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© Pearson Education, Inc. publishing as Prentice Hall7-1 Chapter 7: Intercompany Profit Transactions – Bonds by Jeanne M. David, Ph.D., Univ. of Detroit.

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Presentation on theme: "© Pearson Education, Inc. publishing as Prentice Hall7-1 Chapter 7: Intercompany Profit Transactions – Bonds by Jeanne M. David, Ph.D., Univ. of Detroit."— Presentation transcript:

1 © Pearson Education, Inc. publishing as Prentice Hall7-1 Chapter 7: Intercompany Profit Transactions – Bonds by Jeanne M. David, Ph.D., Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn

2 © Pearson Education, Inc. publishing as Prentice Hall7-2 Intercompany Profits on Bonds: Objectives 1.Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. 2.Defer unrealized profits and later recognize realized profits on bond transfers between parent and subsidiary companies. 3.Demonstrate how a consolidated reporting entity constructively retires debt. 4.Adjust calculation of noncontrolling interest amounts in the presence of intercompany profits on debt transfers.

3 © Pearson Education, Inc. publishing as Prentice Hall7-3 1: Intercompany Receivables and Payables Intercompany Profit Transactions – Bonds

4 © Pearson Education, Inc. publishing as Prentice Hall7-4 Intercompany Payables and Receivables Remove intercompany: –Payables and interest expense –Receivables and interest income Loans directly between affiliates generally pose no special problems

5 © Pearson Education, Inc. publishing as Prentice Hall7-5 Retirement of Debt 1.Issuing firm uses own resources to retire its own bonds – no intercompany (IC) issues 2.Issuing firm borrows from unaffiliated entity and uses funds to retire its own debt – no IC 3.Issuing firm borrows from affiliate and uses funds to retire its own debt – simple IC loan 4.Non-issuing firm purchases debt securities of an affiliate resulting in constructive retirement – IC constructive retirement

6 © Pearson Education, Inc. publishing as Prentice Hall7-6 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 © Pearson Education, Inc. publishing as Prentice Hall7-7 Agency Theory Agency theory –Assigns gain or loss to the issuing firm –Conceptually a superior than other methods Text: –Follows agency theory –Simplifies discussion using straight line amortization of premiums & discounts Other methods –Par value theory or assign all gain or loss to the parent

8 © Pearson Education, Inc. publishing as Prentice Hall7-8 2: Profits on Bonds Intercompany Profit Transactions – Bonds

9 © Pearson Education, Inc. publishing as Prentice Hall7-9 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

10 © Pearson Education, Inc. publishing as Prentice Hall7-10 Subsidiary Acquires Parent Bonds Pam owns 70% of Sue, acquired at book value. Sue's net income for 2010 is $220. On 1/1/10, Pam has $10,000 bonds outstanding with unamortized premium of $100. Bonds mature in 5 years. Straight line amortization. On 1/1/10, Sue 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 Sue: 70%(220) + 60 – 12 = $202 Noncontrolling interest share: 30%(220) = $66

11 © Pearson Education, Inc. publishing as Prentice Hall7-11 Amortizations and Interest Book valueDuring Book value DuringBook value Pam's books:1/1/2010201012/31/2010201112/31/2011 Bonds payable$10,100-$20$10,080-$20$10,060 10% retired$1,010 $1,008 $1,006 Interest expense 500+500-20 = $980 500+500-20 = $980 10% retired $98 Sue's books: Investment in bonds$950+$10$960+$10$970 Interest income 50+50+10 = $110

12 © Pearson Education, Inc. publishing as Prentice Hall7-12 Worksheet Entries for Bonds Entries for 2010 worksheet. Had a consolidated balance sheet been prepared on 1/1/2010, 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. Bonds payable1,008 Investment in bonds960 Gain on retirement of bonds48 Interest income110 Interest expense 98 Gain on retirement of bonds 12

13 © Pearson Education, Inc. publishing as Prentice Hall7-13 3: Constructive Retirement of Debt Intercompany Profit Transactions – Bonds

14 © Pearson Education, Inc. publishing as Prentice Hall7-14 Piecemeal Recognition The constructive gain of $60 is recognized in 2010 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.

15 © Pearson Education, Inc. publishing as Prentice Hall7-15 2011 Worksheet Entries Entries for 2011 worksheet, assuming that Pam has not yet paid the second interest payment. Bonds payable1,006 Interest income110 Investment in bonds970 Interest expense 98 Investment in Sue 48 Interest payable50 Interest receivable50

16 © Pearson Education, Inc. publishing as Prentice Hall7-16 Subsequent Worksheet Entries Notice that there is no gain in subsequent years. The $60 is reduced each year by $12 and is a credit to the Investment in Sue account. Had Sue been the issuer, the $48 would be shared between Investment in Sue and Noncontrolling Interest.

17 © Pearson Education, Inc. publishing as Prentice Hall7-17 4: Effect on Noncontrolling Interest Intercompany Profit Transactions – Bonds

18 © Pearson Education, Inc. publishing as Prentice Hall7-18 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

19 © Pearson Education, Inc. publishing as Prentice Hall7-19 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

20 © Pearson Education, Inc. publishing as Prentice Hall7-20 Parent Acquires Subsidiary Bonds Pine owns 80% of Scent, acquired at book value. Scent's net income for 2010 is $500. On 1/1/10, Scent has $5,000 bonds outstanding with unamortized discount of $200. Bonds mature in 8 years. Straight line amortization. On 1/1/10, Pine acquires $2,000 of Scent's bonds on the open market at $2,040. Straight line. 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 + 15) = $316 Noncontrolling interest share: 20%(500 – 120 + 15) = $79

21 © Pearson Education, Inc. publishing as Prentice Hall7-21 Amortizations and Interest Book valueDuring Book value DuringBook value Scent's books:1/1/2010201012/31/2010201112/31/2011 Bonds payable$4,800+$25$4,825+$25$4,850 40% retired$1,920 $1,930 $1,940 Interest expense 250+250+25 = $525 40% retired $210 Pine's books: Investment in bonds$2,040-$5$2,035-$5$2,030 Interest income 100+100-5 = $195

22 © Pearson Education, Inc. publishing as Prentice Hall7-22 2010 Entries with Loss Entries for 2010 worksheet. Bonds payable1,930 Interest income195 Loss on retirement of bonds120 Interest expense 210 Investment in bonds 2,035

23 © Pearson Education, Inc. publishing as Prentice Hall7-23 Amortizations and Interest Book valueDuring Book value DuringBook value Scent's books:1/1/2010201012/31/2010201112/31/2011 Bonds payable$4,800+$25$4,825+$25$4,850 40% retired$1,920 $1,930 $1,940 Interest expense 250+250+25 = $525 40% retired $210 Pine's books: Investment in bonds$2,040-$5$2,035-$5$2,030 Interest income 100+100-5 = $195

24 © Pearson Education, Inc. publishing as Prentice Hall7-24 2011 Worksheet Entries Entries for 2011 worksheet, assuming that Scent has not yet paid the second interest payment. Bonds payable1,940 Interest income195 Investment in Scent105 Investment in bonds2,030 Interest expense 210 Interest payable100 Interest receivable100

25 © Pearson Education, Inc. publishing as Prentice Hall7-25 Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.


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