CHAPTER 11 INTERCOMPANY BOND HOLDINGS SECTION

FOCUS OF CHAPTER 11 The Constructive Retirement of the Bonds Calculating the Gain or Loss on Extinguishment of Debt

The Consolidated Perspective From a consolidated viewpoint, the purchase by one member of any or all of the outstanding bonds of another member constitutes a constructive retirement of the bonds. Paxco Saxco Consolidated Group

Ways to Acquire Bonds of a Group Member: Directly & Indirectly Intercompany bond holdings can arise in two ways: – DIRECT transactions—One member issues bonds to another member. – INDIRECT transactions—One member acquires in the marketplace the outstanding bonds of another member. The result of an indirect transaction is as if a direct transaction had occurred.

The Constructive Retirement of the Bonds: Reporting Results The constructive retirement of the bonds results in reporting in consolidation: – An imputed gain or loss—in the period of the bond acquisition. – An nonextraordinary item (per FAS 145). – No future interest income or interest expense on the intercompany bond investment or liability, respectively. #1 #2 #3

Calculating the Imputed Gain or Loss: Done At the Acquisition Date Compare at the acquisition date: – The acquiring entity’s cost—excluding any amount related to purchased interest—with – The issuing entity’s carrying value of the intercompany portion of the bonds.

Calculating the Imputed Gain or Loss: Done At the Acquisition Date Compare at the acquisition date: – The acquiring entity’s cost—excluding any amount related to purchased interest—with – The issuing entity’s carrying value of the intercompany portion of the bonds.

Premiums and Discounts: They Result in Gains or Losses *It depends on which entity has the larger item.

Partial Ownerships: Determining the NCI Share of the Gain or Loss Three possible ways exist for assigning a portion of the imputed gain or loss to the NCI: – The Parent Company Method: Assign 100% to the parent (an arbitrary method). – The Issuing Company Method: Assign 100% to the issuing company (an arbitrary method). – The Face Value Method: Assign only the subsidiary’s premium or discount to the NCI (based on legal boundary realities). #1 #2 #3

Partial Ownerships: Determining the NCI Share of the Gain or Loss Three possible ways exist for assigning a portion of the imputed gain or loss to the NCI: – The Parent Company Method: Assign 100% to the parent (an arbitrary method). – The Issuing Company Method: Assign 100% to the issuing company (an arbitrary method). – The Face Value Method: Assign only the subsidiary’s premium or discount to the NCI (based on legal boundary realities). #1 #2 #3

Simplified Procedures: Eliminating Premiums and Discounts in the G/L Rationale for These Procedures—Substance Over Form: The parent can either – (1) Loan money to the subsidiary for it to retire bonds held by the parent or – (2) Have the subsidiary lend money to the parent for it to retire its own bonds held by the subsidiary. – The results are identical to that of eliminating the premiums and discounts in the G/L.

Review Question #1 On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/1/06, and (4) semiannual interest payments (on 1/1 and 7/1). What is the 2006 consolidated reportable gain or loss? A. $1,000 loss. B. $7,000 loss. C. $2,000 gain D. $11,000 gain

Review Question #1 With Answer On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/1/06, and (4) semiannual interest payments (on 1/1 and 7/1). What is the 2006 consolidated reportable gain or loss? A. $1,000 loss. B. $7,000 loss. C. $2,000 gain ([$520,000 x 60%] - [$319,000 - $9,000 for interest]) D. $11,000 gain

Review Question #2 On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/3/06, and (4) semiannual interest payments (on 7/1 and 1/1). What is the unrealized gain at 12/31/06? A. $ -0- B. $500 C. $1,500 D. $2,000

Review Question #2 With Answer On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/3/06, and (4) semiannual interest payments (on 7/1 and 1/1). What is the unrealized gain at 12/31/06? A. $ -0- B. $500 C. $1,500 ($2,000 x 3/4 unexpired) D. $2,000

End of Chapter 11 Time to Clear Things Up — Any Questions?