Chapter 08 - Intercompany Indebtedness CHAPTER INTERCOMPANY INDEBTEDNESS ANSWERS TO QUESTIONS Q8-1 A gain or loss on bond retirement is reported by the consolidated entity whenever (a) one of the companies purchases its own bonds from a nonaffiliate at an amount other than book value, or (b) a company within the consolidated entity purchases the bonds of an affiliate from a nonaffiliate at an amount other than book value Q8-2 A constructive retirement occurs when the bonds of a company included in the consolidated entity are purchased by another company included within the consolidated entity Although the debtor still considers the bonds as outstanding, and the investor views the bonds as an investment, they are constructively retired for consolidation purposes If bonds are actually retired, the debtor purchases its own bonds from a nonaffiliate and they are no longer outstanding Q8-3 When bonds sold to an affiliate at par value are not eliminated, bonds payable and bond investment are misstated in the balance sheet accounts and interest income and interest expense are misstated in the income statement accounts There is also a premium or discount account to be eliminated when the bonds are not issued at par value Unless interest is paid at year-end, there is likely to be some amount of interest receivable and interest payable to be eliminated as well Q8-4 Both the bond investment and interest income reported by the purchaser will be improperly included Interest expense, bonds payable, and any premium or discount recorded on the books of the debtor also will be improperly included In addition, the constructive gain or loss on bond retirement will be omitted if no eliminating entries are recorded in connection with the purchase Q8-5 If the focus is placed on the legal entity, only bonds actually reacquired by the debtor will be treated as retired This treatment can lead to incorrect reports for the consolidated entity in two dimensions If a company were to repurchase bonds from an affiliate, any retirement gain or loss reported by the debtor is not a gain or loss to the economic entity and must be eliminated in preparing consolidated statements Moreover, although a purchase of debt of any of the other companies in the consolidated entity will not be recognized as a retirement by the debtor, when emphasis is placed on the economic entity the purchase must serve as a basis for recognition of a bond retirement for the consolidated entity Q8-6 The difference in treatment is due to the effect of the transactions on the consolidated entity In the case of land sold to another affiliate, a gain has been recorded that is not a gain from the viewpoint of the consolidated entity Thus, it must be eliminated in the consolidation process On the other hand, in a bond repurchase the buyer simply records an investment in bonds and the debtor makes no special entries because of the purchase by an affiliate Neither company records the effect of the transaction on the economic entity Thus, in the consolidation process an entry must be made to show the gain on bond retirement that has occurred from the viewpoint of the economic entity 8-1 Chapter 08 - Intercompany Indebtedness Q8-7 When there has been a direct sale to an affiliate, the interest income recorded by the purchaser should equal the interest expense recorded by the seller and the two items should have no net effect on reported income The eliminating entries not change consolidated net income in this case, but they will result in a more appropriate statement of the relevant income and expense categories in the consolidated income statement Q8-8 Whenever a loss on bond retirement has been reported in a prior period, the affiliate that purchased the bonds paid more than the book value of the debt shown by the debtor As a result, each period the interest income recorded by the buyer will be less than the interest expense reported by the debtor When the two income statement accounts are eliminated in the consolidation process, the effect will be to increase consolidated net income Because the full amount of the loss was recognized for consolidated purposes in the year in which the bonds were purchased by the affiliate, the effect of the elimination process in each of the periods that follow should be to increase consolidated income Q8-9 The difference between the carrying value of the debt on the debtor's books and the carrying value of the investment on the purchaser's books indicates the amount of unrecognized gain or loss at the end of the period To determine the amount of the gain or loss on retirement at the start of the period, the difference between interest income recorded by the purchaser on