrolling Interest’s Share of Income Net income of PT AnakRp75,000,000 Less gain on constructive retirement of bond recognized in 2002: Amort. PT Induk’s Bond discount(1,000,000) Amort PT Anak’s Bond Premium (200,000) Realized net income of PT AnakRp73,800,000 Noncontrolling stockholders’ sharex.20 Noncontrolling interest’s share of incomeRp14,760,000

29. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-29 Income to Noncontrolling Interest Dividends Declared(60,000)(40,000) (31) 32,000 Noncontrolling Interest Consolidation Workpaper--20X2 (in ‘000) An entry is required eliminate the income from the subsidiary. PT Induk PT Anak Eliminations Item Debits Credits Consolidated

30. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-30 Consolidation Workpaper--20X2 (in ‘000) Income to Noncontrolling Interest (32) 14,760(14,760) Dividends Declared(60,000)(40,000) (31) 32,000 (32) 8,000(60,000) Noncontrolling Interest (32) 6,760 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

31. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-31 Retained Earn- ings, Jan. 1420,000 120,000 Investment in PT Anak Stock284,000 (21) 28,000 Common Stock500,000200,000 Noncontrolling Interest (32) 6,760 An entry is necessary to eliminate PT Induk’s investment account and the stockholders’ equity balances of PT Anak at the beginning of the year, and establish the amount of the noncontrolling interest at the beginning of the year. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

32. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-32 Retained Earn- ings, Jan. 1420,000 120,000 (33) 120,000 420,000 Investment in PT Anak Stock284,000 (31) 28,000 (33) 256,000 Common Stock500,000200,000 (33) 200,000500,000 Noncontrolling Interest (32) 6,760 (33) 64,000 Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

33. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-33 Journal elimination no 34 – 20X2 Bonds Payable100,000,000 Premium on B/P 1,600,000 Interest Income 13,000,000 Investment in PT Anak Bonds92,000,000 Interest Expense11,800,000 R/E, Jan 1 8,640,000 Noncontrolling Interest 2,160,000

34. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-34 Interest Income13,000 Interest Expense20,00011,800 Investment in PT Anak Bonds92,000 Bonds Payable200,000100,000 Premium on Bonds Payable1,600 Noncontrolling Interest (32) 6,760 (33) 4,000 Consolidation Workpaper--20X2 (in ‘000) An entry is required to eliminate intercompany holdings. PT Induk PT Anak Eliminations Item Debits Credits Consolidated

35. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-35 Retained Earn- ings, Jan. 1 420,000 120,000 (33) 120,000 (34) 8,640 428,640 Interest Income13,000 (34) 13,000 Interest Expense20,00011,800 (34) 11,80020,000 Investment in PT Anak Bonds92,000 (34) 92,000 Bonds Payable200,000100,000 (34) 100,000200,000 Premium on Bonds Payable1,600 (34) 1,600 Noncontrolling Interest (32) 6,760 (33) 4,000 (34) 2,16072,920 Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

36. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-36 PT Induk’s separate operating incomeRp173,000,000 PT Induk’s share of PT Anak’ income: PT Anak’ net incomeRp75,000,000 PT Induk’s amortization of bond discount- 1,000,000 PT Anak’ amortization of bond premium - 200,000 Income as a basis of apportionmentRp73,800,000 PT Induk’s proportionate sharex.80 59,040,000 Consolidated net income, 20X2Rp232,040,000 Consolidated Net Income--20X2

37. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-37 Journal elimination for B/P – 20X3 Bonds Payable100,000,000 Premium on B/P 1,400,000 Interest Income 13,000,000 Investment in PT Anak Bonds93,000,000 Interest Expense11,800,000 R/E, Jan 1 7,680,000 Noncontrolling Interest 1,920,000

38. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-38 Purchase at Greater than Book Value When an affiliate’s bonds are purchased from a nonaffiliate at an amount greater than their book value, a loss is recognized on the constructive retirement of the debt. All other aspects of the consolidation process remain the same, that is, there are no other differences between constructive loss and a constructive gain.

39. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-39 You Will Survive This Chapter !!! The effects of intercompany debt transactions must be eliminated completely in preparing consolidated financial statements, just as with other types of intercompany transactions. Only debt transactions between the consolidated entity and unaffiliated parties are reported in the consolidated statements.

40. McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 8-40 Chapter Eight The End