Advanced Accounting by Debra Jeter and Paul Chaney Chapter 9: Intercompany Bond Holdings and Miscellaneous Topics Slides Authored by Hannah Wong, Ph.D. Rutgers University

Intercompany Bond Holdings Bonds acquired by an affiliate are no longer held by external parties In the consolidated financial statements: the bonds are viewed as being constructively retired record a gain or loss on this early retirement of debt obj 1

Allocation of Constructive Gain/Loss Entirely to the issuing company Entirely to the purchasing company Entirely to the parent company Allocated between the purchasing and issuing companies Note: the allocation method affects the consolidated net income each year. However, it does not affect the total consolidated net income over the life of the issue. obj 1, 2

Computation of Constructive Gain/Loss Book value Constructive gain/loss allocated to issuing company Par value Constructive gain/loss allocated to purchasing company Purchase price obj 2

Accounting for Intercompany Bonds An Example 12/31/2001 12/31/2003 P acquired S’s 9% bonds Bond matures Par value of bonds acquired = $500,000 x 60% Book value of bonds acquired = $480,000 x 60% Purchase price = $310,000 obj 2

Accounting for Intercompany Bonds Book value $288,000 Constructive loss allocated to S Company $12,000 Par value $300,000 Constructive loss allocated to P Company $10,000 Purchase price $310,000 obj 2

Accounting for Intercompany Bonds Year of Intercompany Bond Purchase - EE’s Loss on constructive retirement of bonds 10,000 Investment in S Bonds 10,000 (1) To recognize the constructive loss not recorded by P and (2) adjust the intercompany bonds to par value Loss on constructive retirement of bonds 12,000 Discount on bonds payable 12,000 (1) To recognize the constructive loss not recorded by S and (2) adjust the intercompany bonds to par value obj 2

Accounting for Intercompany Bonds Year of Intercompany Bond Purchase - EE’s Bonds payable 300,000 Investment in S Bonds 300,000 To eliminate intercompany bond investment and liability obj 2

Intercompany Bonds Cost and Partial Equity Methods Year After Intercompany Bond Purchase - EE’s Beginning retained earnings- P 10,000 Investment in S Bonds 10,000 (1) To record last year’s constructive loss not recorded by P and (2) adjust the intercompany bond investment to par value Beginning retained earnings- P 9,600 Beginning retained earnings- S 2,400 Discount on bonds payable 12,000 (1) To recognize the constructive loss not recorded by S and (2) adjust the intercompany bonds to par value obj 2

Intercompany Bonds Cost and Partial Equity Methods Year After Intercompany Bond Purchase - EE’s Investment in S Bonds 2,500 Interest revenue 2,500 To reverse amortization of premium recorded by P in the current year Discount on bonds payable 3,000 Interest expense 3,000 To reverse amortization of discount recorded by S in the current year obj 2

Intercompany Bonds Cost and Partial Equity Methods Year After Intercompany Bond Purchase - EE’s Interest revenue 27,000 Interest expense 27,000 To eliminate intercompany bond interest Bonds payable 300,000 Investment in S Bonds 300,000 To eliminate intercompany bond investment and liability obj 2

Intercompany Bonds Complete Equity Method Year After Intercompany Bond Purchase - EE’s Investment in S 19,600 Beginning retained earnings- S 2,400 Discount on bonds payable 12,000 Investment in S Bonds 10,000 (1) To record last year’s constructive loss not recorded by P or S and (2) adjust the intercompany bond investment to par value obj 2

Intercompany Bonds Complete Equity Method Year After Intercompany Bond Purchase - EE’s Investment in S Bonds 2,500 Interest revenue 2,500 To reverse amortization of premium recorded by P in the current year Discount on bonds payable 3,000 Interest expense 3,000 To reverse amortization of discount recorded by S in the current year obj 2

Intercompany Bonds Complete Equity Method Year After Intercompany Bond Purchase - EE’s Bonds payable 300,000 Investment in S Bonds 300,000 To eliminate intercompany bond investment and liability Interest revenue 27,000 Interest expense 27,000 To eliminate intercompany bond interest obj 2

Intercompany Bonds Consolidated NI-Year after Bond Purchase Reported income of P Dividend income Constructive loss recorded by P in the current year (premium amortization) P’s contribution to combined income Reported NI of S + Constructive loss recorded by S in the current year (discount amortization) Adjusted NI of S x P% Consolidated net income obj 2

Notes Receivable Discounted Subsidiary Issues $100,000 note Parent Company Discount note with bank If S credits notes receivable upon discounting the note, no adjustment is needed in consolidation. If S credits notes receivable discounted upon discounting the note, an adjustment is needed in consolidation: Dr Notes receivable discounted Cr Notes receivable obj 3

Notes Receivable Discounted Subsidiary Issues $100,000 note Parent Company Discount note with bank Receives note from third party If P and S credits notes receivable upon discounting the note, no adjustment is needed in consolidation. If P or S credits notes receivable discounted upon discounting the note, an adjustment is needed in consolidation: Dr Notes receivable discounted Cr Notes receivable obj 3

Stock Dividend from Subsidiary Journal Entries Stock dividend declared (or R/E) 150,000 Capital stock 150,000 Parent Memorandum entry only. obj 4

Stock Dividend from Subsidiary Eliminating Entries Year of stock dividend Capital stock 150,000 Stock dividend declared (or R/E) 150,000 To reverse the subsidiary’s JE on stock dividend obj 4

Dividends on Subsidiary Stock Stock vs. Cash Cash Dividends – considered to be from current earnings. Reduce undistributed profits by this amount. Stock Dividends – considered to be from earliest retained earnings balances. Reduce retained earnings balance at date of acquisition. obj 5

Large Stock Distribution from Subsidiary Preacquisition Earnings Sub issues 1,500 shares of stock (30%) as a dividend. Par value is $100. Stock Dividend Declared or Retained Earnings $150,000 Capital Stock ($1,500 shares x $100) $150,000 If this was a small (<20-25%) dividend the entry would be recorded at market rather than par. obj 6

Stock Distribution Parent & Consolidated Preacquisition Earnings Parent makes a memorandum entry only when the dividend is declared and paid. Total equity after consolidation is not changed by a stock distribution. obj 6

Subsidiary with Preferred Stock Book value of net assets Less: allocated to preferred stock par value + call premium + dividends in arrears = residual allocated to common stock obj 7

Subsidiary with Preferred Stock Noncontrolling interest Common stock not held by parent Common stock held by parent Preferred stock not held by parent Preferred stock held by parent Controlling interest obj 7, 8

Subsidiary with Preferred Stock Controlling Interest in Net Income Reported income of P Dividend income Other adjustments P’s contribution to combined income P’s share of S adjusted income Consolidated net income Adjusted NI of S assigned to preferred stock x (P’s preferred stock %) + Adjusted NI of S assigned to common stock x (P’s common stock %) obj 7,8

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