1. CHAPTER 11 INTERCOMPANY BOND HOLDINGS SECTION

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

3. 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

4. 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.

5. 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

6. 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.

7. 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.

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

9. 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

10. 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

11. 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.

12. 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

13. 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

14. 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

15. 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

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