the bond that has been purchased and interest expense recorded by the debtor during the period is added to the difference between carrying values at the end of the period Q8-10 Interest income and interest expense must be eliminated and a loss on bond retirement established in the elimination process Consolidated net income will decrease by the amount of the loss Because the loss is attributed to the subsidiary, income assigned to the controlling and noncontrolling interests will decrease in proportion to their share of common stock held Q8-11 A constructive gain will be included in the consolidated income statement in this case and both consolidated net income and income to the controlling interest will increase by the full amount of the gain Q8-12 A direct placement of subsidiary bonds with the parent should have no effect on consolidated income or on income assigned to the noncontrolling shareholders Q8-13 When subsidiary bonds are purchased from a nonaffiliate by the parent and there is a constructive gain or loss for consolidated purposes, the gain or loss is assigned to the subsidiary and included in computing income to the noncontrolling shareholders Q8-14 Interest income recorded by the subsidiary and interest expense recorded by the parent should be equal in the direct placement case When the subsidiary purchases parent company bonds from a nonaffiliate, interest income and interest expense will not be the same unless the bonds are purchased from the nonaffiliate at an amount equal to the liability reported by the parent 8-2 Chapter 08 - Intercompany Indebtedness Q8-15 A gain on constructive bond retirement recorded in a prior period means the bonds were purchased for less than book value and the interest income recorded by the subsidiary each period will be greater than the interest expense recorded by the parent Consolidated net income for the current period will decrease by the difference between interest income and interest expense as these amounts are eliminated in preparing the consolidated statements Income to the noncontrolling interest will be unaffected since the constructive gain is assigned to parent company Q8-16 A constructive loss recorded on the subsidiary's bonds in a prior period means the interest income recorded by the parent is less than the interest expense recorded by the subsidiary in each of the following periods Consolidated net income will increase when interest income and expense are eliminated Income assigned to the noncontrolling interest will be based on the reported net income of the subsidiary plus the difference between interest income and interest expense each period following the retirement As a result, the amount assigned will be greater than if the bond had not been constructively retired Q8-17 On the date the parent sells the bonds to a nonaffiliate they are issued for the first time from a consolidated perspective While the parent will record a gain or loss on sale of the bonds on its books, none is recognized from a consolidated viewpoint The difference between the sale price received by the parent and par value is a premium or discount Each period there will be a need to establish the correct amount for the premium or discount account and to adjust interest expense recorded by the subsidiary to bring the reported amounts into conformity with the sale price to the nonaffiliate Q8-18 The retirement gain or loss reported by the subsidiary when it repurchases the bonds held by the parent must be eliminated in the consolidation process From the viewpoint of the consolidated entity the bonds were retired at the point they were purchased by the parent and a gain or loss should have been recognized at that point 8-3 Chapter 08 - Intercompany Indebtedness SOLUTIONS TO CASES C8-1 Recognition of Retirement Gains and Losses a When Flood purchases the bonds it establishes an investment account on its books and Bradley establishes a bond liability and discount account on its books No entry is made by Century When Century purchases the bonds, Century records an investment and Flood removes the balance in the investment account and records a gain on the sale Bradley makes no entry When Bradley retires the issue, Bradley removes its liability and unamortized discount and records a loss on bond retirement Century removes the bond investment account and records a loss on the sale of bonds Flood makes no entry b A constructive loss on bond retirement is reported by the consolidated entity at the time Century purchases the bonds from Flood The exact amount of the loss cannot be ascertained without knowing the maturity date of the bonds, the date of initial sale, and the date of purchase by Century c The