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CHAPTER. Intercompany Bonds, Cash Flow, EPS, and Unconsolidated Investments Fundamentals of Advanced Accounting 1 st Edition Fischer, Taylor, and Cheng . 5. 5. Intercompany Bonds. A subsidiary may have debt that is more expensive than if it were issued by the parent

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CHAPTER

Intercompany Bonds, Cash Flow, EPS, andUnconsolidated InvestmentsFundamentals of Advanced Accounting1st EditionFischer, Taylor, and Cheng

5

5


Intercompany bonds l.jpg
Intercompany Bonds

  • A subsidiary may have debt that is more expensive than if it were issued by the parent

  • One member of the affiliated group (usually the subsidiary) has bonds outstanding that are held by outsiders; the other member (usually the parent) purchases the bonds from the outsiders

    • Consolidation treatment (on Worksheet) is retirement with an ordinary gain or loss (no longer extraordinary)

    • The result is the same if the parent loans money to the subsidiary and the subsidiary retires the bonds

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Intercompany bonds eliminations l.jpg
Intercompany Bonds - Eliminations

  • Elimination entry B1:

    • Bonds payable/receivable are eliminated

    • Intercompany interest revenues/expenses are eliminated

  • Elimination entry B2:

    • Intercompany interest receivables/payables are eliminated

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Bond issued at face value example facts l.jpg
Bond Issued at Face Value Example: Facts

Sub(80%)issues to third parties $100,000, 5-year, 8% bond on 1/1/20X1 at 100.

Int. Exp. = $8,000 per year

Parentpurchases the bonds from third party for $103,600 on 1/2/20X3

3 remaining years

Discount amortization (st.-line) = $1,200 per year

Int. Rev. = $6,800 per year

Consolidated statements:$103,600 was paid to retire bonds with a book value of $100,000

There is $3,600 loss on the date of purchase

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Bond example general ledger journal entries years 1 5 l.jpg
Bond Example: General Ledger Journal Entries (Years 1–5)

Sub Journal Entries

Year 1

Cash 100,000

Bond Pay. 100,000

Int. Exp. 8,000

Int. Pay. 8,000

Year 2

Int. Exp 8,000

Int. Pay 8,000

Years 3, 4 & 5

Int. Exp. 8,000

Int. Pay. 8,000

Parent Journal Entries

Year 1

No entry

Year 2

No entry

Years 3, 4 & 5

Int. Rec. 8,000

Invest in Bond 1,200

Int. Pay. 6,800

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Bonds issued at face value elimination entries at 12 31 x3 l.jpg
Bonds Issued at Face Value – Elimination entries at 12/31/X3

B1 Bond payable 100,000

Invest. In Bonds 102,400*

Interest income 6,800

Interest expense 8,000

Loss on Bond retirement 3,600

(eliminates intercompany bonds and interest expense)

* Net of $1,200 amortization of bond premium

B2 Interest payable 8,000

Interest receivable 8,000

(eliminates intercompany accrued interest)

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Bond issued at discount example facts l.jpg
Bond Issued at Discount Example: Facts

Sub(80%)issues to third party $100,000, 5-year, 8% bond on 1/1/20X1 at $96,110.(Discount = $3,890)

  • Discount amortization (straight line) = $778 per year

  • Int. Exp. = $8,778 per year (Interest paid on 12/31)

  • Discount balance $1,556 at 12/31/X3

    Parentpurchases the bonds from third party for $103,600 on 12/31/20X3

  • 2 remaining years

  • Premium amortization (st.-line) = $1,800 per year

  • Int. Rev. = $6,200 per year

    Consolidated statements:$103,600 was paid to retire bonds with a book value of $98,444

  • There is $5,156 loss on the date of purchase

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Bond example carrying values l.jpg
Bond Example: Carrying Values

Parent buys 12/31/X3

$98,444 less $103,600 results in a $5,156 loss.

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Bond issued at a discount example journal entries years 4 5 l.jpg
Bond Issued at a Discount Example: Journal Entries (Years 4–5)

Sub Journal Entries

Year 4

Int. Exp. 8,778

Discount on BP 778

Cash 8,000

Year 5

Int. Exp. 8,778

Discount on BP 778

Cash 8,000

Parent Journal Entries

Year 4

Bond Invest. 103,600

Cash 103,600

Cash. 8,000

Bond investment 1,800

Int. Rev. 6,200

Year 5

Cash 8,000

Bond investment 1,800

Int. Rev. 6,200

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Bonds issued at discount elimination entries at 12 31 x4 l.jpg
Bonds Issued at Discount – Elimination entries at 12/31/X4

B Bond payable 100,000

Discount on Bonds payable 778

Invest. In Bonds 101,800*

Interest income 6,200

Interest expense 8,778

Retained Earnings - P 4,640**

Retained Earnings – S 516^

(eliminates intercompany bonds and interest expense)

* Net of $1,200 amortization of bond premium

**$5,156 loss x 80%

^$5,156 loss x 20%

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Worksheet 5 3 eliminations 12 31 x4 bonds issued at a discount l.jpg
Worksheet 5-3: Eliminations (12/31/X4)Bonds Issued at a Discount

  • Bonds issued at a discount/premium does not change consolidation entries.

