Advanced accounting 10th by a beams athony ch07

1: Intercompany Receivables and Payables Intercompany Profit Transactions – Bonds... Intercompany Payables and Receivables Remove intercompany: – Payables and interest expense – Receivab

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

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.

1: Intercompany Receivables and

Payables

Intercompany Profit Transactions – Bonds

Intercompany Payables and

Receivables

Remove intercompany:

– Payables and interest expense

– Receivables and interest income

Loans directly between affiliates generally pose no special

problems

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

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.

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

2: Profits on Bonds

Intercompany Profit Transactions – Bonds

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

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

• Pam's Investment in Sue: 70%(220) + 60 – 12 = $202

• Noncontrolling interest share: 30%(220) = $66

Amortizations and Interest

  Book value During  Book value  During Book value Pam's books: 1/1/2010 2010 12/31/2010 2011 12/31/2011 Bonds payable $10,100 -$20 $10,080 -$20 $10,060

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.

3: Constructive Retirement of Debt

Intercompany Profit Transactions – Bonds

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.

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.

4: Effect on Noncontrolling Interest

Intercompany Profit Transactions – Bonds

Subsidiary Issuer with Gain

• Increase Income from subsidiary

• Increase Noncontrolling interest share

– In current and subsequent years, use

piecemeal recognition

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

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

Amortizations and Interest

  Book value During  Book value  During Book value Scent's books: 1/1/2010 2010 12/31/2010 2011 12/31/2011

2010 Entries with Loss

Entries for 2010 worksheet.

Amortizations and Interest

  Book value During  Book value  During Book value Scent's books: 1/1/2010 2010 12/31/2010 2011 12/31/2011

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