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Chapter INTERCOMPANY PROFIT TRANSACTIONS — BONDS Answers to Questions Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as reciprocal interest receivable and interest payable accounts and interest income and interest expense accounts Direct lending and borrowing transactions not give rise to unrealized gains and losses Any income reported by the lender is precisely reciprocal to an expense reported by the borrower, and the transactions are complete on the date consummated Similarly, direct lending and borrowing transactions not give rise to unrecognized gains and losses since intercompany amounts received and paid are both realized and recognized from the viewpoint of the separate legal entities Constructive gains and losses are gains and losses from the viewpoint of the consolidated entity but not from the viewpoint of the separate affiliated companies involved The purchase of a parent company’s outstanding bonds by its subsidiary at a price below the book value of the bonds on the parent company’s books results in a constructive gain Although the bonds are not actually retired, they are constructively retired from the viewpoint of the consolidated entity because they are no longer liabilities of the consolidated entity to outside parties The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300 If an affiliated company purchases half of the bonds at 98, it will record a bond investment of $490,000 From the viewpoint of the consolidated entity, the purchase of the bonds results in a constructive retirement of $500,000 par of bonds payable The constructive gain on the bonds is $12,350 [($1,004,700 ´ 50%) – $490,000] A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the books of the separate affiliated companies The affiliated companies continue to carry the bonds as a liability (issuer) and investment (purchaser) on their separate books Alternatively, an unrealized gain on the sale of land is recorded on the books of the selling affiliate, but it is not recognized as a gain for consolidated statement purposes because the land is still held within the consolidated entity Thus, a constructive gain on bonds is realized and recognized from the viewpoint of the consolidated entity but it is not recognized on the books of the affiliated companies An unrealized gain on the sale of land is recognized on the books of the selling affiliate but is not realized or recognized from the viewpoint of the consolidated entity Constructive gains on intercompany bonds are realized and recognized through the interest income and interest expense reported on the separate books of the affiliated companies The difference between the interest income reported by the investing affiliate and the interest expense reported by the issuing affiliate on the intercompany bonds is the amount of constructive gain recognized in each period Constructive gains and losses are recognized in the consolidated financial statements before they are recognized on the books of the affiliated companies If a subsidiary purchases parent company bonds in excess of their book value, a constructive loss results The loss is attributed to the parent company since it is the parent company bonds that are constructively retired This approach of associating constructive gains and losses on intercompany bonds with the issuing company is consistent with the procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with the selling affiliates ©2009 Pearson Education, Inc publishing as Prentice Hall 7-1 7-2 8a Intercompany Profit Transactions — Bonds Assume bonds were purchased at the beginning of the current year 10% bonds payable 52,000 Interest income 5,250 Interest payable 2,500 Investment in S bonds 49,000 Interest expense 4,500 Interest receivable 2,500 Constructive gain on bonds 3,750 To eliminate reciprocal bond investment and bond liability amounts, reciprocal interest income and interest expense amounts, reciprocal interest receivable and interest payable amounts, and enter the constructive gain on bonds The constructive gain is computed as the $52,500 book value of bonds that were retired for $48,750 8b Assume bonds