Test bank advanced accounting 10e by beams chapter 07

The gain from the bond purchase that appeared on the December 31, 2006 consolidated income statement was 5.. The gain or loss on the constructive retirement of $400,000 of Tunnel bonds o

Chapter 7 Test Bank INTERCOMPANY PROFIT TRANSACTIONS – BONDS

Multiple Choice Questions

LO1

1 The intercompany purchase of the parent company bonds by a

subsidiary has the same effect on the consolidated financial statements as the

a purchase of the bonds by a non-affiliate

b parent's retirement of the bonds using funds from newly issued common stock

c parent's retirement of the bonds using funds from a

subsidiary loan

d parent's retirement of the bonds using funds from the sale

of new bonds to non-affiliates

LO1

2 If an affiliate purchases bonds in the open market, the

intercompany bond liability book value is

Use the following information in answering questions 4 and 5

Australian Owl Company owns an 80% interest in Glider Company On January 1, 2006, Australian Owl had $600,000, 8% bonds outstanding with an unamortized premium of $9,000 The bonds mature on December

31, 2010 Glider acquired one-third of Australian Owl’s bonds in the open market for $198,000 on January 1, 2006 On December 31, 2006, the books of the two affiliates held the following balances:

Australian Owl’s books

4 The gain from the bond purchase that appeared on the December

31, 2006 consolidated income statement was

5 Consolidated Interest Expense and consolidated Interest Income,

respectively, that appeared on the consolidated income statement for the year ended December 31, 2006 was

LO2

6 Kingfisher Corporation owns 80% the voting stock of Tunnel

Corporation On January 1, 2006, Kingfisher paid $391,000 cash for $400,000 par of Tunnel’s 10% $1,000,000 par value outstanding bonds, due on April 1, 2011 Tunnel’s bonds had a book value of $1,045,000 on January 1, 2006 Straight-line amortization is used The gain or loss on the constructive retirement of $400,000 of Tunnel bonds on January 1, 2006 wasreported in the 2006 consolidated income statement in the amount of

Use the following information in answering questions 7, 8, and 9

Rufous Owl Inc had $800,000 par of 10% bonds payable outstanding on January 1, 2006 due January 1, 2010 with an unamortized discount of

$16,000 Bird is a 90%-owned subsidiary of Rufous On January 1,

2006, Bird Corporation purchased $160,000 par value of Rufous’s outstanding bonds for $152,000 The bonds have interest payment dates

of January 1 and July 1, and mature on January 1, 2009 Straight-line amortization is used

LO2

7 With respect to the bond purchase, the consolidated income

statement of Rufous Owl Corporation and Subsidiary for 2006showed a gain or loss of

LO2

9 Bonds Payable appeared in the December 31, 2006 consolidated

balance sheet of Rufous Owl Corporation and Subsidiary in the amount of

Use the following information for questions 10 through 15

Dollarbird Corporation issued five thousand, $1,000 par, 12% bonds on January 1, 2004 Interest is paid on January 1 and July 1 of each year; the bonds mature on January 1, 2009 On January 1, 2006, BranchCorporation, an 80%-owned subsidiary of Dollarbird, purchased 3,000

of the bonds on the open market at 101.50 Dollarbird's separate net income for 2006 included the annual interest expense for all 3,000 bonds Branch’s separate net income was $300,000, which included the bond interest received on July 1 as well as the accrual of bond interest revenue earned on December 31

LO2

10 What was the amount of gain or (loss) from the intercompany

purchase of Dollarbird’s bonds on January 1, 2006?

11 If the bonds were originally issued at 106, and 80% of them

were purchased by Branch on January 1, 2007 at 98, the gain or (loss) from the intercompany purchase was

LO2

12 If the bonds were originally issued at 103, and 70% of them

were purchased on January 1, 2008 at 104, the constructive gain

or (loss) on the purchase was

13 Using the original information, the amount of consolidated

Interest Expense for 2006 was

14 Using the original information, the balances for the Bonds

Payable and Bond Interest Payable accounts, respectively, on the consolidated balance sheet for December 31, 2007 were

15 The elimination entries on the consolidation working papers

prepared on December 31, 2006 included at least

a debit to Bond Interest Expense for $360,000

b credit to Bond Interest Expense for $360,000 and a debit to

Bond Interest Payable for $180,000

c credit to Bond Interest Receivable for $360,000

d debit to Bond Interest Revenue for $360,000

LO3

16 No constructive gain or loss arises from the purchase of an

affiliate’s bonds if the

a affiliate is a 100%-owned subsidiary

b bonds are purchased at book value

c bonds are purchased with arm’s-length bargaining from outside entities

d gain or loss cannot be reasonably estimated

LO3

17 Constructive gains or losses are allocated between purchasing

and issuing affiliates according to

a the agency theory

b the par value theory

c either the agency theory or the par value theory

d neither the agency theory nor the par value theory

LO3

18 No allocation of gain or loss on the constructive retirement of

intercompany bonds will occur

a when the subsidiary is the issuing affiliate

b when the effective interest rate method is applied

c in the consolidated income statement

d when the parent company is the issuing affiliate

Use the following information in answering questions 19 and 20

Mistletoebird Corporation owns an 80% interest in Berries Company acquired at book value several years ago On January 1, 2006, Berriespurchased $100,000 par of Mistletoebird’s outstanding bonds for

