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Chapter 08 - Intercompany Indebtedness

CHAPTER 8 INTERCOMPANY INDEBTEDNESS SOLUTIONS TO APPENDIX EXERCISES E8-1A Bond Sale from Parent to Subsidiary a.

Journal entries recorded by Stick Corporation:

January 1, 20X2 Investment in Pretzel Corporation Bonds Cash

156,000 156,000

July 1, 20X2 Cash Interest Income Investment in Pretzel Corporation Bonds

4,500 4,200 300

December 31, 20X2 Interest Receivable Interest Income Investment in Pretzel Corporation Bonds b.

4,500 4,200 300

Journal entries recorded by Pretzel Corporation:

January 1, 20X2 Cash Bonds Payable Bond Premium

156,000 150,000 6,000

July 1, 20X2 Interest Expense Bond Premium Cash December 31, 20X2 Interest Expense Bond Premium Interest Payable c.

4,200 300 4,500 4,200 300 4,500

Consolidation entries, December 31, 20X2: Bonds payable Premium on Bonds Payable Interest income Investment in Pretzel Corporation Bonds Interest expense Eliminate intercompany bond holdings. Interest payable Interest receivable Eliminate intercompany receivable/payable.

150,000 5,400 8,400 155,400 8,400 4,500 4,500

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Chapter 08 - Intercompany Indebtedness

E8-2A Computation of Transfer Price a.

$105,000 = $100,000 par value + ($250 x 20 periods) premium

b.

$103,500 = $105,000 - ($250 x 6 periods)

c.

Consolidation entries: Bonds Payable Bond Premium Interest Income Investment in Stallion Corporation Bonds Interest Expense Interest Payable Interest Receivable

100,000 3,500 11,500 103,500 11,500 6,000 6,000

E8-3A Bond Sale at Discount a.

$16,800 = [($600,000 x 0.08) + ($12,000 / 5 years)] x 1/3

b.

Journal entries recorded by Purse Corporation:

January 1, 20X4 Cash Interest Receivable July 1, 20X4 Cash Investment in Scarf Company Bonds Interest Income $800 = ($400,000 - $392,000)/(5 x 2) December 31, 20X4 Interest Receivable Investment in Scarf Company Bonds Interest Income c.

16,000 16,000 16,000 800 16,800

16,000 800 16,800

Consolidation entries, December 31, 20X4: Bonds Payable Interest Income Investment in Scarf Company Bonds Bond Discount Interest Expense $33,600 = $16,000 + $16,000 + $800 + $800 $395,200 = $392,000 + ($800 x 4) $4,800 = $8,000 - ($800 x 4) Interest Payable Interest Receivable

400,000 33,600 395,200 4,800 33,600

16,000 16,000

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Chapter 08 - Intercompany Indebtedness

E8-5A Multiple-Choice Questions 1. b – $4,700 = ($50,000 x 0.10) - ($3,000 / 10 years) 2. a – $4,000 = ($50,000 x 0.10) - ($8,000 / 8 years) 3. c – $5,600 = $58,000 purchase price - [$53,000 - ($3,000 / 10 years) x 2 years] 4 c – .

Operating income of Kruse Corporation

$40,000

Net income of Gary's Ice Cream Parlors

20,000 $60,000 (5,600)

Less:

Loss on bond retirement Recognition during 20X6 ($4,700 - $4,000) Consolidated net income

700 $55,100

Sub is the issuer, so the adjustment for net income effect, including loss on bond retirement [5600 =58,000-(53000-3000/10*2)], interest expense by Sub [4700= 50000*10% -- 3000/10], and interest income by Parent [4000= 50000*10% -- 8000/8], is assigned to the Sub. Total NI effect from the unadjusted actual recording = 700 reduction, total NI from the adjusted (realized) transaction should be loss on retirement of 5600 and zero interest expense or income between the two companies. Thus, the adjustment is to add back 700 and subtract 5600. E8-6A Multiple-Choice Questions 1.

a–

$14,000 = [($300,000 x 0.09) - ($60,000 / 10 years)] x ($200,000 / $300,000)

2.

c–

$12,000 = [$120,000 - ($20,000 / 10 years) x 2 years] - $104,000

3.

b–

Net income of Solar Corporation Unrecognized portion of gain on bond retirement ($12,000 - $1,500) Proportion of stock held by noncontrolling interest Income to noncontrolling interest