were purchased one year earlier 10% bonds payable 52,000 Interest income 5,250 Interest payable 2,500 Investment in S bonds 49,000 Interest expense 4,500 Interest receivable 2,500 Investment in S stock (90%) 3,375 Noncontrolling interest 375 To eliminate reciprocal bond investment and bond liability amounts, reciprocal interest income and interest expense amounts, reciprocal interest receivable and interest payable amounts, and adjust controlling and noncontrolling interest holdings for constructive gain less piecemeal recognition The constructive gain is computed as: $53,000 book value - $48,500 cost = $4,500 of which $750 was recognized on the books of the separate affiliated companies in the prior year Separate entries are as follows: Investment in S Income from S To recognize income subsidiary income 40,000 40,000 equal to 80% of reported Investment in S Income from S 4,000 4,000 To recognize gain on constructive retirement of bonds (parent’s books) The full amount of the constructive gain on bonds is recognized as investment income because the full amount is assigned to the parent company issuer 10 Investment income from subsidiary 75% of subsidiary’s $100,000 reported income Less: 75% of $8,000 constructive loss on retirement of subsidiary bonds $75,000 6,000 Investment income $69,000 ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 7-3 11a A constructive gain will result when interest income exceeds interest expense on the bonds that are constructively retired 11b The constructive gain is associated with the parent company since the issuer reports interest expense 11c The $200 difference between interest income and interest expense represents a piecemeal recognition of the constructive gain on the books of the separate companies 12 Intercompany receivables and payables of associated companies (equity investees) are generally aggregated with the investments in such companies In other words, receivables from associates are usually added to the investments in associates and payables are generally deducted from the investments in order to show the equity of the investor in its equity investees in a single amount, with separate disclosure of the components of such equity, either parenthetically or in statement notes SOLUTIONS TO EXERCISES Solution E7-1 C A D A Solution E7-2 A Book value of Pavone bond’s acquired by Showalter ($900,000 + $48,000) ´ 2/3 Cost to Showalter Constructive gain D Nominal interest on Pavone’s remaining outstanding bonds $300,000 ´ 8% Less: Amortization of premium ($48,000 ´ 1/3)/ years Interest expense on consolidated income statement Solution E7-3 C Cost of $80,000 par of Palmer bonds January 1, 2009 Book value acquired ($400,000 par - $8,000 discount) ´ 20% Constructive gain D Par value of bonds payable Less: Unamortized discount ($8,000 - $2,000) Book value of bonds Percent outstanding Bonds payable C Constructive gain $2,400/4 years ´ years C Nominal interest Add: Amortization of discount Percent outstanding Interest expense $632,000 602,000 $ 30,000 $ 24,000 4,000 $ 20,000 $ 76,000 78,400 $ 2,400 $400,000 (6,000) 394,000 80% $315,200 $ 1,800 $ 40,000 2,000 42,000 80% $ 33,600 b Piecemeal recognition of gain is $2,400 ´ 25% in 2009 ©2009 Pearson Education, Inc publishing as Prentice Hall 7-4 Intercompany Profit Transactions — Bonds Solution E7-4 Consolidated net income (in thousands) Paul’s separate income Add: Income from Sally Share of Sally’s income ($500 ´ 80%) Less: Loss on bonds constructively retired Book value ($1,000 - $40) ´ 40% Cost to Sally Add: Piecemeal recognition of loss ($16,000/4 years) Consolidated net income $ 800 $400 $384 400 (16) 388 $1,188 Noncontrolling interest share Sally’s reported income $500 ´ 20% $ 100 Solution E7-5 Prim Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2017 (in thousands) Sales Less: Cost of sales $1,500 (870) Gross profit Add: Gain on constructive retirement of bondsb Less: Operating expenses Operating profit Other Items: Bond interest expensea Consolidated net income a b 630 (250) 386 $ (30) 356 Parent’s bond interest expense $50,000 less interest on bonds held intercompany $20,000 = $30,000 Book value of parent’s bonds purchased $200,000 less purchase price $194,000 = $6,000 gain on constructive retirement ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 7-5 Solution E7-6 Constructive loss Cost paid to retire 1/2 of Smedley’s bonds Book value of bonds retired ($990,000 ´ 5) Constructive loss on bond retirement $503,000 495,000 $ 8,000 Income from Smedley Share of Smedley’s reported income $14,000 ´ 70% Less: Constructive loss $8,000 ´ 70% Add: Piecemeal recognition of constructive loss ($8,000/4 years) ´ 70% Income from Smedley $ $ 9,800 (5,600) 1,400 5,600 Solution E7-7 a January 1, 2009 cost of $200,000 par bonds Book value acquired ($1,000,000 + $45,000 premium) ´ 20% Constructive gain $195,500 209,000 $ 13,500 b Constructive gain $13,500/5 years ´ years $ 10,800 c Book value $1,036,000 ´ 80% outstanding $828,800 Solution E7-8 1a 1b Constructive gain Book value of bonds January 1, 2010 Amortization for months ($30,000/5 years ´ 1/2 year) Book value of bonds July 1, 2010 Percent purchased by Saydo $970,000 3,000 973,000 60% Book value of bonds purchased Purchase price $583,800 574,800 Constructive gain $ 9,000 Consolidated bond interest expense for 2010 Bond interest expense January to July ($1,000,000 ´ 8% ´ 1/2 year) + $3,000 amortization $ 43,000 Bond interest expense July to December 31 [($1,000,000 ´ 8% ´ 1/2 year) + $3,000 amortization] ´ 40% Consolidated bond interest expense 17,200 $ 60,200 ©2009 Pearson Education, Inc publishing as Prentice Hall 7-6 Intercompany Profit Transactions — Bonds ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 1c 7-7 Bond liability of Partie January 1, 2010 Amortization 2010 December 31, 2010 Par $1,000,000 $1,000,000 Discount $30,000 - 6,000 $24,000 Consolidated bond liability $976,000 ´ 40% outstanding Book Value $970,000 + 6,000 $976,000 $390,400 The amounts would not be different if Saydo had been the issuer and Partie the purchaser However, the constructive retirement gains would ‘belong’ to Saydo and would have been allocated to both Partie and the noncontrolling interests in Saydo Solution E7-9 (amounts in thousands) Subsidiary purchases parent company bonds: 1a Gain on constructive retirement of bonds Book value of Picker’s bonds constructively retired ($5,000 - $100 unamortized discount) ´ 40% Purchase price of $1,000 par bonds Gain on constructive bond retirement 1b $1,960 1,900 $ 60 Consolidated interest payable ($3,000 + $1,000) ´ 10% interest ´ 1/2 year $ 1c Bonds payable at par ($3,000 + $1,000) $4,000 1d None But Skidden’s investment in Picker bonds will be $1,920,000 Cost January Add: Amortization ($100,000/5 years) 2a 2b 200 $1,900 20 $1,920 Parent company purchases subsidiary bonds: Loss on constructive retirement of bonds Skidden’s bonds payable ($1,000 + $20) Price paid by Picker Loss on constructive retirement of bonds $1,020 1,030 $ (10) Consolidated interest expense Picker bonds ($5,000 ´ 10% interest) + $20 amortization $ 2c None Interest receivable of $50 is eliminated in consolidation 2d Book value of bonds payable Picker’s bonds December 31, 2009 Add: Amortization for 2010 ($100 / years) Book value of bonds payable 520 $4,900 20 $4,920 ©2009 Pearson Education, Inc publishing as Prentice Hall 7-8 Intercompany Profit Transactions — Bonds Solution E7-10 Gain from constructive retirement of bonds Book value of bonds purchased by Shelly ($2,000,000 + $60,000) ´ 25% Price paid by Shelly Gain from constructive retirement of bonds Working paper entry to eliminate effect of intercompany bond holdings 12% bonds payable 512,000 62,000 Interest incomea Interest payable 30,000 Investment in Perdue bonds 492,000 Gain on retirement of bonds 25,000 57,000 Interest expenseb Interest receivable 30,000 a b ($500,000 ´ 12% interest) + $2,000 amortization = $62,000 [($2,000,000 ´ 12%) - $12,000 amortization] ´ 25% intercompany = $57,000 Consolidated income statement amounts — 2011 a Constructive gain None b Noncontrolling interest share ($300,000 ´ 20%) $ 60,000 c Bond interest expense [($2,000,000 ´ 12%) - $12,000] ´ 75% outsiders $ 171,000 d $515,000 490,000 $ 25,000 Bond interest income None Consolidated balance sheet amounts — December 31, 2011 a Investment in Perdue bonds b Book value of