$103,000 The bonds were issued at par and mature on January 1, 2009 Straight-line amortization is used Separate incomes of Mistletoebirdand Berries for 2006 are $350,000 and $120,000, respectively

LO1

Exercise 1

Separate company and consolidated income statements for Pitta and New Guinea Corporations for the year ended December 31, 2006 are summarized as follows:

Pitta

New Guinea

dated

Consoli-Sales Revenue $ 500,000 $ 100,000 $ 600,000

Income from New Guinea 19,900

Bond interest income 6,000

Total revenues 519,900 106,000 603,000

Cost of sales $ 280,000 $ 50,000 $ 330,000

Bond interest expense 9,000 3,600

2011 On January 1, 2006, a portion of the bonds was purchased and constructively retired

LO1

Exercise 2

Jacky Winter Corporation owns a 90% interest in Park Company The

following information is from the adjusted trial balances at December

31, 2005, at which time the bonds have four years to maturity Jacky

Winter acquired Park’s bonds at the beginning of the year The bonds

have interest payment dates of January 1 and July 1

Prepare the necessary consolidation working paper entries on December

31, 2006 with respect to the intercompany bonds

LO2

Exercise 3

Pheasant Corporation owns 80% of Rural Corporation’s outstanding

common stock that was purchased at book value and fair value on

January 1, 1999

Additional information:

1 Pheasant sold inventory items that cost $3,000 to Rural during

2006 for $6,000 One-half of this merchandise was inventoried by

Rural at year-end At December 31, 2006, Rural owed Pheasant

$2,000 on account from the inventory sales No other

intercompany sales of inventory have occurred since Pheasant

acquired its interest in Rural

2 Pheasant sold a plant asset with a book value of $5,000 and a

5-year useful life to Rural for $10,000 on December 31, 2004 This

plant asset remains in use by Rural and is depreciated by the

straight-line method

3 On January 2, 2006, Rural paid $10,800 for $10,000 par value of Pheasant’s 10-year, 10% bonds These bonds have interest payment dates of January 1 and July 1, and mature on January 1, 2010 Straight-line amortization has been applied by Rural to the Pheasant bond investment

Complete the working papers to consolidate the financial statements

of Pheasant Corporation and Rural for the year ended December 31,

2006

Pheasant Corporation and Subsidiary Consolidation Working Papers

at December 31, 2006

Pheasant Rural

Eliminations Balance

Sheet Debit Credit

LO2

Exercise 4

December 31, 2006 balance sheets for Wren Corporation, and SchrubCorporation, its 90%-owned subsidiary, are presented in the first two columns of partially completed balance sheet working papers Wrenpaid $160,000 for its 90% interest in Schrub on January 1, 2003 when Schrub had $150,000 of total stockholders’ equity The $25,000 cost-book differential was assigned to plant assets with a 10-year remaining life

On January 1, 2006, Wren purchased $50,000 of Schrub Corporation’s 10% bonds for $48,000, at which time the unamortized premium on the bonds was $2,000 The bonds pay interest on June 30 and December 31 and mature on December 31, 2010 Both Wren and Schrub use straight-line amortization Wren uses the equity method of accounting for its investment in Schrub

Wren Corporation and Subsidiary Consolidated Balance Sheet Working Papers

BALANCE SHEET

39,100

LO2

Exercise 5

Sunbird Corporation owns a 70% interest in Veranda Corporation At December 31, 2005, Veranda had $3,000,000 of par value 12% bonds outstanding with an unamortized premium of $60,000 The bonds have interest payment dates of January 1 and July 1 and mature on January

1, 2010

On January 2, 2006, Sunbird purchased $1,200,000 par value of Veranda’s outstanding bonds for $1,209,600 Assume straight-line amortization

Required:

Prepare the necessary consolidation working paper entries on December

31, 2006 with respect to the intercompany bonds

LO2

Exercise 6

Rock is an 80%-owned subsidiary of Gibberbird On January 1, 2005, Rock issued $450,000 of $1,000 face amount 6% bonds at par The bonds have interest payments on January 1 and July 1 of each year and mature on January 1, 2009 On July 1, 2006, Gibberbird purchased all

450 bonds on the open market for $1,030 per bond

Required: With respect to the bonds, use General Journal format to:

1 Record the 2006 journal entries from July 1 to December 31 on Rock’s books

LO2 & 3

Exercise 7

Caterpillar Inc is an 80%-owned subsidiary of Bellbird Corp On January 1, 2005, Caterpillar issued $600,000 of $1,000 face amount 6% bonds at $964 per bond Interest is paid on January 1 and July 1 of each year and covers the preceding six months On July 1, 2006, Bellbird purchased all 600 bonds on the open market for $1,030 per bond The following table shows selected amounts of amortization on the bonds:

