1. CHAPTER 5 5
Intercompany Bonds, Cash Flow, EPS, and Unconsolidated Investments Fundamentals of Advanced Accounting 1st Edition Fischer, Taylor, and Cheng

2. Intercompany Bonds
A subsidiary may have debt that is more expensive than if it were issued by the parent
One member of the affiliated group (usually the subsidiary) has bonds outstanding that are held by outsiders; the other member (usually the parent) purchases the bonds from the outsiders
Consolidation treatment (on Worksheet) is retirement with an ordinary gain or loss (no longer extraordinary)
The result is the same if the parent loans money to the subsidiary and the subsidiary retires the bonds
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3. Intercompany Bonds - Eliminations
Elimination entry B1:
Bonds payable/receivable are eliminated
Intercompany interest revenues/expenses are eliminated
Elimination entry B2:
Intercompany interest receivables/payables are eliminated
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4. Bond Issued at Face Value Example: Facts
Sub (80%) issues to third parties $100,000, 5-year, 8% bond on 1/1/20X1 at 100.
Int. Exp. = $8,000 per year
Parent purchases the bonds from third party for $103,600 on 1/2/20X3
3 remaining years
Discount amortization (st.-line) = $1,200 per year
Int. Rev. = $6,800 per year
Consolidated statements: $103,600 was paid to retire bonds with a book value of $100,000
There is $3,600 loss on the date of purchase
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5. Bond Example: General Ledger Journal Entries (Years 1–5)
Sub Journal Entries
Year 1
Cash 100,000
Bond Pay. 100,000
Int. Exp. 8,000
Int. Pay ,000
Year 2
Int. Exp 8,000
Int. Pay 8,000
Years 3, 4 & 5
Int. Pay. 8,000
Parent Journal Entries
Year 1
No entry
Year 2
Years 3, 4 & 5
Int. Rec. 8,000
Invest in Bond 1,200
Int. Pay. 6,800
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6. Bonds Issued at Face Value – Elimination entries at 12/31/X3
B1 Bond payable 100,000
Invest. In Bonds 102,400*
Interest income 6,800
Interest expense 8,000
Loss on Bond retirement 3,600
(eliminates intercompany bonds and interest expense)
* Net of $1,200 amortization of bond premium
B2 Interest payable 8,000
Interest receivable 8,000
(eliminates intercompany accrued interest)
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7. Bond Issued at Discount Example: Facts
Sub (80%) issues to third party $100,000, 5-year, 8% bond on 1/1/20X1 at $96,110.(Discount = $3,890)
Discount amortization (straight line) = $778 per year
Int. Exp. = $8,778 per year (Interest paid on 12/31)
Discount balance $1,556 at 12/31/X3
Parent purchases the bonds from third party for $103,600 on 12/31/20X3
2 remaining years
Premium amortization (st.-line) = $1,800 per year
Int. Rev. = $6,200 per year
Consolidated statements: $103,600 was paid to retire bonds with a book value of $98,444
There is $5,156 loss on the date of purchase
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8. Bond Example: Carrying Values
Parent buys 12/31/X3
$98,444 less $103,600 results in a $5,156 loss.
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9. Bond Issued at a Discount Example: Journal Entries (Years 4–5)
Sub Journal Entries
Year 4
Int. Exp. 8,778
Discount on BP 778
Cash 8,000
Year 5
Parent Journal Entries
Year 4
Bond Invest. 103,600
Cash 103,600
Cash. 8,000
Bond investment 1,800
Int. Rev. 6,200
Year 5
Cash 8,000
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10. Bonds Issued at Discount – Elimination entries at 12/31/X4
B Bond payable 100,000
Discount on Bonds payable 778
Invest. In Bonds ,800*
Interest income 6,200
Interest expense 8,778
Retained Earnings - P ,640**
Retained Earnings – S ^
(eliminates intercompany bonds and interest expense)
* Net of $1,200 amortization of bond premium
**$5,156 loss x 80%
^$5,156 loss x 20%
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11. Worksheet 5-3: Eliminations (12/31/X4) Bonds Issued at a Discount
Bonds issued at a discount/premium does not change consolidation entries.
Bonds issued at a discount/premium does require additional calculations.
