Chapter 7 INTERCOMPANY PROFIT TRANSACTIONS — BONDS Answers to Questions 1

Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as reciprocal interest receivable and payable accounts and interest income and expense accounts.

2

Direct lending and borrowing transactions do 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 do 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.

3

Constructive gains and losses are gains and losses from the viewpoint of the consolidated entity but not from the viewpoint of the separate affiliates involved. The purchase of a parent’s outstanding bonds by its subsidiary at a price below the book value of the bonds on the parent’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.

4

The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300. If an affiliate 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].

5

A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the books of the separate affiliates. The affiliates 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 affiliates. 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.

6

Constructive gains on intercompany bonds are realized and recognized through the interest income and expense reported on the separate books of the affiliates. The difference between the interest income reported by the investor and the interest expense reported by the issuer 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 affiliates.

7

If a subsidiary purchases parent bonds at a price in excess of book value, a constructive loss results. The loss is attributed to the parent since it is the parent bonds that are constructively retired. This approach of associating constructive gains and losses on intercompany bonds with the issuer is consistent with the procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with the selling affiliates.

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Intercompany Profit Transactions — Bonds

7-2

8a

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 liability amounts, reciprocal interest income and expense amounts, reciprocal interest receivable and 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 liability amounts, reciprocal interest income and expense amounts, reciprocal interest receivable and 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 affiliates in the prior year.

9

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 constructive gain on bonds is recognized as investment income because we assign the full amount to the parent 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

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Chapter 7

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 since the issuer reports interest expense.

11c

The $200 difference between interest income and expense represents a piecemeal recognition of the constructive gain from the constructive retirement of bonds payable.

SOLUTIONS TO EXERCISES Solution E7-1 c 1 a 2

3 4

d a

Solution E7-2 a 1 Book value of Pan bond’s acquired by Sow ($900,000 + $48,000)  2/3 Cost to Sow Constructive gain d 2 Nominal interest on Pan’s remaining outstanding bonds $300,000  8% Less: Amortization of premium ($48,000  1/3)/ 4 years Interest expense on consolidated income statement Solution E7-3 c 1 Cost of $80,000 par of Pal bonds January 1, 2011 Book value acquired ($400,000 par - $8,000 discount)  20% Constructive gain d 2 Par value of bonds payable Less: Unamortized discount ($8,000 - $2,000) Book value of bonds Percent outstanding Bonds payable c 3 Constructive gain $2,400/4 years  3 years c 4 Nominal interest Add: Amortization of discount Percent outstanding Interest expense 5

b

$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

Piecemeal recognition of gain is $2,400  25% in 2012.

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Intercompany Profit Transactions — Bonds

7-4

Solution E7-4 1

Controlling Interest Share of Consolidated net income (in thousands) Pat’s separate income Add: Income from Sal Share of Sal’s income ($500  80%) Less: Loss on bonds constructively retired Book value ($1,000 - $40)  40% Cost to Sal Add: Piecemeal recognition of loss ($16,000/4 years) Controlling Interest Share of Consolidated net income

2

$

800

$400

$384 400

(16) 4

388 $1,188

Noncontrolling interest share Sal’s reported income $500  20%

$

100

Consolidated Net Income = $1,188 + $100 = $1,288. Solution E7-5 Pim Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2019 (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 6 (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.

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Chapter 7

7-5

Solution E7-6 1

Constructive loss Cost paid to retire 1/2 of Son’s bonds Book value of bonds retired ($990,000  .5) Constructive loss on bond retirement

2

$503,000 495,000 $ 8,000

Income from Son Share of Son’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 Son

$

$

9,800 (5,600) 1,400 5,600

Solution E7-7 1

2

3

a January 1, 2011 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  4 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, 2012 Amortization for 6 months ($30,000/4 years  1/2 year) Book value of bonds July 1, 2012 Percent purchased by Say

$970,000 3,750 973,750 60%

Book value of bonds purchased Purchase price

$584,250 574,800

Constructive gain

$

9,450

Consolidated bond interest expense for 2012 Bond interest expense January 1 to July 1 ($1,000,000  8%  1/2 year) + $3,750 amortization

$ 43,750

Bond interest expense July 1 to December 31 [($1,000,000  8%  1/2 year) + $3,750 amortization]  40% Consolidated bond interest expense

17,500 $ 61,250

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Intercompany Profit Transactions — Bonds

7-6

1c

Bond liability of Par January 1, 2012 Amortization 2012 December 31, 2012

Par $1,000,000 $1,000,000

Discount $30,000 - 7,500 $22,500

Consolidated bond liability $977,500  40% outstanding Alternative Calculation: Book value at July 1, 2012 Portion left Remaining book value at July 1, 2012 Add: Discount amortization(40% x $3,750) Book value at December 31, 2012 2

Book Value $970,000 + 7,500 $977,500 $391,000

$973,750 x 40% $389,500 1,500 $391,000

The amounts would not be different if Say had been the issuer and Par the purchaser. However, the constructive retirement gains would ‘belong’ to Say and would have been allocated to both Par and the noncontrolling interests in Say.