initial sale of bonds by Bradley is treated as a normal transaction with no need for an adjustment to income assigned to the noncontrolling shareholders Income assigned to noncontrolling shareholders will be reduced by a proportionate share of the loss reported in the consolidated income statement in the period in which Century purchases the bonds from Flood In the years before the bonds are retired by Bradley, income assigned to the noncontrolling interest (assuming no differential) will be greater than a pro rata portion of the reported net income of Bradley In the period in which the bonds are retired by Bradley, reported net income of Bradley must be adjusted to remove its loss on bond retirement before assigning income to the noncontrolling interest No adjustment is made in the years following the repurchase by Bradley 8-4 Chapter 08 - Intercompany Indebtedness C8-2 Borrowing by Variable Interest Entities MEMO To: President Hydro Corporation From: Re: , Accounting Staff Consolidation of Joint Venture Hydro Corporation and Rich Corner Bank established a joint venture which borrowed $30,000,000 and built a new production facility That facility is now leased to Hydro on a 10year operating lease Hydro currently reports the annual lease payment as an operating expense and in the notes to its financial statements must report a contingent liability for its guarantee of the debt of the joint venture I have been asked to review the current financial reporting standards and determine whether Hydro’s current reporting is appropriate The circumstances surrounding the creation of the joint venture and the lease arrangement with Hydro appear to point to the need for Hydro to consolidate the joint venture with its own operations Although Rich Corner Bank holds 100 percent of the equity of the joint venture, it has contributed less than percent of the total assets of the joint venture ($200,000 of equity versus $30,000,000 of total borrowings) Under normal circumstances, less than a 10 percent investment in the entity’s total assets is considered insufficient to permit the entity to finance its activities [FASB INT 46, Par 9] In this situation, Hydro has guaranteed the $30,000,000 borrowed by the joint venture and has guaranteed a 20 percent annual return on the equity investment of Rich Corner Bank These conditions will result in Hydro Corporation absorbing any losses incurred by the joint venture and establish Hydro Corporation as the primary beneficiary of the entity The FASB requires consolidation by the entity that will absorb a majority of the entity’s expected losses if they occur [FASB INT 46, Par 14] Consolidation of the joint venture will result in including the production facility among Hydro’s assets and the debt as part of its long-term liabilities The claim on the net assets of the joint venture held by Rich Corner Bank will be reported as part of noncontrolling interest Hydro’s consolidated income statement will not include the lease payment as an operating expense, but will include depreciation expense on the production facility and interest expense for the interest payment made on the borrowing of the joint venture Primary citation: FASB INT 46 8-5 Chapter 08 - Intercompany Indebtedness Case 8-3 Subsidiary Bond Holdings MEMO To: Financial Vice-President Farflung Corporation From: Re: , Accounting Staff Investment in Bonds Issued by Subsidiary The consolidated financial statements of Farflung Corporation should include both Micro Company and Eagle Corporation The purpose of the consolidated statements is to present the financial position and results of operations for a parent and one or more subsidiaries as if the individual entities actually were a single company or entity [ARB 51, Par 1] When one subsidiary purchases the bonds of another, the investment reported by the purchasing affiliate and the liability reported by the debtor must be eliminated and a gain or loss reported on the difference between the purchase price and the carrying value of the debt at the time of purchase In preparing Farflung’s consolidated statements at December 31, 20X4, the following eliminating entry should have been included in the workpaper: E(1) Bonds Payable Loss on Bond Retirement Investment in Micro Company Bonds 400,000 24,000 424,000 The $24,000 loss should have been included in the consolidated income statement, leading to a reduction of $15,600 ($24,000 x 65) in income assigned to the controlling interest and a reduction of $8,400 ($24,000 x 35) in income assigned to noncontrolling shareholders This error should be corrected by restating the financial statements of the consolidated entity for 20X4 While omission of the eliminating entry