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12. Effective Interest Method
Procedures for elimination do not change!
Only dollar values are different…
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13. Effective Interest Bond Example: Facts
Sub issues to third party a $100,000, 5-year, 8% bond on 1/1/20X1 for $96,110
Parent purchases the bonds from outsiders for $103,667 on 12/31/20X3 (2 remaining years)
Consolidated statements: $103,667 was paid to retire bonds with a book value of $98,240.
There is a $5,427 loss
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14. Effective Interest Bond Example: Amortization Tables
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15. Bonds Issued at Discount – Elimination entries at 12/31/X4
B Bond payable 100,000
Discount on Bonds payable 918
Invest. In Bonds ,887*
Interest income 6,220
Interest expense 8,842
Retained Earnings - P ,342**
Retained Earnings – S ,085^
(eliminates intercompany bonds and interest expense)
* Net of $1,780 amortization of bond premium
**$5,427 loss x 80%
^$5,427 loss x 20%
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16. Consolidated Cash Flow: The Issues
Consolidated Statement of Cash Flows is required – FASB No. 95
Use consolidated financial statements to analyze cash flow
Intercompany transactions already eliminated…no effect
Investment and financing activities reported (even if non-cash)
Cash purchase is investing
Stock issue is a noncash transaction
Amortizations are a non-cash adjustment to operations
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17. Cash Purchase: Example
Balance Sheet of Company Acquired
Cash 50,000 Liabilities 1500,000
Inventory 60,000
Building 190,000 Common Stock 200,000
Equipment 400,000 Retained Earnings 350,000
Total 700, Total 700,000
Building Fair Value = $425,000; Life = 10 years
Equipment Fair Value = $250,000; Life = 5 years
Goodwill = Excess of price paid over fair value of net assets
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18. Cash Purchase: Example (continued)
D&D Schedule
Price paid 540,000
Interest (80%  $550,000) 440,000
Excess 100,000
Allocate to building (80%  25,000) (20,000) 10-year
Allocate to equipment (80% x 60,000) (48,000) 5-year
Goodwill 32,000
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19. Cash Purchase: Example (continued)
To see cash flow impact, consider additions to parent balance sheet on purchase date:
Inventory 60,000
Building 420,000
Equipment 238,000
Goodwill 32,000
Liabilities 150,000
Cash (540,000 – 50,000 sub cash) 490,000
NCI (20%  550,000) 110,000
Dr Cr
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20. Cash Purchase Example: Effect on Statement of Cash Flows
Cash operations
+$10,600 depreciation adjustment
Cash flows from investing activities
Payment for purchase of Company S,
net of cash acquired $(490,000)
Noncash “investing” is
$150,000 liability
$110,000 NCI
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21. Non-Cash Purchase: Example
Balance Sheet of Company Acquired
Cash 50,000 Liabilities 1500,000
Inventory 60,000
Building 190,000 Common Stock 200,000
Equipment 400,000 Retained Earnings 350,000
Total 700, Total 700,000
10,000 shares of Stock issued for sub
$10 par value
$54 market value
Building Fair Value = $425,000; Life = 10 years
Equipment Fair Value = $250,000; Life = 5 years
Goodwill = Excess of price paid over fair value of net assets
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22. Stock Issued for Sub: Example (continued)
D&D Schedule
Price paid (10,000 shares x $54) 540,000
Interest (80%  $550,000) 440,000
Excess 100,000
Allocate to building (80%  25,000) (20,000) 10-year
Allocate to equipment (80% x 60,000) (48,000) 5-year
Goodwill 32,000
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23. Non-Cash Purchase: Example (continued)
To see cash flow impact, consider additions to parent balance sheet on purchase date:
Cash 50,000
Inventory 60,000
Building 420,000
Equipment 238,000
Goodwill 32,000
Liabilities 150,000
Common Stock – Par 100,000
Paid-in Capital in Excess of Par 440,000
NCI (20%  550,000) 110,000
Dr Cr
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24. Non-Cash Purchase Example: Effect on Statement of Cash Flows
Cash operations
+$10,600 depreciation adjustment
Cash flows from investing activities
Cash acquired in purchase
of Company S, $(490,000)
Noncash financing and investing
Adjusted value of assets acquired $800,000
Common Stock issued, 540,000
Liabilities assumed 150,000
Non-controlling Interest 110,000
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25. Consolidated Diluted EPS
Subsidiary has no dilutive shares
Calculated by dividing controlling interest in consolidated net income by parent company outstanding stock
Parent dilutive shares cause numerator and denominator adjustments just as in a single entity calculation
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26. Consolidated Diluted EPS - continued
Subsidiary has dilutive shares – Two step process
Step 1 – Calculate sub’s Diluted Earnings per Share (DEPS)
Step 2 – Calculate consolidated DEPS
Uses sub’s DEPS calculation as part of this calculation.
