1. Chapter 7: Intercompany Profit Transactions – Bonds
Beams, Advanced Accounting 10e, Ch. 7
4/15/2017
Chapter 7: Intercompany Profit Transactions – Bonds
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn
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2. Intercompany Profits on Bonds: Objectives
Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity.
Defer unrealized profits and later recognize realized profits on bond transfers between parent and subsidiary companies.
Demonstrate how a consolidated reporting entity constructively retires debt.
Adjust calculation of noncontrolling interest amounts in the presence of intercompany profits on debt transfers.
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3. 1: Intercompany Receivables and Payables
Intercompany Profit Transactions – Bonds
1: Intercompany Receivables and Payables
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4. Intercompany Payables and Receivables
Remove intercompany:
Payables and interest expense
Receivables and interest income
Loans directly between affiliates generally pose no special problems
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5. 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
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6. Constructive Retirement
One company purchases debt instruments of an affiliate from outside entities
Constructive gains and losses on bonds are
Realized gains and losses from the consolidated viewpoint
That arise when a company purchases the bonds of an affiliate
From other entities
At a price other than the book value of the bonds.
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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
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8. 2: Profits on Bonds Intercompany Profit Transactions – Bonds
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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
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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
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11. Amortizations and Interest
Book value
During 
 During
Pam's books:
1/1/2010
2010
12/31/2010
2011
12/31/2011
Bonds payable
$10,100
-$20
$10,080
$10,060
10% retired
$1,010
$1,008
$1,006
Interest expense
=$980
=$980
$98
Sue's books:
Investment in bonds
$950
+$10
$960
$970
Interest income
=$110
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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 payable
1,008
Investment in bonds
960
Gain on retirement of bonds 48
Interest income
110
Interest expense 98 12
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13. 3: Constructive Retirement of Debt
Intercompany Profit Transactions – Bonds
3: Constructive Retirement of Debt
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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.
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15. 2011 Worksheet Entries
Entries for 2011 worksheet, assuming that Pam has not yet paid the second interest payment.
Bonds payable
1,006
Interest income
110
Investment in bonds
970
Interest expense 98
Investment in Sue 48
Interest payable 50
Interest receivable
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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.
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17. 4: Effect on Noncontrolling Interest
Intercompany Profit Transactions – Bonds
4: Effect on Noncontrolling Interest
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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
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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
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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 – ) = $316
Noncontrolling interest share: 20%(500 – ) = $79
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21. Amortizations and Interest
Book value
During 
 During
Scent's books:
1/1/2010
2010
12/31/2010
2011
12/31/2011
Bonds payable
$4,800
+$25
$4,825
$4,850
40% retired
$1,920
$1,930
$1,940
Interest expense
=$525
$210
Pine's books:
Investment in bonds
$2,040
-$5
$2,035
$2,030
Interest income
=$195
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22. 2010 Entries with Loss Entries for 2010 worksheet. Bonds payable 1,930
Interest income
195
Loss on retirement of bonds
120
Interest expense
210
Investment in bonds
2,035
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23. Amortizations and Interest
Book value
During 
 During
Scent's books:
1/1/2010
2010
12/31/2010
2011
12/31/2011
Bonds payable
$4,800
+$25
$4,825
$4,850
40% retired
$1,920
$1,930
$1,940
Interest expense
=$525
$210
Pine's books:
Investment in bonds
$2,040
-$5
$2,035
$2,030
Interest income
=$195
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24. 2011 Worksheet Entries
Entries for 2011 worksheet, assuming that Scent has not yet paid the second interest payment.
Bonds payable
1,940
Interest income
195
Investment in Scent
105
Investment in bonds
2,030
Interest expense
210
Interest payable
100
Interest receivable
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Copyright © 2009 Pearson Education, Inc.   Publishing as Prentice Hall
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