Solution E7-9 (amounts in thousands) Subsidiary purchases parent company bonds: Gain on constructive retirement of bonds 1a Book value of Pin’s bonds constructively retired ($5,000 - $100 unamortized discount)  40% Purchase price of $1,000 par bonds Gain on constructive bond retirement

$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 Sid’s investment in Pin bonds will be $1,920.

1b

Cost January 2 Add: Amortization ($100,000/5 years) Total (Eliminated in consolidation) 2a

2b

200

$1,900 20 $1,920

Parent purchases subsidiary bonds: Loss on constructive retirement of bonds Sid’s bonds payable ($1,000 + $20) Price paid by Pin Loss on constructive retirement of bonds (80% to Pin and 20% to Noncontrolling interests) Consolidated interest expense Pin bonds ($5,000  10% interest) + $20 amortization

$1,020 1,030 $ (10)

$

2c

None Interest receivable of $50 is eliminated in consolidation.

2d

Book value of bonds payable Pin’s bonds December 31, 2011 Add: Amortization for 2012 ($100 / 5 years) Book value of bonds payable

520

$4,900 20 $4,920

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Chapter 7

7-7

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Intercompany Profit Transactions — Bonds

7-8

Solution E7-10 (in thousands) 1

2

Gain from constructive retirement of bonds Book value of bonds purchased by Sal ($2,000 + $60)  25% Price paid by Sal Gain from constructive retirement of bonds

Working paper entry to eliminate effect of intercompany bond holdings 12% bonds payable 512 62 Interest incomea Interest payable 30 Investment in Pad bonds 492 Gain on retirement of bonds 25 57 Interest expenseb Interest receivable 30 a b

3

($500  12% interest) + $2 amortization = $62 [($2,000  12%) - $12 amortization]  25% intercompany = $57

Consolidated income statement amounts — 2013 Constructive gain a

None

b

Noncontrolling interest share ($300  20%)

$

60

c

Bond interest expense [($2,000  12%) - $12]  75% outsiders

$

171

d 4

$515 490 $ 25

Bond interest income

None

Consolidated balance sheet amounts — December 31, 2013 Investment in Pad bonds a b

Book value of bonds payable ($2,000 + $36)  75% outsiders

c

Bond interest receivable

d

Bond interest payable $2,000  12%  75% outsiders  1/2 year

None

$1,527 None

$

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90

Chapter 7

7-9

Solution E7-11 Preliminary computations: Book value of Saw bonds on January 1, 2012 Purchase price paid by Par Gain on constructive retirement of Saw bonds

$1,000,000 783,000 $ 217,000

Amortization of gain on bonds ($217,000/7 years) Computation of noncontrolling interest share: Share of Saw’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

$

Par Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2012 (in thousands) Sales Less: Cost of sales Gross profit Add: Gain from constructive retirement of Saw Less: Operating expenses Consolidated net income Less: Noncontrolling interest share Controlling interest share of NI

$1,800 950

$ $

850 217 400 667 65.2 601.8

Solution E7-12 1

Pub Corporation and Subsidiary, December 31, 2011

Interest receivable Investment in Sap bonds Interest payable ($40,000  80%) 8% bonds payable (($1,000,000  80%)- 13,500 discount) Interest income Interest expense ($86,000/2) + .8(86,000/2) Loss on retirement of bonds payable

Amounts Appearing in Consolidated Financial Statements 0 0 32,000 786,500 0 77,400 7,800a

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Intercompany Profit Transactions — Bonds

7-10

Solution E7-12 (continued) a

Computation of loss on intercompany bonds Balance of investment in bonds at December 31, 2011 Add: Amount amortized for July 1 to December 31, 2011 ($5,000 balance at December 31  30/36 months = $6,000 unamortized at July 1) Investment cost July 1, 2011 Less: Book value acquired [$1,000,000 - ($15,000 unamortized discount at December 31  30/36 months)]  10% Loss on constructive retirement of bonds

2

$105,000

1,000 $106,000

$

98,200 7,800

Consolidation working paper entries at December 31, 2011 Interest income 3,000 8% bonds payable 98,500 Loss on retirement of bonds 7,800 Investment in Sap bonds 105,000 Interest expense 4,300 To eliminate intercompany bonds, record constructive loss on retirement, and eliminate intercompany interest income and expense. Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and receivable amounts.