Additional complication:
Sub may have outstanding securities that may require the parent to issue additional shares
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27. Consolidated Diluted EPS Calculation – Only Sub has Possible Dilution
Example on next slide
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28. Consolidated Diluted EPS Calculation – Only Sub has Possible Dilution Example
Subsidiary financial information:
Net Income (adjusted for interco profits) $22,000
Pref. stock cash dividend $2,000
Interest paid on convertible bonds $3,000
Common stock shares outstanding 5,000
Warrants to purchase one share of common stock 1,000
Warrants held by parent 500
Convertible bonds outstanding (conv. to 10 shares cs) 200
Convertible bonds held by parent 180
Parent financial information:
Parent owns 80% of sub
Net income (internal, adjusted) $40,000
Interest paid on convertible shares $5,000
Common shares outstanding 10,000
Bonds outstanding can convert to shares 3,000
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29. Consolidated Diluted EPS Calculation – Only Sub has Possible Dilution
Sub’s DEPS
Consol DEPS
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30. Consolidated Diluted EPS Calculation – Parent Possible Dilution from Sub’s Securities
If sub has dilutive securities that affect Parent’s stock:
These securities are not included in sub’s DEPS calculation
These securities must be included in the parent’s share adjustment for consolidated DEPS.
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31. Equity Method for Unconsolidated Investments
Income on investment is recorded as earned
Investor records income when the company invested in reports net income
Investor reduces the investment account when the company invested in declares dividends
Required for certain types of investments
Influential investments
Corporate joint ventures
Unconsolidated subsidiaries
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32. Influential Investment: Example Excel purchases 25% of Flag’s Stock
D&D of Excess Schedule
Price paid $250,000
Equity (25%  $800,000) 200,000
Excess of cost over book value 50,000
Less Equipment with 5-year life ,000
Goodwill (not amortized) $30,000
Purchase date 1/1/20X1
Flag sells inventory to Excel:
$30,000 goods in ending inventory with 40% GP – 12/31/X1
$40,000 goods in ending inventory with 45% GP – 12/31/X2
Flag sold Excel a truck (4 year life) on 1/1/20X1
NBV $16,000, Sell price $20,000
Investee reports income of $60,000 (before tax) in 20X1 and $70,000 in 20X2
Flag declared and paid $10,000 in dividends in 20X2
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33. Influential Investment: 20X1 IDS to Calculate Investment Income
20X1 IDS for Flag
Truck. gain 4,000 Reported income 60,000
Profit in Excel end. Inv. 12,000 Realized truck gain 1,000
Adjusted Income 45,000
Ownership interest (25%) 11,250
Less Equip amort. 4,000
Investment income 7,250
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34. Influential Investment: 20X2 IDS to Calculate Investment Income
20X2 IDS for Flag
Profit in Excel end. Inv. 18,000 Reported income 70,000
Profit in Excel beg. Inv. 12,000
Realized truck gain 1,000
Adjusted Income 65,000
Ownership interest (25%) 16,250
Less Equip amort. 4,000
Investment income 12,250
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35. Influential Investment: Entries to Record Income & Dividends
20X1 Investment in Flag Company 7,250
Investment Income 7,250
20X2 Investment in Flag Company 12,250
Investment Income 12,250
(to record investment income)
20X2 Cash 12,250
Investment in Flag Company 12,250
(to record dividends received)
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36. Influential Investment: Special Issues
Investee with Preferred Stock
Investee stock transactions
Write-down to market value
Zero investment balance
Intercompany transactions by investor
Gain or loss of influence
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