Chapter 8 Intercompany Indebtedness

1
Chapter 8 Inter-company Indebtedness

• All accounts balances arising from
  inter-corporate financing arrangements must be
  eliminated when consolidated statements are
  prepared.
• Any gain or loss must be recognized on the
  consolidated income statement in the year of
  purchase of the bond.

2
Inter-company bond-holdingsExample

• Assume that P Company owns 80 of the outstanding
  stock of S Company.
• P Company had outstanding bonds that was issued
  many years ago with the following balances on
  January 1, 20x4
• 8 bonds payable (due
  1/1/20x8)---------- 100,000
• unamortized Premium
  ------------------------ 4,000
• Interest is paid annually on January 1.
• S Company purchased this bonds on 1/2/20x4 for
  98,000 from the open market.

3
Book entries for P Company and S Company

• P Companys book
• 12/31/20x4 Interest expense
  7,000
• Premium
  on bonds 1,000
• 
  Interest payable 8,000
• S Companys book
• 1/2/20x4 Investment in bonds
  98,000
• 
  Cash
  98,000
• 12/31/20x4 Interest receivable
  8,000
• Investment
  in bonds 500
• 
  Interest income
  8,500

4
Consolidation elimination for 20x4

• (a) 8 bonds payable
  100,000
• Premium on bonds
  3,000
• Interest income
  8,500
• Investment in bonds
  98,500
• Interest expense
  7,000
• Gain on retirement of the
  bonds 6,000
• (b) Interest payable
  8,000
• Interest receivable
  8,000

5
Consolidation elimination- 20x5

• (a) Bonds payable
  100,000
• Premium on bonds
  2,000
• Interest income
  8,500
• Investment in bonds
  99,000
• Interest expense
  7,000
• Retained earnings-
  1/1/20x5 4,500
• (b) Interest payable
  8,000
• Interest receivable
  8,000

6
If upstream ( subsidiarys bonds purchased by
parent company)

• Assume the same data except that the bonds was
  issued by subsidiary and subsequently purchased
  by parent on the open market.
• The eliminating entries for 20x4 would be as
  follows
• (a) Bonds payable
  100,000
• Premium on bonds
  3,000
• Interest income
  8,500
• Investment in
  bonds
  98,500
• Interest
  expense
  7,000
• Gain on
  retirement of the bonds 6,000
• (b) Interest payable
  8,000
• Interest
  receivable
  8,000

7
(upstream, continued)

• Please note that all inter-company bonds must be
  eliminated and 100 of the gain must be
  recognized.
• Part of the gain would be allocated to the
  minority interest. If S company reports 50,000
  net income in 20x4, then the income assigned to
  the minority interest (non-controlling interest)
  would be
• 20 x (50,000 6,000 gain - 1,500
  piecemeal on gain)
• 10,900

8
Consolidation elimination for 20x5 if upstream

• (a) Bonds payable
  100,000
• Premium on bonds
  2,000
• Interest income
  8,500
• Investment in bonds
  99,000
• Interest expense
  
  7,000
• Retained earnings- 1/1/20x5
  (4,500x 80) 3,600
• Minority interest (4,500 x
  20) 900
• (b) Interest payable
  8,000
• Interest receivable
  
  8,000

9
Income to minority interest in subsequent year

• Assume that the 80-owned subsidiary reports net
  income of 60,000 in 20x5.
• Income to minority interest in 20x5
• 20 x (60,000 - 1,500 piecemeal on gain)
• 20 x 58,500
• 11,700