$30,000 10,500 $40,500 x .20 $ 8,100

To understand 12k and $1500 reduction of income, refer to the chart below. $12k is “gain on constructive retirement” for 1/1/20X14. $1500 is the difference between interest income recorded by parent (cash receipt – 2000 investment amortization) and interest expense recorded by subsidiary (cash payment – 500 amortization), both of which should be eliminated. 12/31/20X4

Parent Bonds Payable

Sub (100k)

Total (unadjusted) (100,000)

Consolidated (adjusted) 0

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Chapter 08 - Intercompany Indebtedness

Premium on Bonds Payable Investment in Sub Bonds Interest expense

Interest income

20k1K*6 104k-250*2 100k*4.5 %*21k*2 (100k*4.5% *2-250*2)

16k-2k

0

104k-500

0

9k-2k

0

(9k-500)

0

Gain on constructive bond retirement

Carrying value of (100K+16K) – payment by parent of 104k on 1/1/20X4 =12k

E8-7A Constructive Retirement at End of Year a.

Consolidation entries, December 31, 20X5: Bonds Payable Premium on Bonds Payable Investment in Suspect Company Bonds Gain on Bond Retirement $9,000 = [($400,000 x 1.03) - $400,000] x 15/20 $12,000 = $9,000 + $400,000 - $397,000

400,000 9,000 397,000 12,000

Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 12,000 to complete the elimination process.

E8-7A (continued) Consolidation entries, December 31, 20X6: b. Bonds Payable Premium on Bonds Payable Interest Income Investment in Suspect Company Bonds Interest Expense Investment in Suspect Co. NCI in NA of Suspect Co. $8,400 = $9,000 - [$9,000 / (15 x 2)] x 2 $36,200 = $36,000 + [$3,000 / (15 x 2)] x 2

400,000 8,400 36,200 397,200 35,400 7,200 4,800

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Chapter 08 - Intercompany Indebtedness

$397,200 = $397,000 + ($100 x 2) $35,400 = $36,000 - ($300 x 2) $7,200 = $12,000 x 0.60 $4,800 = $12,000 x 0.40 Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 800 to complete the elimination process. E8-8A Constructive Retirement at Beginning of Year a.

Consolidation entries, December 31, 20X5: Bonds Payable 400,000 Premium on Bonds Payable 9,000 Interest Income 36,200 Investment in Suspect Company Bonds 397,000 Interest Expense 35,400 Gain on Bond Retirement 12,800 $9,000 = [($400,000 x 1.03) - $400,000] x 15/20 $36,200 = $36,000 +[($400,000 - $396,800)/(16 x 2)] x 2 $397,000 = $396,800 + ($100 x 2) $35,400 = $36,000 - ($300 x 2) $12,800 = [($400,000 x 1.03) - $400,000] x 16/20 + ($400,000 - $396,800) Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 800 to complete the elimination process.

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Chapter 08 - Intercompany Indebtedness

E8-8A (continued) b.

Consolidation entries, December 31, 20X6: Bonds Payable Premium on Bonds Payable Interest Income Investment in Suspect Company Bonds Interest Expense Investment in Suspect Co. NCI in NA of Suspect Co.

400,000 8,400 36,200 397,200 35,400 7,200 4,800

Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 800 to complete the elimination process. E8-9A Retirement of Bonds Sold at a Discount Elimination of bond investment at December 31, 20X8: Bonds Payable 300,000 Interest Income 21,240 Loss on Constructive Bond Retirement 2,730 Investment in Packed Corporation Bonds 297,120 Interest Expense 21,450 Discount on Bonds Payable 5,400 The basic entry (not shown) would be adjusted by 2,520 (21240+273021450) to complete the elimination process. i.e., the following entry is included in the basic elimination entry. We called the entry below as reversal of equity method adjustment. Dr. Investment in Sub Stock 2,520 Cr. Investment income from Sub

2,520

For the equity method, the subtotal effect of intercompany indebtedness on net income is a debit to Investment income at 2,520 = interest expense elimination of 21,450 - interest income elimination of 21,240 - loss on constructive bond retirement of 2,730. The entry above reverses that. Eliminate intercompany bond holdings: $21,240 = $21,000 + [($300,000 - $296,880) / 13 years] $2,730 = $296,880 - $294,150 (computed below) $297,120 = $296,880 + [($300,000 - $296,880) / 13 years] $21,450 = $21,000 + ($9,000 / 20 years) $5,400 = ($9,000 / 20 years) x 12 years Computation of book value of liability at constructive retirement Sale price of bonds ($300,000 x 0.97) Amortization of discount [($300,000 - $291,000) / 20 years] x 7 years Book value of liability at January 1, 20X8

$291,000 3,150 $294,150

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Chapter 08 - Intercompany Indebtedness

Fyi., A tip on how to check whether your amortization of discount or premium is correct: after each amortization, the discount or premium should be closer to $0 and Investment in bonds should be closer to the par value.