  • Bonds issued at a discount/premium does require additional calculations.

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Effective interest method l.jpg
Effective Interest Method

  • Procedures for elimination do not change!

  • Only dollar values are different…

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Effective interest bond example facts l.jpg
Effective Interest Bond Example: Facts

  • Subissues to third party a $100,000, 5-year, 8% bond on 1/1/20X1 for $96,110

  • Parentpurchases the bonds from outsiders for $103,667 on 12/31/20X3 (2 remaining years)

  • Consolidated statements:$103,667 was paid to retire bonds with a book value of $98,240.

    • There is a $5,427 loss

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Effective interest bond example amortization tables l.jpg
Effective Interest Bond Example: Amortization Tables

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Bonds issued at discount elimination entries at 12 31 x415 l.jpg
Bonds Issued at Discount – Elimination entries at 12/31/X4

B Bond payable 100,000

Discount on Bonds payable 918

Invest. In Bonds 101,887*

Interest income 6,220

Interest expense 8,842

Retained Earnings - P 4,342**

Retained Earnings – S 1,085^

(eliminates intercompany bonds and interest expense)

* Net of $1,780 amortization of bond premium

**$5,427 loss x 80%

^$5,427 loss x 20%

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Consolidated cash flow the issues l.jpg
Consolidated Cash Flow: The Issues

  • Consolidated Statement of Cash Flows is required – FASB No. 95

  • Use consolidated financial statements to analyze cash flow

    • Intercompany transactions already eliminated…no effect

  • Investment and financing activities reported (even if non-cash)

    • Cash purchase is investing

    • Stock issue is a noncash transaction

  • Amortizations are a non-cash adjustment to operations

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Cash purchase example l.jpg
Cash Purchase: Example

Balance Sheet of Company Acquired

Cash 50,000 Liabilities 1500,000

Inventory 60,000

Building 190,000 Common Stock 200,000

Equipment 400,000 Retained Earnings 350,000

Total 700,000 Total 700,000

Building Fair Value = $425,000; Life = 10 years

Equipment Fair Value = $250,000; Life = 5 years

Goodwill = Excess of price paid over fair value of net assets

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Cash purchase example continued l.jpg
Cash Purchase: Example (continued)

D&D Schedule

Price paid 540,000

Interest (80%  $550,000) 440,000

Excess 100,000

Allocate to building (80%  25,000) (20,000) 10-year

Allocate to equipment (80% x 60,000) (48,000) 5-year

Goodwill 32,000

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Cash purchase example continued19 l.jpg
Cash Purchase: Example (continued)

To see cash flow impact, consider additions to parent balance sheet on purchase date:

Inventory 60,000

Building 420,000

Equipment 238,000

Goodwill 32,000

Liabilities 150,000

Cash (540,000 – 50,000 sub cash) 490,000

NCI (20%  550,000) 110,000

Dr Cr

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Cash purchase example effect on statement of cash flows l.jpg
Cash Purchase Example:Effect on Statement of Cash Flows

  • Cash operations

    • +$10,600 depreciation adjustment

  • Cash flows from investing activities

    • Payment for purchase of Company S,

      net of cash acquired $(490,000)

  • Noncash “investing” is

    • $150,000 liability

    • $110,000 NCI

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Non cash purchase example l.jpg
Non-Cash Purchase: Example

Balance Sheet of Company Acquired

Cash 50,000 Liabilities 1500,000

Inventory 60,000

Building 190,000 Common Stock 200,000

Equipment 400,000 Retained Earnings 350,000

Total 700,000 Total 700,000

10,000 shares of Stock issued for sub

$10 par value

$54 market value

Building Fair Value = $425,000; Life = 10 years

Equipment Fair Value = $250,000; Life = 5 years

Goodwill = Excess of price paid over fair value of net assets

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Stock issued for sub example continued l.jpg
Stock Issued for Sub: Example (continued)

D&D Schedule

Price paid (10,000 shares x $54) 540,000

Interest (80%  $550,000) 440,000

Excess 100,000

Allocate to building (80%  25,000) (20,000) 10-year

Allocate to equipment (80% x 60,000) (48,000) 5-year

Goodwill 32,000

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Non cash purchase example continued l.jpg
Non-Cash Purchase: Example (continued)

To see cash flow impact, consider additions to parent balance sheet on purchase date:

Cash 50,000

Inventory 60,000

Building 420,000

Equipment 238,000

Goodwill 32,000

Liabilities 150,000

Common Stock – Par 100,000

Paid-in Capital in Excess of Par 440,000

NCI (20%  550,000) 110,000

Dr Cr

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Non cash purchase example effect on statement of cash flows l.jpg
Non-Cash Purchase Example:Effect on Statement of Cash Flows

  • Cash operations

    • +$10,600 depreciation adjustment

  • Cash flows from investing activities

    • Cash acquired in purchase

      of Company S, $(490,000)