bonds payable ($2,000,000 + $36,000) ´ 75% outsiders c Bond interest receivable d Bond interest payable $2,000,000 ´ 12% ´ 75% outsiders ´ 1/2 year None $1,527,000 None $ ©2009 Pearson Education, Inc publishing as Prentice Hall 90,000 Chapter 7-9 Solution E7-11 Preliminary computations: Book value of Sandwood bonds on January 1, 2010 Purchase price paid by Parrish Gain on constructive retirement of Sandwood bonds $1,000,000 783,000 $ 217,000 Amortization of discount on bonds ($217,000/7 years) Computation of noncontrolling interest share: Share of Sandwood’s reported income ($140,000 ´ 20%) Add: Share of constructive gain ($217,000 ´ 20%) Less: Piecemeal recognition of constructive gain ($31,000 ´ 20%) Noncontrolling interest share $ 31,000 $ 28,000 43,400 (6,200) 65,200 $ Parrish Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2010 (in thousands) Sales Less: Cost of sales $1,800 950 Gross profit Add: Gain from constructive retirement of Sandwood Less: Operating expenses Consolidated net income Less: Noncontrolling interest share Controlling interest share of NI $ $ 850 217 400 667 65.2 601.8 Solution E7-12 Public Corporation and Subsidiary, December 31, 2009 Interest receivable Investment in Spede bonds Interest payable ($40,000 ´ 90%) 8% bonds payable (($1,000,000 ´ 90%)- 13,500 discount) Interest income Interest expense ($86,000/2) + 9(86,000/2) Loss on intercompany bonds Amounts Appearing in Consolidated Financial Statements 0 36,000 886,500 81,700 7,800a ©2009 Pearson Education, Inc publishing as Prentice Hall 7-10 Intercompany Profit Transactions — Bonds Solution E7-12 (continued) a Computation of loss on intercompany bonds Balance of investment in bonds at December 31, 2009 $105,000 Add: Amount amortized for July to December 31, 2009 ($5,000 balance at December 31 ¸ 30/36 months = $6,000 unamortized at July 1) 1,000 Investment cost July 1, 2009 $106,000 Less: Book value acquired [$1,000,000 - ($15,000 unamortized discount at December 31 ¸ 30/36 months)] ´ 10% 98,200 Loss on constructive retirement of bonds $ 7,800 Consolidation working paper entries at December 31, 2009 Interest income 3,000 8% bonds payable 98,500 Loss on retirement of bonds 7,800 Investment in Spede bonds 105,000 Interest expense 4,300 To eliminate intercompany bonds and record constructive loss on retirement of bonds, and eliminate intercompany interest income and interest expense Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and interest receivable amounts Consolidation working paper entries at December 31, 2010 Investment in Spede (90%) 5,850 Noncontrolling interest 650 Interest income 6,000 8% bonds payable 99,100 Investment in Spede bonds 103,000 Interest expense 8,600 To eliminate intercompany bonds, interest income and interest expense, and to charge the unrecognized portion of the constructive loss at the beginning of the period 90% to the investment in Spede and 10% to the noncontrolling interest Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and interest receivable amounts ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 7-11 Solution E7-13 Gain on constructive retirement of bonds Purchase price of bonds Book value Gain on constructive retirement of bonds $48,800 50,000 $ 1,200 Sonny accounts for its investment in Pappy bonds January 1, 2011 Investment in Pappy bonds 48,800 Cash To record investment in $50,000 par, 8% Pappy bonds July 1, 2011 Cash Investment in Pappy bonds Interest income To record interest and amortization 48,800 2,000 200 2,200 December 31, 2011 Interest receivable 2,000 Investment in Pappy bonds 200 Interest income To accrue interest and record amortization Pappy accounts for its bonds payable July 1, 2011 Interest expense Cash To record interest payable for months December 31, 2011 Interest expense Interest payable To accrue interest for months 2,200 4,000 4,000 4,000 4,000 Pappy accounts for its investment in Sonny December 31, 2011 Investment in Sonny 40,800 Income from Sonny 40,800 To record income from Sonny (80% ´ $50,000) + $1,200 constructive gain - $400 piecemeal recognition of gain Noncontrolling interest share ($50,000 ´ 20%) $ 10,000 Controlling share of NI ($200,000 + $40,800) $240,800 ©2009 Pearson Education, Inc publishing as Prentice Hall 7-12 Intercompany Profit Transactions — Bonds SOLUTIONS TO PROBLEMS Solution P7-1 Loss on constructive retirement of bonds Purchase price of $50,000 par bonds April 1, 2009 Book value of bonds acquired: Par value Less: Unamortized discount $1,800 for 27 of 36 months ($1,800 ¸ 75) Book value of bonds Intercompany bonds $53,600 $100,000 2,400 97,600 50% Loss on constructive retirement of bonds $ 4,800 Interest income and interest expense Interest income in consolidated income statement — 2009 Interest expense in consolidated income statement — 2009 $8,800 - ($8,800 ´ 3/4 year ´ 50%) 48,800 $ 5,500 Interest receivable and interest payable Interest receivable in consolidated balance sheet at December 31, 2009 Interest payable in consolidated balance sheet at December 31, 2009 $ 1,000 Consolidation working paper entries Loss on constructive retirement of bonds 4,800 8% bonds payable 49,100 Interest income 2,100 Investment in Pongo bonds 52,700 Interest expense 3,300 To eliminate reciprocal interest income and interest expense amounts and reciprocal bond investment and bond liability amounts and enter unrecognized constructive loss Interest payable 1,000 Interest receivable To eliminate reciprocal payables and receivables ©2009 Pearson Education, Inc publishing as Prentice Hall 1,000 Chapter 7-13 Solution P7-2 Pewter Corporation and Steel Corporation Schedule to Determine Pewter’s Net Income and Consolidated Net Income Pewter’s separate income 2009 $500,000 2010 $375,000 2011 $460,000 2012 $510,000 Total $1,845,000 80% of Steel’s net income + 80,000 + 96,000 + 88,000 + 96,000 + 360,000 $5,000 unrealized profit in Steel’s December 31, 2009 Inventory - + 5,000 $10,000 unrealized profit in Steel’s December 31, 2010 Inventory 5,000 - 10,000 + 10,000 $15,000 unrealized profit in 2011 on sale of land upstream ´ 80% - 12,000 - 12,000 $30,000 unrealized profit on sale of equipment in 2011 - 30,000 - 30,000 $7,500 depreciation on unrealized profit on equipment in 2011 and 2012 + + 7,500 + 15,000 $8,000 constructive loss on purchase of Pewter’s bonds in 2012 - 8,000 - 8,000 $2,000 piecemeal recognition of constructive loss in 2012 + 2,000 + 2,000 Pewter’s net income $575,000 $466,000 7,500 $523,500 $607,500 $2,172,000 Solution P7-3 Income from Storm for 2009: Share of reported income of Storm ($200,000 ´ 75%) Add: Unrealized profit in beginning inventory of Storm Less: Unrealized profit in ending inventory of Storm Add: Piecemeal recognition of gain on sale of equipment to Paar ($48,000/6 years) ´ 75% Less: Unrealized gain on sale of land to Storm Less: Unrealized gain on sale of building to Storm less piecemeal recognition through depreciation ($40,000 - $2,000) Add: Gain on constructive retirement of Paar bonds ($200,000 - $188,000) Income from Storm $ 150,000 24,000 (30,000) 6,000 (20,000) (38,000) 12,000 $ 104,000 ©2009 Pearson Education, Inc publishing as Prentice Hall 7-14 Intercompany Profit Transactions — Bonds Solution P7-3 (continued) Investment in Storm at December 31, 2009: Underlying equity in Storm ($1,040,000 ´ 75%) Less: Unrealized profit in Storm’s ending inventory Less: Unrealized gain on equipment sold to Placid ($48,000 - $24,000 recognized) ´ 75% Less: Unrealized gain on sale of land to Storm Less: Unrealized gain on sale of building to Storm ($40,000 - $2,000 recognized) Add: Gain on constructive retirement of Placid’s bonds Investment in Storm December 31 $780,000 (30,000) (18,000) (20,000) (38,000) 12,000 $686,000 Noncontrolling interest share: Net income of Storm $200,000 Add: Piecemeal recognition of gain on equipment ($48,000/6 years) 8,000 Storm’s realized income 208,000 Noncontrolling interest percentage 25% Noncontrolling interest share $ 52,000 ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 7-15 Solution P7-3 (continued) Placid Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2009 (in thousands) Placid Income Statement Sales Gain on land Gain on building Income from Sahl Gain on bonds Cost of sales $ 1,260 20 40 104 $ 1,000 700 * 600 * 152 * 80* Depreciation expense Interest expense Operating expense Consolidated NI Noncontrolling int share