Advanced accounting 10th by a beams athony ch07

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 © Pearson Education, Inc publishing as Prentice Hal 7-1 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 © Pearson Education, Inc publishing as Prentice Hal 7-2 Intercompany Profit Transactions – Bonds 1: Intercompany Receivables and Payables © Pearson Education, Inc publishing as Prentice Hal 7-3 Intercompany Payables and Receivables Remove intercompany: – Payables and interest expense – Receivables and interest income Loans directly between affiliates generally pose no special problems © Pearson Education, Inc publishing as Prentice Hal 7-4 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 © Pearson Education, Inc publishing as Prentice Hal 7-5 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 © Pearson Education, Inc publishing as Prentice Hal 7-6 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 © Pearson Education, Inc publishing as Prentice Hal 7-7 Intercompany Profit Transactions – Bonds 2: Profits on Bonds © Pearson Education, Inc publishing as Prentice Hal 7-8 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 © Pearson Education, Inc publishing as Prentice Hal 7-9 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 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 © Pearson Education, Inc publishing as Prentice Hal 7-10 Amortizations and Interest   Pam's books: Bonds payable 10% retired Interest expense 10% retired   Sue's books: Investment in bonds Interest income Book value 1/1/2010 $10,100 $1,010         During  2010 -$20   500+500-20 =$980 Book value 12/31/2010 $10,080 $1,008 $98             $950 +$10   50+50+10 =$110  During 2011 -$20   500+500-20 =$980 Book value 12/31/2011 $10,060 $1,006 $98             $960 +$10 $970   50+50+10 =$110   © Pearson Education, Inc publishing as Prentice Hal 7-11 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 Investment in bonds Gain on retirement of bonds Interest income Interest expense Gain on retirement of bonds © Pearson Education, Inc publishing as Prentice Hal 1,008 960 48 110 98 12 7-12 Intercompany Profit Transactions – Bonds 3: Constructive Retirement of Debt © Pearson Education, Inc publishing as Prentice Hal 7-13 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 © Pearson Education, Inc publishing as Prentice Hal 7-14 2011 Worksheet Entries Entries for 2011 worksheet, assuming that Pam has not yet paid the second interest payment Bonds payable Interest income Investment in bonds Interest expense Investment in Sue Interest payable Interest receivable © Pearson Education, Inc publishing as Prentice Hal 1,006 110 50 970 98 48 50 7-15 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 © Pearson Education, Inc publishing as Prentice Hal 7-16 Intercompany Profit Transactions – Bonds 4: Effect on Noncontrolling Interest © Pearson Education, Inc publishing as Prentice Hal 7-17 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 © Pearson Education, Inc publishing as Prentice Hal 7-18 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 © Pearson Education, Inc publishing as Prentice Hal 7-19 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 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 – 120 + 15) = $316 Noncontrolling interest share: 20%(500 – 120 + 15) = $79 © Pearson Education, Inc publishing as Prentice Hal 7-20 Amortizations and Interest   Scent's books: Bonds payable 40% retired Interest expense 40% retired   Pine's books: Investment in bonds Interest income Book value 1/1/2010 $4,800 $1,920         During  2010 +$25   250+250+25 =$525 Book value 12/31/2010 $4,825 $1,930 $210             $2,040 -$5   100+100-5 =$195  During 2011 +$25   250+250+25 =$525 Book value 12/31/2011 $4,850 $1,940 $210             $2,035 -$5 $2,030   100+100-5 =$195   © Pearson Education, Inc publishing as Prentice Hal 7-21 2010 Entries with Loss Entries for 2010 worksheet Bonds payable 1,930 Interest income 195 Loss on retirement of bonds 120 Interest expense Investment in bonds © Pearson Education, Inc publishing as Prentice Hal 210 2,035 7-22 Amortizations and Interest   Scent's books: Bonds payable 40% retired Interest expense 40% retired   Pine's books: Investment in bonds Interest income Book value 1/1/2010 $4,800 $1,920         During  2010 +$25   250+250+25 =$525 Book value 12/31/2010 $4,825 $1,930 $210             $2,040 -$5   100+100-5 =$195  During 2011 +$25   250+250+25 =$525 Book value 12/31/2011 $4,850 $1,940 $210             $2,035 -$5 $2,030   100+100-5 =$195   © Pearson Education, Inc publishing as Prentice Hal 7-23 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 Interest payable Interest receivable © Pearson Education, Inc publishing as Prentice Hal 210 100 100 7-24 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher Printed in the United States of America Copyright © 2009 Pearson Education, Inc   Publishing as Prentice Hall © Pearson Education, Inc publishing as Prentice Hal 7-25 ... Receivables and Payables © Pearson Education, Inc publishing as Prentice Hal 7-3 Intercompany Payables and Receivables Remove intercompany: – Payables and interest expense – Receivables and interest... 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... company purchases the bonds of an affiliate From other entities At a price other than the book value of the bonds © Pearson Education, Inc publishing as Prentice Hal 7-6 Agency Theory • Agency