resulted in incorrect financial statements for the consolidated entity, it should have no impact on the financial statements of the individual subsidiaries Assuming (1) the bonds had 15 years remaining until maturity when purchased by Eagle and pay percent interest annually, (2) straight-line amortization of the premium paid by Eagle is appropriate, and (3) the consolidated financial statements as of December 31, 20X4, are corrected, the eliminating entry at December 31, 20X5, is: 8-6 Chapter 08 - Intercompany Indebtedness C8-3 (continued) E(2) Bonds Payable Interest Income Retained Earnings Noncontrolling Interest Investment in Micro Company Bonds Interest Expense 400,000 30,400(a) 15,600 8,400 422,400(b) 32,000(c) (a) ($400,000 x 08) - ($24,000/15 years) (b) $424,000 - ($24,000/15 years) (c) $400,000 x 08 Primary citation: ARB 51, Par C8-4 Interest Income and Expense a Snerd apparently paid more than par value for the bonds and is amortizing the premium against interest income over the life of the bonds Thus, the cash received is greater than the amount of interest income recorded b With the information given, the following appears to be true: (1) When purchasing the bonds, Snerd apparently paid less than the current carrying amount of the bonds on the subsidiary’s books because a constructive gain on bond retirement is included in the 20X3 consolidated income statement Since Snerd paid par value for the bonds, they must have been sold at a premium by the subsidiary (2) Because the bonds were sold at a premium, interest expense recorded by the subsidiary will be less than the annual interest payment made to the parent (3) Interest income recorded each period by Snerd will exceed interest expense recorded by the subsidiary When the two balances are eliminated, the effect will be to reduce income to both the controlling and noncontrolling shareholders 8-7 Chapter 08 - Intercompany Indebtedness C8-5 Intercompany Debt Answers to this case can be found in the SEC Form 10-K filed by Hershey Foods and its annual report a When intercompany loans are made between affiliates in different countries, the problem of changing currency exchange rates may arise, especially if any of the loans are denominated in a currency that rapidly changes in value against the dollar Hershey Foods and many other companies in the same situation hedge their intercompany receivables/payables through foreign currency forward contracts and swaps b Hershey's intercompany receivables/payables intercompany purchases and sales of goods 8-8 appear to come primarily from Chapter 08 - Intercompany Indebtedness SOLUTIONS TO EXERCISES E8-1 Bond Sale from Parent to Subsidiary a Journal entries recorded by Humbolt Corporation: January 1, 20X2 Investment in Lamar Corporation Bonds Cash July 1, 20X2 Cash Interest Income Investment in Lamar Corporation Bonds 156,000 4,500 156,000 4,200 300 December 31, 20X2 Interest Receivable Interest Income Investment in Lamar Corporation Bonds b 4,500 Journal entries recorded by Lamar Corporation: January 1, 20X2 Cash Bonds Payable Bond Premium 156,000 July 1, 20X2 Interest Expense Bond Premium Cash 4,200 300 December 31, 20X2 Interest Expense Bond Premium Interest Payable 4,200 300 c 4,200 300 150,000 6,000 4,500 4,500 Eliminating entries, December 31, 20X2: E(1) E(2) Bonds payable Premium on Bonds Payable Interest income Investment in Lamar Corporation Bonds Interest expense Eliminate intercorporate bond holdings Interest payable Interest receivable Eliminate intercompany receivable/payable 8-9 150,000 5,400 8,400 4,500 155,400 8,400 4,500 Chapter 08 - Intercompany Indebtedness E8-2 Computation of Transfer Price a $105,000 = $100,000 par value + ($250 x 20 periods) premium b $103,500 = $105,000 - ($250 x periods) c Eliminating entries: E(1) E(2) Bonds Payable Bond Premium Interest Income Investment in Nettle Corporation Bonds Interest Expense Interest Payable Interest Receivable 100,000 3,500 11,500 6,000 103,500 11,500 6,000 E8-3 Bond Sale at Discount a $16,800 = [($600,000 x 08) + ($12,000 / years)] x 1/3 b Journal entries recorded by Wood Corporation: January 1, 20X4 Cash Interest Receivable 16,000 July 1, 20X4 Cash Investment in Carter Company Bonds Interest Income $800 = ($400,000 - $392,000)/(5 x 2) December 31, 20X4 Interest Receivable Investment in Carter Company Bonds Interest Income c 16,000 800 16,000 800 16,000 16,800 16,800 Eliminating entries, December 31, 20X4: E(1) E(2) Bonds Payable Interest Income Investment in Carter 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 16,000 8-10 395,200 4,800 33,600 16,000 Chapter 08 - Intercompany Indebtedness P8-26 (continued) E(6) E(7) Bonds Payable Interest Income Retained Earnings, January