Dr. M.D. Chase
Advanced Accounting 505-40B
Long Beach State University
Interco Transactions-Intercompany Bonds
Page 1
I. INTERCOMPANY BONDS
A. Procedures:
1. Intercompany bonds are treated as though retired. Therefore there are several accounts to eliminate:
a. Amortization effect caused by premium / discount on intercompany bonds.(NOTE: SHOULD BE DONE FIRST!)
b. Intercompany bond investment / bond payable
Note: (GAIN OR LOSS WILL BE THE BALANCING AMOUNT IN THIS ENTRY. SEE (2) BELOW FOR DETAILS)
c. Bond interest income/Bond interest expense
d. Bond interest payable/Bond interest receivable
2. Year of intercompany bond purchase:
a. Gain or loss on constructive retirement is recognized (not eliminated) in year of acquisition along with unamortized premium or
discount on issuance of bonds by affiliate. See example below:
(Gain) or loss recognized = Unamortized investment premium or (discount)
Plus: Unamortized issue (premium) or discount
(Gain) or loss recognized on retirement
NOTE: The process of recognizing the gain or loss is twofold:
1. determine the amount of gain or loss
2. determine if that amount is gain or if it is a loss
--if "better off" then gain is recognized (This is to say, you have a positive cash flow)
--if "worse off" loss is recognized
(This is to say, you have a negative cash flow)
Although this process is quite simple, it can seem daunting when learning. Let’s consider four situations to illustrate how simple this process
actually is:
Sales (issue) Premium/(discount)
Purchase (Premium)/discount
Gain or (loss)
Situation (A)
125
125
250
Situation (B)
125
(50)
75
Situation (C)
(125)
75
( 50)
Situation (D)
These gains/(losses) can be computed graphically as illustrated below:
Unamortized
Premium
125
Above the “Face Value” line
represents the area we are
“better off”; that is to say that
area where we sell at a premium
and buy at a discount.
125
75 GAIN
Face
Value
S*
P*
(A)
Unamortized
Discount
250Gain
_
50
S*
S*
P*
_
P*
(B)
(C) 75
50 LOSS
125
125
Below the “Face Value” line
represents the area we are
“worse off”; that is to say that
area where we sell at a discount
and buy at a premium.
*S indicates sales premium or (discount) on bond
*P indicates purchase (premium) or discount on bond
NOTE: IAW SFAS 4 the gain or loss would normally be an extraordinary item.
Dr. M.D. Chase
Advanced Accounting-40B
Long Beach State University
Intercompany Bonds: Introduction
Page 2
3. Years subsequent to intercompany bond purchase
a. Amortization of intercompany premiums and discounts is eliminated to prevent double counting.
4. Upstream Purchases:If purchase is made by "P" (upstream) then apportion any amortizations of premium or discount to RE-P and RE-S IAW
% ownership.
5. Purchases in "open market": There is NEVER a gain or loss on intercompany bonds when bonds are purchased directly from the affiliate
rather than in the open market.
a. The amortization effect in subsequent years is eliminated
6.Minority interest effects: The amount of gain or loss recognized in (2) above is also recognized in MI income in the year of purchase if the
sale is upstream and in subsequent years based on the amortizations of premiums and discounts.
MAJOR POINTS TO CONSIDER WITH INTERCOMPANY BONDS:
a. Were bonds purchased from an affiliate or in the market?
b. Is the purchase upstream or downstream?
c. What is the amount of gain or loss to be recognized?
INTERCOMPANY BONDS ILLUSTRATIVE EXAMPLE
(An attempt to convince you that Intercompany Bonds are really nothing to fear!)
This example will help you review several issues from Intermediate Accounting…not that you need a review, of course…
I. BONDS ORIGINALLY ISSUED AT FACE VALUE (NO PREMIUM OR DISCOUNT)
A. Issue: Although there may be no "original" premium or discount, there will be an "investment premium or discount" due to differences in
the stated and effective interest rates.
EXAMPLE:
--S, a 90% subsidiary of P issues $100,000 5 year, 8% bonds on 1/1/1.
--Interest is payable annually on January 1.
--On 1/1/4, P purchases all the bonds from outsiders at a price that reflects the 6% market rate.
REQUIRED:
1. Compute the cost of the bonds to P.
2. Present the amortization schedule P would use (effective Interest)
3. Compute gain or loss on constructive retirement of bonds.
4. Present all necessary entries to record the purchase of the bonds by P.
5. Present the necessary working paper entries for years 4 and 5.
6. Show all computations in good form.
1. Price paid by P for bonds:
PV of $100,000 @ 6% in 2 years................
$
89,000
PV of annuity of $8,000 for 2 years @ 6%......
14,667
Cost to P reflecting 6% ROI..............
$
103,667
2. Amortization schedule: (something you definitely need to know how to do)
(Prem
Year
6%
8%
Amort. Disc.
CV
(3667)
103,667
4
6220
8000
1780
(1887) 101,887
5
6113
8000
1887
0
100,000
3. Gain or Loss on retirement:
Bonds are purchased at a premium of............. $ 3,667
Bonds are issued at face value.......................
-0amount of gain or loss recognized.................