3

Consolidation working paper entries at December 31, 2012 Investment in Sap (80%) 5,200 Noncontrolling interest 1,300 Interest income 6,000 8% bonds payable 99,100 Investment in Sap bonds 103,000 Interest expense 8,600 To eliminate intercompany bonds, interest income and expense, and to charge the unrecognized portion of the constructive loss at the beginning of the period 80% to the investment in Sap and 20% to the noncontrolling interest. Interest payable 4,000 Interest receivable 4,000 To eliminate reciprocal interest payable and receivable amounts.

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Chapter 7

7-11

Solution E7-13 1

Gain on constructive retirement of bonds Purchase price of bonds Book value Gain on constructive retirement of bonds

2

$48,800 50,000 $ 1,200

Son accounts for its investment in Pap bonds January 2, 2013 Investment in Pap bonds 48,800 Cash To record investment in $50,000 par, 8% Pap bonds. July 1, 2013 Cash Investment in Pap bonds Interest income To record interest and amortization.

48,800

2,000 200 2,200

December 31, 2013 Interest receivable 2,000 Investment in Pap bonds 200 Interest income To accrue interest and record amortization. 3

Pap accounts for its bonds payable July 1, 2013 Interest expense Cash To record interest payable for 6 months. December 31, 2013 Interest expense Interest payable To accrue interest for 6 months.

4

2,200

4,000 4,000

4,000 4,000

Pap accounts for its investment in Son December 31, 2013 Investment in Son 40,800 Income from Son 40,800 To record income from Son (80%  $50,000) + $1,200 constructive gain - $400 piecemeal recognition of gain.

5

Noncontrolling interest share ($50,000  20%)

Controlling share of NI ($200,000 + $40,800) Consolidated Net Income = $10,000 + $240,800 = $250,800

$ 10,000 $240,800

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Intercompany Profit Transactions — Bonds

7-12

SOLUTIONS TO PROBLEMS Solution P7-1 1

Loss on constructive retirement of bonds Purchase price of $50,000 par bonds April 1, 2011 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 2

4

$ 4,800

Interest income and expense Interest income in consolidated income statement — 2011 Interest expense in consolidated income statement — 2011 $8,800 - ($8,800  3/4 year  50%)

3

48,800

0 $ 5,500

Interest receivable and payable Interest receivable in consolidated balance sheet at December 31, 2011

0

Interest payable in consolidated balance sheet at December 31, 2011

$ 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 Pan bonds 52,700 Interest expense 3,300 To eliminate reciprocal interest income and expense amounts and reciprocal bond investment and liability amounts and enter unrecognized constructive loss. Interest payable 1,000 Interest receivable To eliminate reciprocal payables and receivables.

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1,000

Chapter 7

7-13

Solution P7-2 Pew Corporation and Steel Corporation Schedule to Determine Pew’s Net Income and Controlling Interest Share of Consolidated Net Income Pew’s separate income

2011 $500,000

2012 $375,000

2013 $460,000

2014 $510,000

Total $1,845,000

80% of Sat’s net income

+ 80,000

+ 96,000

+ 88,000

+ 96,000

+

360,000

$5,000 unrealized profit in Sat’s December 31, 2011 Inventory

-

+

5,000

$10,000 unrealized profit in Sat’s December 31, 2012 Inventory

5,000

- 10,000

+ 10,000

$15,000 unrealized profit in 2013 on sale of land upstream  80%

- 12,000

-

12,000

$30,000 unrealized profit on sale of equipment in 2013

- 30,000

-

30,000

$7,500 depreciation on unrealized profit on equipment in 2013 and 2014

+

+

7,500

+

15,000

$8,000 constructive loss on purchase of Pew’s bonds in 2014

-

8,000

-

8,000

$2,000 piecemeal recognition of constructive loss in 2014

+

2,000

+

2,000

Pew’s net income

$575,000

$466,000

7,500

$523,500

$607,500

$2,172,000

Pew’s net income under the equity method equals the Controlling Interest Share of consolidated net income. Solution P7-3 Income from Sum for 2011: Share of reported income of Sum ($200,000  75%) Add: Unrealized profit in beginning inventory of Sum Less: Unrealized profit in ending inventory of Sum Add: Piecemeal recognition of gain on sale of equipment to Pad ($48,000/6 years)  75% Less: Unrealized gain on sale of land to Sum Less: Unrealized gain on sale of building to Sum less piecemeal recognition through depreciation ($40,000 - $2,000) Add: Gain on constructive retirement of Pad bonds ($200,000 - $188,000) Income from Sum