Noncontrolling Interest Investment in Skate Company Bonds Interest Expense Bond Discount Eliminate intercorporate bond holdings: $3,600 = ($40,000 x 10) - ($2,800 / years) $3,150 = ($42,800 - $38,600) x 75 $1,050 = ($42,800 - $38,600) x 25 $42,400 = $42,800 - ($2,800 / years) $4,200 = ($40,000 x 10) + ($2,000 / 10 years) $1,200 = ($2,000 / 10 years) x years Interest and Other Payables Interest and Other Receivables Eliminate intercompany interest receivable/payable 40,000 3,600 3,150 1,050 2,000 42,400 4,200 1,200 2,000 Chapter 08 - Intercompany Indebtedness P8-26 (continued) b Pond Corporation and Skate Company Consolidation Workpaper December 31, 20X8 Pond Corp Skate Co 450,000 22,500 18,500 491,000 285,000 50,000 35,000 24,000 11,900 (405,900) 250,000 250,000 136,000 40,000 24,000 10,500 9,500 (220,000) 85,100 30,000 Ret Earnings, Jan 250,400 150,000 Income, from above Dividends Declared 85,100 335,500 (30,000) 30,000 180,000 (10,000) Ret Earnings, Dec 31, carry forward 305,500 170,000 53,100 176,000 47,000 65,000 45,000 140,000 50,000 400,000 10,000 50,000 22,000 240,000 Item Sales Income from Subsidiary Interest Income Credits Cost of Goods Sold Other Operating Expenses Depreciation Expense Interest Expense Miscellaneous Expenses Debits Consolidated Net Income Income to Noncontrolling Interest Income, carry forward Cash Accounts Receivable Interest and Other Receivables Inventory Land Buildings and Equipment Investment in Skate: Company Stock Company Bonds Investment in Tin Co Bonds Bond Discount Debits 165,000 1,205,500 700,000 (1) 22,500 (6) 3,600 (4) 1,500 (6) 4,200 (2) 7,650 33,750 5,700 (3)150,000 (4) 15,000 (5) 9,750 (6) 3,150 33,750 5,700 (1) 7,500 (2) 2,500 211,650 Consolidated 15,700 14,900 714,900 421,000 90,000 57,500 30,300 21,400 (620,200) 94,700 (7,650) 87,050 222,500 87,050 309,550 (30,000) 279,550 100,100 241,000 (7) 2,000 (4) 60,000 (5) 13,000 53,000 190,000 59,000 700,000 (1) 15,000 (3)150,000 (6) 42,400 42,400 134,000 Eliminations Debit Credit 3,000 437,000 (6) 1,200 134,000 1,800 1,478,900 Chapter 08 - Intercompany Indebtedness P8-26 (continued) Item Accum Depreciation Accounts Payable Interest & Other Payables Bonds Payable Common Stock Pond Corporation Skate Company Additional Paid-In Capital Retained Earnings, from above Noncontrolling Interest Credits Pond Corp Skate Co 185,000 65,000 45,000 300,000 94,000 11,000 12,000 100,000 (7) 2,000 (6) 40,000 30,000 (3) 30,000 155,000 20,000 (3) 20,000 305,500 170,000 211,650 15,700 279,550 437,000 (5) 3,250 (6) 1,050 367,950 (2) 5,150 (3) 50,000 367,950 50,850 1,478,900 150,000 1,205,500 Eliminations Debit Credit (4) 73,500 Consolidated 352,500 76,000 55,000 360,000 150,000 155,000 Chapter 08 - Intercompany Indebtedness P8-27 Comprehensive Multiple-Choice Questions b $374,000 [$200,000 + $180,000 - 30($70,000 - $50,000)] b $294,000 [$220,000 + $140,000 - $2,000 - ($70,000 - $6,000)] a $7,400 [($100,000 x 09) - ($6,400 premium / years)] b $32,000 [$24,000 + ($16,000 / 2)] b $13,125 ($293,125 - $200,000 - $50,000 - $30,000) d $83,000 ($50,000 + $30,000 + $3,000) b $3,000 Purchase price [$106,400 + ($6,400 / years)] Book value [$100,000 + $4,000 + ($4,000 / years)] Loss on bond retirement $108,000 (105,000) $ 3,000 Reported net income of Grange Corporation Add: Inventory profits of prior period realized in 20X6 Less: Unrealized inventory profits of 20X6 Less: Loss on bond retirement, January 1, 20X6 Add: Interest differential in 20X6 Realized income of Grange Less: Depreciation on differential assigned to buildings and equipment Less: Impairment of goodwill Adjusted income Proportion of stock held by noncontrolling interest Income assigned to noncontrolling interest $40,000 Par value of shares outstanding Retained earnings, December 31, 20X6 Less: Unrealized inventory profit Unrecorded portion of bond retirement loss ($3,000 - $600) Add: Unamortized differential assigned to buildings and equipment ($30,000 $9,000) Unimpaired goodwill ($13,125 - $7,500) $200,000 125,000 (6,000) Proportion of stock held by noncontrolling interest Assigned to noncontrolling interest ($13,125 - $7,500) 2,000 (6,000) (3,000) 600 $33,600 (3,000) (7,500) $23,100 x 20 $ 4,620 (2,400) 21,000 5,625 $343,225 x 20 $ 68,645 Chapter 08 - Intercompany Indebtedness P8-28 Comprehensive Problem: Intercorporate Transfers a Goodwill as of January 1, 20X7: Fair value of consideration given by Topp Fair value of noncontrolling interest at acquisition Total Book value of net assets at acquisition Differential at acquisition Increase in fair value of land Goodwill at acquisition b $1,152,000 128,000 $1,280,000 (1,200,000) $ 80,000 (30,000) $ 50,000 Computation of balance in investment account, January 