Controlling share of NI $ Retained Earnings Retained earnings — Placid $ Retained earnings — Storm Controlling share of NI Dividends Retained earnings December 31 $ Balance Sheet Cash $ Bond interest receivable Other receivables Inventories Land Buildings — net Equipment — net Investment in Storm stock 40* 92* b 100 f 20 f 40 h 104 d k 440 30 $2,160 g 12 b 100 c 24 e f $ 200 $ 200 200 160 * 440 320 * 420 $ 240 54 $ 162 10 60 100 140 360 180 80 160 180 300 280 686 1,206 * $ 222 * 40* 212 * 492 52* 440 $ 300 i 200 440 h 120 k 40 a c e h 20 24 24 16 188 $1,740 $1,200 $ $ Noncontrolling interest January 12 52 300 100 20 400 800 420 $1,740 Consolidated Statements 120 * Investment in Placid bonds Accounts payable Bond interest payable 10% bonds payable Common stock Retained earnings Adjustments and Eliminations Storm 75% $ 420 $ 236 j 10 a 20 d 30 f 20 f 38 e 24 i 750 120 230 300 622 436 g 188 $1,944 160 800 240 $1,200 320 * $ j 10 g 200 i 800 e i 250 ©2009 Pearson Education, Inc publishing as Prentice Hall 260 10 200 800 420 7-16 Intercompany Profit Transactions — Bonds Noncontrolling interest December 31 k 12 254 $1,944 ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 7-17 Solution P7-4 Preliminary Computations: Acquisition price Implied fair value of Sher ($320,000 / 80%) Sher’s book value Excess allocated to plant & equipment with year life $ 320,000 $ 400,000 (300,000) $ 100,000 Annual depreciation of excess ($100,000 / years) $ 12,500 Loss is from the constructive retirement of bonds Purchase price of bonds Book value of bonds ($100,000 + $3,000 premium) Loss on retirement of bonds $106,000 103,000 $ 3,000 Consolidated sales Combined sales Less: Intercompany sales Consolidated sales $280,000 50,000 $230,000 Consolidated cost of goods sold Combined cost of goods sold Less: Intercompany sales Less: Unrealized profits in beginning inventory Add: Unrealized profits in ending inventory Consolidated cost of goods sold $170,000 (50,000) (20,000) 10,000 $110,000 Unrealized profit in beginning inventory Forced computations ($170,000 + $10,000) - ($50,000 + $110,000) $ 20,000 Unrealized profit in ending inventory Combined inventories ($100,000 + $50,000) Less: Consolidated inventories Unrealized profit in ending inventory $150,000 140,000 $ 10,000 Consolidated accounts receivable Combined accounts receivable ($120,000 + $60,000) Less: Intercompany receivables Consolidated accounts receivable $180,000 15,000 $165,000 Noncontrolling interest share Sher’s reported net income Less: Depreciation of excess Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Sher’s realized income Noncontrolling interest percentage Noncontrolling interest share $ 30,000 (12,500) 20,000 (10,000) 27,500 20% $ 5,500 ©2009 Pearson Education, Inc publishing as Prentice Hall 7-18 Intercompany Profit Transactions — Bonds Solution P7-4 (continued) Noncontrolling interest December 31, 2011 Beginning noncontrolling interest (($335,000 + $75,000 unamortized excess) ´ 20%) Less: Unrealized profit in beginning inventory ($20,000 ´ 20%) Less: Noncontrolling interest dividends ($15,000 ´ 20%) Add: Noncontrolling interest share Noncontrolling interest December 31 $ 82,000 (4,000) (3,000) 5,500 $ 80,500 Alternative computation: Ending equity of Sher (($350,000 + $62,500 unamortized excess( ´ 20%) $ 82,500 Less: Unrealized profit in ending inventory ($10,000 ´ 20%) (2,000) Noncontrolling interest December 31, 2011 $ 80,500 Investment in Sher stock at December 31, 2010 Investment in Sher stock at cost Add: Changes in retained earnings to December 31, 2010 ($135,000 - $100,000) ´ 80% Less: 80% of Excess of (($100,000/8 years x 80%) = $10,000 per year ´ years) Less: Unrealized profit in beginning inventory ($20,000 ´ 80%) Investment in Sher stock December 31, 2010 Alternative computation: Investment in Sher stock December 31, 2011 Less: Income from Sher for 2011 Add: Dividends from Sher ($15,000 ´ 80%) Investment in Sher stock December 31, 2010 10 Income from Sher Share of Sher’s reported net income Less: Depreciation on excess ($100,000/8 years) Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Sher’s adjusted and realized income Peter’s 80% controlling share Less: Constructive loss on retirement of bonds ($3,000 - $1,000) Peter’s income from Sher $320,000 28,000 (20,000) (16,000) $312,000 $320,000 (20,000) 12,000 $312,000 $ 30,000 (12,500) 20,000 (10,000) $ 27,500 $ 22,000 (2,000) $ 20,000 ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 7-19 Solution P7-5 [AICPA adapted] Consolidated cash ($50,000 + $15,000) $ 65,000 Equipment — net ($800,000 equipment - $320,000 accumulated depreciation - $21,000 unrealized profit + $7,000 profit realized through depreciation of excess) $466,000 Investment in Shaw does not appear in consolidated statements Bonds payable (Shaw’s bonds payable of $200,000 ´ 1/2 held outside the consolidated entity) $100,000 Common stock (Poe’s stock) $100,000 Beginning retained earnings (Poe’s retained earnings) $272,000 Dividends paid (Poe’s dividends) $ 80,000 Gain on retirement of bonds (Book value of Shaw’s bonds acquired by Poe $100,000 less acquisition cost of $91,000 Since bonds were acquired on December 31, 2006, none of the $9,000 gain has been amortized.) $ Cost of goods sold ($860,000 combined - $60,000 intercompany sales + $10,000 unrealized profit in ending inventory) $810,000 9,000 10 Interest expense (Shaw paid interest for the entire year to outside entities so all of Shaw’s interest is reported) $ 16,000 11 Depreciation expense ($45,000 combined - depreciation on the unrealized gain $7,000) $ 38,000 Solution P7-6 Income from Sahl for 2010: Share of reported income of Sahl ($100,000 ´ 75%) Add: Unrealized profit in beginning inventory of Sahl Less: Unrealized profit in ending inventory of Sahl Add: Piecemeal recognition of gain on sale of equipment to Paar ($24,000/6 years) ´ 75% Less: Unrealized gain on sale of land to Sahl Less: Unrealized gain on sale of building to Sahl less piecemeal recognition through depreciation ($20,000 - $1,000) Add: Gain on constructive retirement of Paar bonds ($100,000 - $94,000) Income from Sahl for 2010 $ 75,000 12,000 (15,000) 3,000 (10,000) (19,000) 6,000 $ 52,000 ©2009 Pearson Education, Inc publishing as Prentice Hall Chapter 7-21 Solution P7-6 (continued) Paar Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2010 (in thousands) Paar Income Statement Sales Gain on plant Income from Sahl Gain on bonds Cost of sales 500 b f h 50 30 52 350 * 300 * d 15 Depreciation expense 76* 40* Interest expense Operating expense Consolidated NI Noncontrolling int share Controlling share of NI $ 20* 46* Retained Earnings Retained earnings — Paar Retained earnings — Sahl Controlling share of NI Dividends Retained earnings December 31 Balance Sheet Cash Bond interest receivable Other receivables Inventories Land Buildings — net Equipment — net Investment in Sahl stock $ $ 630 30 52 Adjustments and Eliminations Sahl 75% $ $ 100 $ 100 100 80* 220 160 * $ 210 $ 120 $ 27 $ 81 30 50 70 180 90 40 80 90 150 140 343 50 12 870 $ 94 600 $ 50 10 200 400 210 870 $ 80 Noncontrolling interest January Noncontrolling interest December 31 603 * $ 111 * 20* 106 * 246 26* 220 $ 150 26 i 100 220 h k a c e h $ $ g b c e f 150 Investment in Paar bonds Accounts payable Bond interest payable 10% bonds payable Common stock Retained earnings $1,080 60* k 220 Consolidated Statements $ 400 120 600 60 20 10 12 12 160 * $ 210 $ 118 j a 10 d 15 f 10 f 19 e 12 i 375 g 60 115 150 311 218 94 $ 972 $ 130 100 400 210 j g 100 i 400 e i 125 k ©2009 Pearson Education, Inc publishing as Prentice Hall 127 7-22 Intercompany Profit Transactions — Bonds $ * Deduct ©2009 Pearson Education, Inc publishing as Prentice Hall 972 ... equity, either parenthetically or in statement notes SOLUTIONS TO EXERCISES Solution E7-1 C A D A Solution E7-2 A Book value of Pavone bond’s acquired by Showalter ($900,000 + $48,000) ´ 2/3 Cost to... Profit Transactions — Bonds Solution E7-10 Gain from constructive retirement of bonds Book value of bonds purchased by Shelly ($2,000,000 + $60,000) ´ 25% Price paid by Shelly Gain from constructive... $828,800 Solution E7-8 1a 1b Constructive gain Book value of bonds January 1, 2010 Amortization for months ($30,000/5 years ´ 1/2 year) Book value of bonds July 1, 2010 Percent purchased by Saydo
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