  • Noncash financing and investing

    • Adjusted value of assets acquired $800,000

    • Common Stock issued, 540,000

    • Liabilities assumed 150,000

    • Non-controlling Interest 110,000

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Consolidated diluted eps l.jpg
Consolidated Diluted EPS

Subsidiary has no dilutive shares

  • Calculated by dividing controlling interest in consolidated net income by parent company outstanding stock

  • Parent dilutive shares cause numerator and denominator adjustments just as in a single entity calculation

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Consolidated diluted eps continued l.jpg
Consolidated Diluted EPS - continued

Subsidiary has dilutive shares – Two step process

  • Step 1 – Calculate sub’s Diluted Earnings per Share (DEPS)

  • Step 2 – Calculate consolidated DEPS

    • Uses sub’s DEPS calculation as part of this calculation.

      Additional complication:

      Sub may have outstanding securities that may require the parent to issue additional shares

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.


Consolidated diluted eps calculation only sub has possible dilution l.jpg
Consolidated Diluted EPS Calculation – Only Sub has Possible Dilution

Example on next slide

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Consolidated diluted eps calculation only sub has possible dilution example l.jpg
Consolidated Diluted EPS Calculation – Only Sub has Possible Dilution Example

  • Subsidiary financial information:

  • Net Income (adjusted for interco profits) $22,000

  • Pref. stock cash dividend $2,000

  • Interest paid on convertible bonds $3,000

  • Common stock shares outstanding 5,000

  • Warrants to purchase one share of common stock 1,000

  • Warrants held by parent 500

  • Convertible bonds outstanding (conv. to 10 shares cs) 200

  • Convertible bonds held by parent 180

  • Parent financial information:

  • Parent owns 80% of sub

  • Net income (internal, adjusted) $40,000

  • Interest paid on convertible shares $5,000

  • Common shares outstanding 10,000

  • Bonds outstanding can convert to shares 3,000

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Consolidated diluted eps calculation only sub has possible dilution29 l.jpg
Consolidated Diluted EPS Calculation – Only Sub has Possible Dilution

Sub’s DEPS

Consol DEPS

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Consolidated diluted eps calculation parent possible dilution from sub s securities l.jpg
Consolidated Diluted EPS Calculation – Parent Possible Dilution from Sub’s Securities

If sub has dilutive securities that affect Parent’s stock:

  • These securities are not included in sub’s DEPS calculation

  • These securities must be included in the parent’s share adjustment for consolidated DEPS.

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Equity method for unconsolidated investments l.jpg
Equity Method for Unconsolidated Investments

  • Income on investment is recorded as earned

    • Investor records income when the company invested in reports net income

    • Investor reduces the investment account when the company invested in declares dividends

  • Required for certain types of investments

    • Influential investments

    • Corporate joint ventures

    • Unconsolidated subsidiaries

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Influential investment example excel purchases 25 of flag s stock l.jpg
Influential Investment: ExampleExcel purchases 25% of Flag’s Stock

D&D of Excess Schedule

Price paid $250,000

Equity (25%  $800,000) 200,000

Excess of cost over book value 50,000

Less Equipment with 5-year life 20,000

Goodwill (not amortized) $30,000

Purchase date 1/1/20X1

Flag sells inventory to Excel:

$30,000 goods in ending inventory with 40% GP – 12/31/X1

$40,000 goods in ending inventory with 45% GP – 12/31/X2

Flag sold Excel a truck (4 year life) on 1/1/20X1

NBV $16,000, Sell price $20,000

Investee reports income of $60,000 (before tax) in 20X1 and $70,000 in 20X2

Flag declared and paid $10,000 in dividends in 20X2

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Influential investment 20x1 ids to calculate investment income l.jpg
Influential Investment:20X1 IDS to Calculate Investment Income

20X1 IDS for Flag

Truck. gain 4,000 Reported income 60,000

Profit in Excel end. Inv. 12,000 Realized truck gain 1,000

Adjusted Income 45,000

Ownership interest (25%) 11,250

Less Equip amort. 4,000

Investment income 7,250

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Influential investment 20x2 ids to calculate investment income l.jpg
Influential Investment:20X2 IDS to Calculate Investment Income

20X2 IDS for Flag

Profit in Excel end. Inv. 18,000 Reported income 70,000

Profit in Excel beg. Inv. 12,000

Realized truck gain 1,000

Adjusted Income 65,000

Ownership interest (25%) 16,250

Less Equip amort. 4,000

Investment income 12,250

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Influential investment entries to record income dividends l.jpg
Influential Investment: Entries to Record Income & Dividends

20X1 Investment in Flag Company 7,250

Investment Income 7,250

20X2 Investment in Flag Company 12,250

Investment Income 12,250

(to record investment income)

20X2 Cash 12,250

Investment in Flag Company 12,250

(to record dividends received)

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Influential investment special issues l.jpg
Influential Investment: Special Issues

  • Investee with Preferred Stock

  • Investee stock transactions

  • Write-down to market value

  • Zero investment balance

  • Intercompany transactions by investor

  • Gain or loss of influence

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