1, 20X7: Bussman stockholders' equity, January 1, 20X7: Common stock Premium on common stock Retained earnings Stockholders' equity, January 1, 20X7 Topp's ownership share Book value of shares held by Topp Differential at January 1, 20X7 ($80,000 x 90) Balance in Investment in Bussman Stock account, January 1, 20X7 $ 500,000 280,000 470,000 $1,250,000 x 90 $1,125,000 72,000 $1,197,000 Computation of balance in investment account, December 31, 20X7: (not required) Balance in Investment in Bussman Stock account, January 1, 20X7 Add: Income from subsidiary, 20X7 Less: Dividends received ($40,000 x 90) Balance in Investment in Bussman Stock account, December 31, 20X7 c $1,197,000 90,000 (36,000) $1,251,000 Gain on constructive retirement of Bussman's bonds: Original proceeds from issuance of Bussman bonds Premium amortized to January 2, 20X7: ($10,000 / 10) x Book value of bonds at constructive retirement Price paid for Bussman bonds by Topp Gain on constructive retirement of Bussman's bonds $1,010,000 (6,000) $1,004,000 (980,000) $ 24,000 Chapter 08 - Intercompany Indebtedness d Income to noncontrolling interest, 20X7: Bussman's 20X7 net income Add: 20X6 intercompany profit realized in 20X7 Constructive gain on retirement of bonds Less: Unrealized intercompany profit on 20X7 transfer Portion of constructive gain on bond retirement recognized currently by separate affiliates ($24,000 / years) Impairment of goodwill Subsidiary income to be apportioned Noncontrolling interest's proportionate share Income to noncontrolling interest $100,000 4,500 24,000 (5,400) (6,000) (25,000) $ 92,100 x 10 $ 9,210 Chapter 08 - Intercompany Indebtedness P8-28 (continued) e Total noncontrolling interest, December 31, 20X6: Bussman's stockholders' equity, December 31, 20X6 Unrealized profit on intercompany sale of inventory Bussman's realized equity, December 31, 20X6 Differential assigned to land Differential assigned to goodwill $1,250,000 (4,500) $1,245,500 30,000 50,000 $1,325,500 x 10 $ 132,550 Noncontrolling interest's proportionate share Total noncontrolling interest, December 31, 20X6 f Elimination entries: E(1) Income from Subsidiary Dividends Declared Investment in Bussman Stock Eliminate income from subsidiary E(2) Income to Noncontrolling Interest Dividends Declared Noncontrolling Interest Assign income to noncontrolling interest: $9,210 = [$100,000 + ($24,000 - $6,000) + $4,500 - $5,400 - $25,000] x 10 E(3) Common Stock — Bussman Premium on Common Stock Retained Earnings, January Differential Investment in Bussman Stock Noncontrolling Interest Eliminate beginning investment balance: $80,000 = $1,280,000 - $1,200,000 $133,000 = ($500,000 + $280,000 + $470,000 + $80,000) x 10 E(4) 90,000 9,210 500,000 280,000 470,000 80,000 Land Goodwill Differential Assign differential 30,000 50,000 E(5) Goodwill Impairment Loss Goodwill Recognize impairment of goodwill 25,000 E(6) Bonds Payable Investment in Topp Bonds Eliminate intercompany holdings of Topp bonds 200,000 36,000 54,000 4,000 5,210 1,197,000 133,000 80,000 25,000 200,000 Chapter 08 - Intercompany Indebtedness P8-28 (continued) E(7) Other Income Other Expenses Eliminate interest on intercompany holdings of Topp bonds: $200,000 x 10 E(8) Current Payables Current Receivables Eliminate accrued interest on intercompany holdings of Topp bonds: ($200,000 x 10) x / year E(9) Bonds Payable Premium on Bonds Payable Other Income (Interest) Investment in Bussman Bonds Gain on Retirement of Bonds Other Expenses (Interest) Eliminate intercompany holdings of Bussman bonds: $125,000 = ($1,000,000 x 12) + $5,000 $24,000 = $1,004,000 - $980,000 $119,000 = ($1,000,000 x 12) - $1,000 E(10) Retained Earnings, January Noncontrolling Interest Cost of Goods Sold Eliminate beginning inventory profit: $4,050 = $4,500 x 90 $450 = $4,500 x 10 $4,500 = $15,000 x 30 E(11) Sales Cost of Goods Sold Inventory Eliminate upstream intercompany sale of inventory: $72,600 = ($78,000 - $18,000) + ($18,000 x 70) $5,400 = $18,000 x 30 E(12) Current Payables Current Receivables Eliminate intercompany dividend owed: $10,000 x 90 20,000 5,000 1,000,000 3,000 125,000 4,050 450 78,000 9,000 20,000 5,000 985,000 24,000 119,000 4,500 72,600 5,400 9,000 Chapter 08 - Intercompany Indebtedness P8-28 (continued) g Item Topp Manufacturing and Bussman Corporation Consolidation Workpaper December 31, 20X7 Topp Eliminations Corp Bussman Debit Credit Sales Income from Subsidiary Other Income 3,101,000 90,000 135,000 790,000 Gain on Retirement of Bonds Credits Cost of Goods Sold 3,326,000 2,009,000 821,000 430,000 Deprec and Amortization Goodwill Impairment Loss Other Expenses 195,000 85,000 643,000 206,000 Debits Consolidated Net Income Income to NCI