$ 3,667 loss
$3,667
purchase
premium
Note: S* was 0 (sold at face value)
S* P*
Face Value
Dr. M.D. Chase
Advanced Accounting-40B
Long Beach State University
Intercompany Bonds: Introduction
Page 3
This amount is a loss because the purchased the bonds for $3,667 more than they received (after amortization) when they were issued,
therefore they are "worse off"
4. Record the bond investment on P books:
Bond Investment.....................
103,667*
Cash...........................
103,667
*face value of $100,000 and purchase premium of 3,667; Note that the Bond investment is recorded at "full cost" as opposed to the bond
liability which is recorded at face value with a separate account for premium or discount.
5. Intercompany eliminations/adjustment 12/31/4:
m. Eliminate current year amortization of bond premium or discount
Investment is S bonds............
1,780
Interest revenue...............
1,780
n. Eliminate investment in bonds and bonds payable
B/P (face value)....................
100,000
Loss on bond retirement.........
3,667
Investment in bonds (CV BOY/Purchaser)
103,667
o. Eliminate intercompany revenues and expenses:
Interest revenue....................
8,000
Interest expense...............
8,000
p. Eliminate intercompay receivables and payables:
Interest payable....................
8,000
Interest receivable............
8,000
6. Intercompany eliminations/adjustments 12/31/5
m. Eliminate amortization of intercompany premium/discount:
Investment in bonds..................... 1,887
Interest revenue...................
1,887
n. Eliminate bonds payable/investment in bonds:
B/P (CV at BOY).........................
100,000
P-RE (.9)(1887).........................
1,698
S-RE (.1)(1887).........................
189
Investment in S bonds..............
101,887
o. Eliminate interest revenue/expense:
Interest revenue........................
8,000
Interest expense...................
8,000
p. Eliminate interest receivable/payable:
Interest payable........................
8,000
Interest receivable................
8,000
NOTE:
The gain or loss is recognized in the year of the intercompany purchase.
This gain or loss is adjusted on the working papers and subsequently finds its' way to the consolidated balance sheet.
It is never booked by the parent.
Finally, the loss is normally an extraordinary item IAW SFAS 4.
Dr. M.D. Chase
Advanced Accounting-40B
Long Beach State University
Intercompany Bonds: Introduction
Page 4
II. BONDS NOT ORIGINALLY ISSUED AT FACE VALUE:
A. This normally this will be the case. The principles of the eliminations are unchanged but the computations become more complex.
EXAMPLE:
--S issues $100,000, 5 year, 8% bonds on 1/1/1 when the market rate is 9%.
--P Purchases the bonds on 12/31/3 at a price to yield 6%.
--P owns 90% of S
REQUIRED:
1. Compute the cost of the bonds to P and the original issue price
2. Present the amortization tables used by P and S (effective interest)
3. Compute gain or loss on constructive retirement of the bonds
4. Present all necessary entries to record the purchase of the bonds by P.
5. Present the necessary working paper entries for years 4 and 5.
6. Assume that S net income is $10,000 and compute the distribution to the minority interest.
1. (See part I for computations relating to P)
Original issue price by S:
PV of $100,000 at 9% in 5 yrs................
$
PV of an annuity of $8,000 in 5 yrs at 9%....
$
64,993
31,117
96,110
2. (See part I for computations relating to P)
S Amortization schedule:
Year
0
1
2
***3
4
5
8%
9%
Amort
8,000
8,000
8,000
8,000
8,000
8,650
8,708
8,772
8,842
8,918
650
708
772
842
918
(Prem)
Disc
3,890
3,240
2,532
1,760**
918
0
CV
96,110
96,760
97,468
98,240**
99,082
100,000
3. Gain or loss on retirement:
Investment premium or (discount) + issue (premium) or discount:
3667 - (-1760) = 5427 loss on retirement (dr balance)
4. Record the bond investment on P books:
(Same as part I)
5. Intercompany eliminations/adjustments 12/31/4
m. Eliminate current year amortization of bond prem/disc:
Investment is S bonds................. 1,780
Discount on B/P ......................
842
Interest revenue.................
1,780
Interest expense.................
842
n. Eliminate investment in bonds and bonds payable:
B/P (face value)...................... 100,000
P-RE (.9)(5427)...................... . 4,884 (PURCH 12/31/3)
S-RE (.1)(5427)......................
543
Discount on B/P..................
1,760
Investment in S bonds (CV BOY)...
103,667
** (o and p are same as part I)**
Purchase
Premium $3,667
Face Value
Issue
Discount $1,760
$5,427 Gain
Dr. M.D. Chase
Advanced Accounting-40B
5.
Long Beach State University
Intercompany Bonds: Introduction
Page 5
(b) Intercompany eliminations/adjustment 12/31/5
m. Eliminate current year amortization of bond premium/disc
Investment in S bonds.................
1,887
Discount on B/P.......................
918
Interest revenue.................
1,887
Interest expense.................
918
n.
Eliminate Investment in bonds/Bonds payable:
Bonds payable.........................
100,000
P-RE (.9)(1887+918)...................
2,515
S-RE (.1)(1887+918)...................
281
Investment in bonds (CV BOY).....
101,887
Discount on bonds payable........
918
***o,p same as Part I***
6.
Distribution of Net income to Minority interest (assume Subsidiary Internally Generated net income is $10,000):
(MI%)(SUB NI+upstream credits - uptstream debits)
Year 4:
(.1)(10,000+1,780+842) = 1262
Year 5:
(.1)(10,000+1,887+918) = 1281
************NOTE THIS COMPUTATION*************