Amortization Table for the Bond Discount

Date Remaining Balance

LO2&3

Exercise 8

Thornbill Corporation owns 90% of the outstanding voting common stock

of Hangout Corporation On January 1, 1998, Hangout issued $1,000,000 face amount of 12%, $1,000 bonds payable at 119.20 The bonds pay interest on January 1 and July 1 of each year and mature on for on January 1, 2009 On July 1, 2006, Thornbill purchased all of the outstanding bonds at a price of 107.50

Required:

1 Explain the relationship between the balances in the Investment

in Hangout Bonds account on Thornbill’s books and the related accounts, i.e., Bonds Payable and Discount/Premium on Bonds Payable, on Hangout’s books

in five years and pay interest on January 1 and July 1 On January 1,

2006, Honeyeater acquired one-third of Waterhole’s bonds for

$317,000 Honeyeater and Waterhole use straight-line amortization Waterhole reports net income of $300,000 for 2006

LO4

Exercise 10

Willy Wagtail Company has $4,000,000 of 12% bonds outstanding on December 31, 2004 with unamortized premium of $120,000 These bonds pay interest semiannually on January 1 and July 1 and mature on January 1, 2010 Straight-line amortization is used

Garden Inc., 80%-owned subsidiary of Willy Wagtail, buys $1,000,000 par value of Willy Wagtail’s outstanding bonds in the market for

$980,000 There is only one issue of outstanding bonds of the affiliated companies and they have consolidated financial statements For the year 2005, Willy Wagtail has income from its separate operations (excluding investment income) of $4,500,000 and Garden reports net income of $600,000

Required: Determine the following:

4 d Book value of Australian Owl’s

bonds acquired by Glider equals 1/3 times ($600,000 + $9,000) $ 203,000 Less: Cost of acquiring

Australian Owl bonds 198,000 Constructive gain on Australian

5 c Because Australian Owl is the

issuing entity the gain or loss

is not allocated to the noncontrolling interest The noncontrolling interest expense

is ($120,000 x 20%) or

$ 24,000

8 c Full interest for 12 months

Equals $920,000 x 10% $ 92,000 Less: interest on $230,000 for 9

months = $230,000 x 10% x 75% 17,250 Consolidated interest expense $ 74,750

9 d

Book value of Polecat’s bonds

$ 4,024,000

x % purchased by Seadog 40% Equals: Book value purchased $ 1,609,600 Purchase price ($970 x 1,600)= 1,552,000 Gain on retirement $ 57,600

10 b Total book value acquired =

$5,000,000 x 60% $ 3,000,000 Purchase price 3,000 bonds x

$980=

3,920,000

Gain on constructive retirement= $ 176,000

12 a Book value at January 1, 2008

equals $5,150,000 minus $120,000

$ 5,030,000

Percentage of bonds acquired 70% Equals book value acquired 3,521,000 Purchase price 3,500 bonds x

14 a Bonds payable $5,000,000 minus

bonds held by Branch of

$3,000,000

$ 2,000,000

Interest accrued on December 31,

2007 will be the interest on bonds held by non-affiliates or

19 b Mistletoebird’s separate income: $ 350,000

Income from Berries ($120,000 x

Less: Loss on constructive retirement of Mistletoebird bonds

20 c Since Mistletoebird is the

issuing entity the gain or loss

is not allocated to the noncontrolling interest The noncontrolling interest income

is ($120,000 x 20%)

$ 24,000

interest income - $5,400 interest expense) ( 600 ) Increase in consolidated net income $ 2,400

Exercise 2

12/31 Bond Interest Payable 10,000

Bond Interest Receivable 10,000

Interest Expense (50% owned) 18,000

Investment in Park’s Bonds 196,000

Book value acquired 1/1/2005 where

4,000 per year is amortized

INCOME STATEMENT

Sales $ 50,000 $24,000 a $ 6,000 $68,000 Income from 6,900 e 6,900

Interest Income 800 d 800

Cost of sales ( 14,000) ( 9,000) b 1,500 a $ 6,000 ( 18,500)Depreciation ( 3,900) ( 5,800) c 1,000 ( 8,700)Interest expense ( 2,000) d 1,000 ( 1,000)

Net income 37,000 10,000 37,000 Retained

Earnings 1/1 12,000 8,000 f 8,000 12,000 Add: Net income 37,000 10,000 37,000 Dividends ( 6,000) ( 2,000) e 1,600 ( 400) ( 6,000)Retained

Earnings 12/31 $ 43,000

Pheasant bonds 10,600 d 10,600

TOTAL ASSETS $ 97,100 $50,000 $99,400 LIAB & EQUITY

Accounts payable

3,100 6,000 g 2,000 7,100 Interest payable 1,000 h 500 500