Income, carry forward (2,847,000) (721,000) 479,000 100,000 31,000 Ret Earnings, Jan 3,033,000 Income, from above Dividends Declared 479,000 3,512,000 (50,000) 100,000 570,000 (40,000) Ret Earnings, Dec 31, 3,462,000 530,000 39,500 112,500 29,000 85,100 301,000 1,251,000 348,900 Cash Current Receivables Inventory Invest in Bussman Stock Invest in Bussman Bonds Invest in Topp Bonds Land Buildings and Equipment Goodwill Differential Debits 985,000 470,000 1,231,000 2,750,000 200,000 513,000 1,835,000 6,670,000 3,011,000 1,210,000 98,000 619,000 79,000 200,000 1,000,000 Premium on Bonds Payable Common Stock Premium on Common Stock Retained Earnings Noncontrolling Interest 1,000,000 700,000 3,462,000 3,000 500,000 280,000 530,000 Credits 6,670,000 3,011,000 Accum Depreciation Current Payables Bonds Payable (11) (1) (7) (9) 78,000 90,000 20,000 125,000 (5) 25,000 (2) 3,813,000 21,000 (9) 24,000 (10) (11) 4,500 72,600 (7) 20,000 (9) 119,000 9,210 347,210 240,100 (3) 470,000 (10) 4,050 347,210 240,100 821,260 (4) 30,000 (4) 50,000 (3) 80,000 (8) 5,000 (12) 9,000 (6) 200,000 (9)1,000,000 (9) 3,000 (3) 500,000 (3) 280,000 821,260 (10) 450 2,978,710 Consolidated (1) (2) 36,000 4,000 280,100 (8) 5,000 (12) 9,000 (11) 5,400 (1) 54,000 (3)1,197,000 (9) 985,000 (6) 200,000 (5) (4) 25,000 80,000 24,000 3,858,000 2,361,900 280,000 25,000 710,000 (3,376,900) 481,100 (9,210) 471,890 3,028,950 471,890 3,500,840 (50,000) 3,450,840 68,500 183,600 644,500 1,774,000 4,585,000 25,000 7,280,600 1,829,000 163,000 280,100 (2) 5,210 (3) 133,000 2,978,710 1,000,000 700,000 3,450,840 137,760 7,280,600 Chapter 08 - Intercompany Indebtedness P8-29A Fully Adjusted Equity Method a Adjusted trial balance: Bennett Corporation Debit Credit Item Cash Accounts Receivable Inventory Other Assets Investment in Stone Container Bonds Investment in Stone Container Stock Interest Expense Other Expenses Dividends Declared Accounts Payable Bonds Payable Common Stock Retained Earnings Sales Interest Income Income from Subsidiary Total b $ 61,600 100,000 120,000 340,000 Stone Container Company Debit Credit $ 20,000 80,000 110,000 250,000 106,000 122,400 20,000 368,600 40,000 $1,278,600 $ 80,000 200,000 300,000 210,000 450,000 8,000 30,600 $1,278,600 18,000 182,000 10,000 $670,000 $ 50,000 200,000 100,000 70,000 250,000 $670,000 Journal entries recorded by Bennett Corporation: (1) Cash Investment in Stone Container Stock Record dividend from Stone Container: $10,000 x 60 (2) Investment in Stone Container Stock Income from Subsidiary Record equity-method income: $50,000 x 60 6,000 30,000 6,000 30,000 Chapter 08 - Intercompany Indebtedness P8-29A (continued) (3) Investment in Stone Container Stock Income from Subsidiary Adjust for portion of loss on constructive retirement recognized: ($7,000 / years) x 60 600 600 Computation of 20X3 constructive loss on bond retirement Bond investment, December 31, 20X4 Amortization of premium in 20X4: Interest income based on par value Interest income recorded by Bennett Amortization of premium Purchase price paid by Bennett, December 31, 20X3 Bond liability reported by Stone Container, December 31, 20X3 Constructive loss on bond retirement c $106,000 $ 9,000 (8,000) 1,000 $107,000 (100,000) $ 7,000 Eliminating entries, December 31, 20X4: E(1) Income from Subsidiary Dividends Declared Investment in Stone Container Stock Eliminate income from subsidiary 30,600 E(2) Income to Noncontrolling Interest Dividends Declared Noncontrolling Interest Assign income to noncontrolling interest: $20,400 = ($50,000 + $1,000) x 40 20,400 E(3) Common Stock – Stone Container Retained Earnings, January Investment in Stone Container Stock Noncontrolling Interest Eliminate beginning investment balance 100,000 70,000 Bonds Payable Interest Income Investment in Stone Container Stock Noncontrolling Interest Investment in Stone Container Bonds Interest Expense Eliminate intercompany bond holdings: $4,200 = $7,000 constructive loss x 60 $2,800 = $7,000 constructive loss x 40 100,000 8,000 4,200 2,800 E(4) 6,000 24,600 4,000 16,400 102,000 68,000 106,000 9,000 Chapter 08 - Intercompany Indebtedness P8-29A (continued) d Bennett Corporation and Stone Container Company Consolidation Workpaper December 31, 20X4 Item Sales Interest Income Income from Subsidiary Credits Interest Expense Other Expenses Debits Consolidated Net Income Income to Noncontrolling Interest Income, carry forward Bennett Corp Stone Container 450,000 8,000 30,600 488,600 20,000 368,600 (388,600) 250,000 250,000 18,000 182,000 (200,000) 100,000 50,000 Dividends Declared 210,000 100,000 310,000 (40,000) Ret Earnings, Dec 31, carry forward Eliminations Debit Credit 700,000 (4) 8,000 (1) 30,600 (4) 9,000 (2) 20,400 