$ 150,000 24,000 (30,000) 6,000 (20,000) (38,000) 12,000 $ 104,000

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Intercompany Profit Transactions — Bonds

7-14

Solution P7-3 (continued) Investment in Sum at December 31, 2011: Underlying equity in Sum ($1,040,000  75%) Less: Unrealized profit in Sum’s ending inventory Less: Unrealized gain on equipment sold to Pad ($48,000 - $24,000 recognized)  75% Less: Unrealized gain on sale of land to Sum Less: Unrealized gain on sale of building to Sum ($40,000 - $2,000 recognized) Add: Gain on constructive retirement of Pad’s bonds Investment in Sum December 31

$780,000 (30,000) (18,000) (20,000) (38,000) 12,000 $686,000

Noncontrolling interest share: Net income of Sum $200,000 Add: Piecemeal recognition of gain on equipment ($48,000/6 years) 8,000 Sum’s realized income 208,000 Noncontrolling interest percentage 25% Noncontrolling interest share $ 52,000

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Chapter 7

7-15

Solution P7-3 (continued) Pad Corporation and Subsidiary Consolidation Working Paper for the year ended December 31, 2011 (in thousands)

Pad Income Statement Sales Gain on land Gain on building Income from Sum Gain on bonds Cost of sales

$ 1,260 20 40 104

$ 1,000

700*

600*

152*

80*

Depreciation expense Interest expense Other expenses Consolidated NI Noncontrolling int. share Controlling share of NI Retained Earnings Retained earnings — Pad Retained earnings — Sum 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 Sum stock

40* 92*

b 100 f 20 m 40 H 104 D

440

$

300

$

200

$

200 200 160*

440 320*

$

420

$

240

$

54

$

162 10 60 100 140 360 180

80 160 180 300 280 686

$2,160

g 12 b 100 c 24 e 8 m 2

12 1,206*

$

222* 40* 212* 492 52* 440

$

300

188 $1,200

$

$

52

i 200 440 h 120 k 40

a

c e h

$1,740 100 20 400 800 420 $1,740 Noncontrolling interest January 1 Noncontrolling interest December 31

30

Consolidated Statements

120* k

$

Investment in Pad bonds

Accounts payable Bond interest payable 10% bonds payable Common stock Retained earnings

Adjustments and Eliminations

Sum 75%

20

24 24 16

$

420

$

236

j 10 a 20 d 30 f 20 m 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

8

i 250 k 12

260 10 200 800 420

254 $1,944

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Intercompany Profit Transactions — Bonds

7-16

Solution P7-4 Preliminary Computations: Acquisition price Implied fair value of She ($320,000 / 80%) She’s book value Excess allocated to plant & equipment with 8 year life

$ 320,000 $ 400,000 (300,000) $ 100,000

Annual depreciation of excess ($100,000 / 8 years)

$

1

2

3

4

5

6

7

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 She’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

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Chapter 7

7-17

Solution P7-4 (continued) 8

Noncontrolling interest December 31, 2013 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 She (($350,000 + $62,500 unamortized $ 82,500 excess(  20%) (2,000) Less: Unrealized profit in ending inventory ($10,000  20%) Noncontrolling interest December 31, 2013 $ 80,500 9

10

Investment in She stock at December 31, 2012 Investment in She stock at cost Add: Changes in retained earnings to December 31, 2012 ($135,000 - $100,000)  80% Less: 80% of Excess of ($100,000/8 years x 80%) = $10,000 per year  2 years) Less: Unrealized profit in beginning inventory ($20,000  80%) Investment in She stock December 31, 2012

(16,000) $312,000

Alternative computation: Investment in She stock December 31, 2013 Less: Income from She for 2013 Add: Dividends from She ($15,000  80%) Investment in She stock December 31, 2012