Parent Bonds Payable Discount on Bonds Payable Investment in Sub Bonds Interest expense Interest income Loss on constructive bond retirement Impact on Net Income

Sub

Total (unadjusted) (300,000) 5,400

Consolidated (adjusted) 0 0

297,120

297,120

0

(21,240)

21,450 (21,240)

0 0 2,730 to parent

(21,240)

210

2730

(300,000) 5,400

21,450

21,450

For you information, for the equity method that is not required by the problem, to adjust total income from 210 (dr) to 2730 (dr), we make the following entry. Investment income 2520 Investment in Sub’s stock 2520 at 100% because it is a downstream transaction.

E8-10A Loss on Constructive Retirement Consolidation entries, December 31, 20X8: Bonds Payable Interest Income Loss on Bond Retirement Investment in Par Corporation Bonds Discount on Bonds Payable Interest Expense Interest Payable Interest Receivable

100,000 8,000 12,000 106,000 3,000 11,000 5,000 5,000

The basic entry (not shown) would be adjusted by 9,000 (8000+12000-11000) to complete the elimination process. E8-11A Determining the Amount of Retirement Gain or Loss a.

Par value of bonds outstanding Annual interest rate

$200,000 x .12

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Chapter 08 - Intercompany Indebtedness

Interest payment Amortization of bond premium ($200,000 x 15%) / 5 years Interest charge for full year Less: Interest on bond purchased by Pepper Enterprises [($18,000 x 1/2) x (4 months / 12 months)] Interest expense included in consolidated income statement b.

Sale price of bonds, January 1, 20X1 Amortization of premium [($15,000 / 5) x 2 2/3 years] Book value at time of purchase Purchase price Gain on bond retirement

c.

Consolidation entries, December 31, 20X3: Bonds Payable Bond Premium Interest Income Investment in Salt Bonds Interest Expense Gain on Bond Retirement Interest Payable Interest Receivable

$ 24,000 (6,000) $ 18,000 (3,000) $ 15,000 $115,000 (8,000) $107,000 (100,000) $ 7,000

100,000 6,000 4,000 100,000 3,000 7,000 6,000 6,000

The basic entry (not shown) would be adjusted by 6,000 (7,000+3,000-4,000) to complete the elimination process.

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Chapter 08 - Intercompany Indebtedness

E8-12A Evaluation of Bond Retirement a.

No gain or loss will be reported by Sibling.

b.

A gain of $13,000 will be reported: Book value of liability reported by Sibling: Par value of bonds outstanding Unamortized premium $8,000 - [($8,000 / 10 years) x 3.5 years] Book value of debt Amount paid by Parent Gain on bond retirement

c.

5,200 $205,200 (192,200) $ 13,000

Consolidated net income for 20X6 will increase by $12,000: Gain on bond retirement Adjustment for excess of interest income over interest expense: Interest income Interest expense Increase in consolidated net income

d.

$200,000

$ 13,000 $(11,600) 10,600

(1,000) $ 12,000

Consolidation entries, December 31, 20X6: Bonds Payable Premium on Bonds Payable Interest Income Investment in Sibling Company Bonds Interest Expense Gain on Bond Retirement Eliminate intercompany bond holdings: $4,800 = ($8,000 / 10 years) x 6 years $11,600 = [$22,000 + ($7,800 / 6.5 years)] / 2 $192,800 = $192,200 + [($7,800 / 6.5 years) / 2] $10,600 = ($22,000 - $800) / 2 Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

200,000 4,800 11,600 192,800 10,600 13,000

11,000 11,000

The basic entry (not shown) would be adjusted by 12,000 (10,600+13,000-11,600) to complete the elimination process.

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Chapter 08 - Intercompany Indebtedness

E8-12A (continued) e.