59,000 9,000 70,000 50,000 120,000 (10,000) (3) 70,000 59,000 9,000 270,000 110,000 129,000 Cash Accounts Receivable Inventory Other Assets Investment in Stone Container Bonds Investment in Stone Container Stock 61,600 100,000 120,000 340,000 20,000 80,000 110,000 250,000 Debits 850,000 460,000 Accounts Payable Bonds Payable Common Stock Retained Earnings, from above Noncontrolling Interest 80,000 200,000 300,000 50,000 200,000 100,000 270,000 110,000 Credits 850,000 460,000 Ret Earnings, Jan Income, from above Consolidated (1) 6,000 (2) 4,000 19,000 700,000 29,000 550,600 (579,600) 120,400 (20,400) 100,000 210,000 100,000 310,000 (40,000) 270,000 81,600 180,000 230,000 590,000 106,000 (4)106,000 122,400 (4) 4,200 (1) 24,600 (3)102,000 130,000 300,000 300,000 (4)100,000 (3)100,000 (4) 129,000 2,800 336,000 1,081,600 19,000 (2) 16,400 (3) 68,000 336,000 270,000 81,600 1,081,600 Chapter 08 - Intercompany Indebtedness P8-30A Cost Method a Journal entry recorded by Bennett Corporation: Cash Dividend Income Record dividend from Stone Container: $10,000 x 60 b 6,000 6,000 Eliminating entries, December 31, 20X4: E(1) Dividend Income Dividends Declared Eliminate dividend income from subsidiary 6,000 E(2) Income to Noncontrolling Interest Dividends Declared Noncontrolling Interest Assign income to noncontrolling interest: $20,400 = ($50,000 + $1,000) x 40 E(3) Common Stock – Stone Container Retained Earnings, January Investment in Stone Container Stock Noncontrolling Interest Eliminate investment balance at date of acquisition: $75,000 = ($100,000 + $25,000) x 60 100,000 25,000 E(4) Retained Earnings, January Noncontrolling Interest Assign undistributed prior earnings of subsidiary to noncontrolling interest: ($70,000 - $25,000) x 40 18,000 E(5) Bonds Payable Interest Income Retained Earnings, January Noncontrolling Interest Investment in Stone Container Bonds Interest Expense Eliminate intercompany bond holdings: $4,200 = $7,000 constructive loss x 60 $2,800 = $7,000 constructive loss x 40 20,400 100,000 8,000 4,200 2,800 6,000 4,000 16,400 75,000 50,000 18,000 106,000 9,000 Chapter 08 - Intercompany Indebtedness P8-30A (continued) Computation of 20X3 constructive loss on bond retirement Bennett's Bond investment, December 31, 20X4 Amortization of premium in 20X4: Interest income based on par value Interest income recorded by Bennett Amortization of premium Purchase price paid by Bennett, December 31, 20X3 Bond liability reported by Stone Container, December 31, 20X3 Constructive loss on bond retirement $106,000 $9,000 (8,000) 1,000 $107,000 (100,000) $ 7,000 Chapter 08 - Intercompany Indebtedness P8-30A (continued) c Bennett Corporation and Stone Container Company Consolidation Workpaper December 31, 20X4 Item Sales Interest Income Dividend Income Credits Interest Expense Other Expenses Debits Consolidated Net Income Income to Noncontrolling Interest Income, carry forward Bennett Corp Stone Container 450,000 250,000 8,000 6,000 464,000 250,000 20,000 18,000 368,600 182,000 (388,600) (200,000) 75,400 50,000 Ret Earnings, Jan 187,200 70,000 Income, from above Dividends Declared 75,400 262,600 (40,000) 50,000 120,000 (10,000) Ret Earnings, Dec 31, carry forward 222,600 110,000 Cash Accounts Receivable Inventory Other Assets Investment in Stone Container Bonds Investment in Stone Container Stock Debits 61,600 100,000 120,000 340,000 20,000 80,000 110,000 250,000 75,000 802,600 460,000 Accounts Payable Bonds Payable Common Stock Retained Earnings, from above Noncontrolling Interest 80,000 200,000 300,000 50,000 200,000 100,000 222,600 110,000 Credits 802,600 460,000 Eliminations Debit Credit (5) (1) 700,000 8,000 6,000 (5) 9,000 (2) 20,400 34,400 9,000 (3) 25,000 (4) 18,000 (5) 4,200 34,400 9,000 (1) (2) 81,600 Consolidated 6,000 4,000 19,000 700,000 29,000 550,600 (579,600) 120,400 (20,400) 100,000 210,000 100,000 310,000 (40,000) 270,000 81,600 180,000 230,000 590,000 106,000 (5)106,000 (3) 75,000 130,000 300,000 300,000 (5)100,000 (3)100,000 (5) 81,600 2,800 284,400 1,081,600 19,000 (2) 16,400 (3) 50,000 (4) 18,000 284,400 270,000 81,600 1,081,600 ... the book value of the debt shown by the debtor As a result, each period the interest income recorded by the buyer will be less than the interest expense reported by the debtor When the two income... interest income recorded by the subsidiary each period will be greater than the interest expense recorded by the parent Consolidated net income for the current period will decrease by the difference... Subsidiary Bond Holdings MEMO To: Financial Vice-President Farflung Corporation From: Re: , Accounting Staff Investment in Bonds Issued by Subsidiary The consolidated financial statements of Farflung