$320,000 (20,000) 12,000 $312,000

Income from She Share of She’s reported net income Less: Depreciation on excess ($100,000/8 years) Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory She’s adjusted and realized income Pet’s 80% controlling share Less: Constructive loss on retirement of bonds ($3,000 - $1,000) Pet’s income from She

$320,000 28,000 (20,000)

$ 30,000 (12,500) 20,000 (10,000) $ 27,500 $ 22,000 (2,000) $ 20,000

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Intercompany Profit Transactions — Bonds

7-18

Solution P7-5 [AICPA adapted] 1

Consolidated cash ($50,000 + $15,000)

$ 65,000

2

Equipment — net ($800,000 equipment - $320,000 accumulated depreciation - $21,000 unrealized profit + $7,000 profit realized through depreciation of excess)

$466,000

3

Investment in Saw does not appear in consolidated statements.

4

Bonds payable (Saw’s bonds payable of $200,000  1/2 held outside the consolidated entity)

$100,000

5

Common stock (Poe’s stock)

$100,000

6

Beginning retained earnings (Poe’s retained earnings)

$272,000

7

Dividends paid (Poe’s dividends)

$ 80,000

8

Gain on retirement of bonds (Book value of Saw’s bonds acquired by Poe $100,000 less acquisition cost of $91,000. Since bonds were acquired on December 31, 2011, 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

Interest expense (Saw paid interest for the entire year to outside entities so all of Saw’s interest is reported)

$ 16,000

Depreciation expense ($45,000 combined - depreciation on the unrealized gain $7,000)

$ 38,000

9

10

11

9,000

Solution P7-6 Income from Sal for 2012: Share of reported income of Sal ($100,000  75%) Add: Unrealized profit in beginning inventory of Sal Less: Unrealized profit in ending inventory of Sal Add: Piecemeal recognition of gain on sale of equipment to Par ($24,000/6 years)  75% Less: Unrealized gain on sale of land to Sal Less: Unrealized gain on sale of building to Sal less piecemeal recognition through depreciation ($20,000 - $1,000) Add: Gain on constructive retirement of Par bonds ($100,000 - $94,000) Income from Sal for 2012

$ 75,000 12,000 (15,000) 3,000 (10,000) (19,000) 6,000 $ 52,000

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Chapter 7

7-19

Solution P7-6 (continued) Investment in Sal at December 31, 2012: Underlying equity in Sal ($520,000  75%) Less: Unrealized profit in Sal’s ending inventory Less: Unrealized gain on equipment sold to Par ($24,000 - $12,000 recognized)  75% Less: Unrealized gain on sale of land to Sal Less: Unrealized gain on sale of building to Sal ($20,000 - $1,000 recognized) Add: Gain on constructive retirement of Par’s bonds Investment in Sal December 31

$390,000 (15,000) (9,000) (10,000) (19,000) 6,000 $343,000

Noncontrolling interest share: Net income of Sal Add: Piecemeal recognition of gain on equipment ($24,000/6 years) Sal’s realized income Noncontrolling interest percentage Noncontrolling interest share

$100,000 4,000 104,000 25% $ 26,000

©2011 Pearson Education, Inc. publishing as Prentice Hall

Intercompany Profit Transactions — Bonds

7-20

Solution P7-6 (continued) Par Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2012 (in thousands) Par Income Statement Sales Gain on plant Income from Sal 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 — Par Retained earnings — Sal 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 Sal stock

$

630 30 52

Adjustments and Eliminations

Sal 75% $

220

$

150

$

100

$

100 100 80*

220 160*

$

210

$

120

$

27

$

81 5 30 50 70 180 90

40 80 90 150 140 343

870 Accounts payable 50 Bond interest payable 10 10% bonds payable 200 Common stock 400 Retained earnings 210 $ 870 Noncontrolling interest January 1 Noncontrolling interest December 31

g b c e f

6 50 12 4 1

6 603*

$

111* 20* 106* 246 26* 220

$

150

$ $

$

26

i 100 220 h k

a

c e h

Investment in Par bonds $ $

$1,080

60* k

$

Consolidated Statements

10

12 12 8

94 600 80

400 120 600

60 20

160* $

210

$

118

j 5 a 10 d 15 f 10 f 19 e 12 i 375

g

60 115 150 311 218

94 $ $

j 5 g 100 i 400

e

4

i 125 k 6 $

*

Deduct

©2011 Pearson Education, Inc. publishing as Prentice Hall

972 130 5 100 400 210

127 972