Consolidation entries, December 31, 20X7: Bonds Payable Premium on Bonds Payable Interest Income Investment in Sibling Company Bonds Interest Expense Investment in Sibling Co. NCI in NA of Sibling Co. Eliminate intercompany bond holdings: $4,000 = ($8,000 / 10 years) x 5 years $23,200 = $22,000 + ($7,800 / 6.5 years) $194,000 = $192,800 + ($7,800 / 6.5 years) $21,200 = $22,000 - ($8,000 / 10 years) $8,400 = ($13,000 - $1,000) x 0.70 $3,600 = ($13,000 - $1,000) x 0.30

200,000 4,000 23,200

Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

11,000

194,000 21,200 8,400 3,600

11,000

The basic entry (not shown) would be adjusted by 2,000 (23,200-21,200) to complete the elimination process. f.

Income assigned to noncontrolling interest in 20X7 is $14,400: Net income reported by Sibling Adjustment for excess of interest income over interest expense: Interest income Interest expense Realized net income Proportion of ownership held Income assigned to noncontrolling interest

$ 50,000 $(23,200) 21,200

(2,000) $ 48,000 x .30 $ 14,400

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Chapter 08 - Intercompany Indebtedness

E8-13A Loss on Constructive Retirement a.

Consolidation entries, December 31, 20X8: Bonds Payable Premium on Bonds Payable Interest Income Constructive Loss on Bond Retirement Investment in Stang Corporation Bonds Interest Expense Eliminate intercompany bond holdings: $3,000 = $5,000 - ($500 x 4 years) $11,300 = $12,000 - ($4,900 / 7 years) $1,400 = $104,900 - ($105,000 - $1,500) $104,200 = $104,900 - ($4,900 / 7 years) $11,500 = $12,000 - ($5,000 / 10 years)

100,000 3,000 11,300 1,400 104,200 11,500

Interest Payable 6,000 Interest Receivable 6,000 Eliminate intercompany receivable/payable. The basic entry (not shown) would be adjusted by 1,200 (11,300+1,40011,500) to complete the elimination process. i.e., the basic elimination entry should have included the entry below to reverse the

equity method recording and allocate 35% of the adjustment to NCI: Investment in Stang Corporation stock 780 NCI in NA of Stang 420 Investment income from Stang NCI in NI from Stang

780 420

Note that for the equity method, the subtotal effect of intercompany indebtedness on net income is a debit to Investment income at 12,000 *65% = 780. -1200 = interest expense elimination of 11,500 - interest income elimination of 11,300 loss on constructive bond retirement of 1,400. Thus, the reversal is as above. Fyi.12/31/20x8 Parent Bonds Payable Premium on Bonds Payable Interest payable Investment in Sub Bonds Interest expense Interest income Interest receivable Loss on constructive bond retirement

Sub (100,000) (3,000)=500 0-250*8 (6,000)

104,200=10 4,900-700 11,500 (11,300) 6,000

Total (unadjusted) (100,000) (3,000)

Consolidated (adjusted) 0 0

(6,000) 104,200

0 0

11,500 (11,300) 6,000

0 0 0 1,400 to sub

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Chapter 08 - Intercompany Indebtedness

If you like journal entries in order to understand how the ending balances in the chart above are calculated, below lists them. Sub July 1: premium 250 = total premium 5000 / total interest payment periods 20 interest expense 6250 cash 6000 Sub Dec 31: premium 250 interest expense 6250 Interest payable Parent July 1: July 1: cash

6000 Investment in Bonds Interest income

6000

350 = (104,900-100,000) / 14 = 350 5650

Parent 12/31: Interest receivable 6000 Investment in Bonds Interest income

b.

350 5650

Income assigned to noncontrolling interest in 20X8 is $6,580: Net income reported by Stang Corporation Constructive loss on bond retirement Adjustment for excess of interest expense over interest income: Interest expense Interest income Realized net income Proportion of ownership held Income assigned to noncontrolling interest

$ 20,000 (1,400) $11,500 (11,300)

200 $ 18,800 x 0.35 $ 6,580

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Chapter 08 - Intercompany Indebtedness

E8-13A (continued) c.

Consolidation entries, December 31, 20X9: Bonds Payable Premium on Bonds Payable Interest Income Investment in Stang Corp. NCI in NA of Stang Corp. Investment in Stang Corporation Bonds Interest Expense Eliminate intercompany bond holdings: $2,500 = $3,000 - $500 $11,300 = $12,000 - ($4,900 / 7 years) $780 = ($1,400 - $200) x 0.65 $420 = ($1,400 - $200) x 0.35 $103,500 = $104,200 - $700 $11,500 = $12,000 - ($5,000 / 10 years) Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

100,000 2,500 11,300 780 420 103,500 11,500
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