Professional Documents
Culture Documents
Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as
reciprocal interest receivable and payable accounts and interest income and expense accounts.
Direct lending and borrowing transactions do not give rise to unrealized gains and losses. Any income
reported by the lender is precisely reciprocal to an expense reported by the borrower, and the transactions
are complete on the date consummated. Similarly, direct lending and borrowing transactions do not give
rise to unrecognized gains and losses since intercompany amounts received and paid are both realized and
recognized from the viewpoint of the separate legal entities.
Constructive gains and losses are gains and losses from the viewpoint of the consolidated entity but not
from the viewpoint of the separate affiliates involved. The purchase of a parents outstanding bonds by its
subsidiary at a price below the book value of the bonds on the parents books results in a constructive gain.
Although the bonds are not actually retired, they are constructively retired from the viewpoint of the
consolidated entity because they are no longer liabilities of the consolidated entity to outside parties.
The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300. If an
affiliate purchases half of the bonds at 98, it will record a bond investment of $490,000. From the
viewpoint of the consolidated entity, the purchase of the bonds results in a constructive retirement of
$500,000 par of bonds payable. The constructive gain on the bonds is $12,350 [($1,004,700 50%)
$490,000].
A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the
books of the separate affiliates. The affiliates continue to carry the bonds as a liability (issuer) and
investment (purchaser) on their separate books. Alternatively, an unrealized gain on the sale of land is
recorded on the books of the selling affiliate, but it is not recognized as a gain for consolidated statement
purposes because the land is still held within the consolidated entity. Thus, a constructive gain on bonds is
realized and recognized from the viewpoint of the consolidated entity but it is not recognized on the books
of the affiliates. An unrealized gain on the sale of land is recognized on the books of the selling affiliate but
is not realized or recognized from the viewpoint of the consolidated entity.
Constructive gains on intercompany bonds are realized and recognized through the interest income and
expense reported on the separate books of the affiliates. The difference between the interest income
reported by the investor and the interest expense reported by the issuer on the intercompany bonds is the
amount of constructive gain recognized in each period. Constructive gains and losses are recognized in the
consolidated financial statements before they are recognized on the books of the affiliates.
If a subsidiary purchases parent bonds at a price in excess of book value, a constructive loss results. The
loss is attributed to the parent since it is the parent bonds that are constructively retired. This approach of
associating constructive gains and losses on intercompany bonds with the issuer is consistent with the
procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with
the selling affiliates.
8a
8b
40,000
40,000
equal
to
80%
of
reported
Investment in S
Income from S
4,000
4,000
10
$75,000
6,000
$69,000
11a
11b
The constructive gain is associated with the parent since the issuer
reports interest expense.
11c
SOLUTIONS TO EXERCISES
Solution E7-1
1
c
2
a
3
4
d
a
Solution E7-2
1
a
Book value of Pan bonds acquired by
Sow ($900,000 + $48,000) 2/3
Cost to Sow
Constructive gain
2
d
Nominal interest on Pans remaining
outstanding bonds $300,000 8%
Less: Amortization of premium ($48,000 1/3)/ 4 years
Interest expense on consolidated income statement
$632,000
602,000
$ 30,000
$ 24,000
4,000
$ 20,000
Solution E7-3
1
c
Cost of $80,000 par of Pal bonds January 1, 2011
Book value acquired ($400,000 par - $8,000 discount) 20%
Constructive gain
2
d
Par value of bonds payable
Less: Unamortized discount ($8,000 - $2,000)
Book value of bonds
Percent outstanding
Bonds payable
3
c
Constructive gain $2,400/4 years 3 years
4
c
Nominal interest
Add: Amortization of discount
Percent outstanding
Interest expense
5
$ 76,000
78,400
$ 2,400
$400,000
(6,000)
394,000
80%
$315,200
$
1,800
$ 40,000
2,000
42,000
80%
$ 33,600
Solution E7-4
1
$1,600
$800
$768
800
(32)
8
776
$2,376
200
750
(435)
Solution E7-5
Pim Corporation and Subsidiary
Consolidated Income Statement
for the year ended December 31, 2019
(in thousands)
Sales
Less: Cost of sales
Gross profit
Add: Gain on constructive retirement of bondsb
Less: Operating expenses
Operating profit
Other Items:
Bond interest expensea
Consolidated net income
a
b
315
3
(125)
193
$
(15)
178
Parents bond interest expense $25,000 less interest on bonds held intercompany
$10,000 = $15,000.
Book value of parents bonds purchased $100,000 less purchase price $97,000 =
$3,000 gain on constructive retirement.
Solution E7-6
1
Constructive loss
Cost paid to retire 1/2 of Sons bonds
Book value of bonds retired ($495,000 .5)
Constructive loss on bond retirement
$251,500
247,500
$ 4,000
4,900
(2,800)
700
2,800
Solution E7-7
1
a
January 1, 2011 cost of $400,000 par bonds
Book value acquired ($2,000,000 + $90,000 premium) 20%
Constructive gain
$391,000
418,000
$ 27,000
b
Constructive gain $27,000/5 years 4 years
$ 21,600
c
Book value $2,072,000 80% outstanding
$1,657,600
Solution E7-8
1a
Constructive gain
Book value of bonds January 1, 2012
Amortization for 6 months ($15,000/4 years 1/2 year)
Book value of bonds July 1, 2012
$485,000
1,875
486,875
1b
60%
$292,125
287,400
Constructive gain
$ 21,875
8,750
$ 30,625
Par
$500,000
$500,000
Discount
$15,000
- 3,750
$11,250
4,725
Book Value
$485,000
+ 3,750
$488,750
$195,500
The amounts would not be different if Say had been the issuer and Par
the purchaser. However, the constructive retirement gains would
belong to Say and would have been allocated to both Par and the
noncontrolling interests in Say.
$1,960
1,900
$
60
1c
$4,000
1d
2a
2b
200
$1,900
20
$1,920
$1,020
1,030
$ (10)
2c
2d
520
$4,900
20
$4,920
None
120
342
d
4
$1,030
980
$
50
None
None
$3,054
None
$
180
Solution E7-11
Preliminary computations:
Book value of Saw bonds on January 1, 2012
Purchase price paid by Par
Gain on constructive retirement of Saw bonds
Amortization of gain on bonds ($217,000/7 years)
Computation of noncontrolling interest share:
Share of Saws reported income ($140,000 20%)
Add: Share of constructive gain ($217,000 20%)
Less: Piecemeal recognition of constructive gain ($31,000 20%)
Noncontrolling interest share
$1,000,000
783,000
$ 217,000
$
31,000
28,000
43,400
(6,200)
65,200
$1,800
950
$
$
850
217
400
667
65.2
601.8
Solution E7-12
1
Interest receivable
Investment in Sap bonds
Interest payable ($40,000 90%)
8% bonds payable (($1,000,000 90%)- 13,500
discount)
Interest income
Interest expense ($86,000/2) + .9(86,000/2)
Loss on constructive retirement of bonds
a
Amounts Appearing
in Consolidated
Financial Statements
0
0
36,000
886,500
0
81,700
7,800a
$105,000
1,000
$106,000
98,200
7,800
Solution E7-13
1
$ 97,600
100,000
$ 2,400
4,000
400
4,400
4,400
97,600
8,000
8,000
8,000
8,000
$ 20,000
$481,600
$501,600
SOLUTIONS TO PROBLEMS
Solution P7-1
1
$53,600
$100,000
2,400
97,600
50%
$ 4,800
48,800
0
$ 5,500
$ 1,000
1,000
Solution P7-2
Pew Corporation and Sat Corporation
Schedule to Determine Pews Net Income and Controlling Share of Consolidated
Net Income
Pews separate income
2011
$250,000
2012
$187,500
2013
$230,000
2014
$255,000
Total
922,500
+ 40,000
+ 48,000
+ 44,000
+ 48,000
180,000
2,500
5,000
2,500
5,000
6,000
6,000
- 15,000
15,000
$3,750 depreciation on
unrealized profit on
equipment in 2013 and 2014
3,750
7,500
4,000
4,000
1,000
1,000
$287,500
$233,000
3,750
$261,750
$303,750
$1,086,000
Solution P7-3
Income from Sum for 2011:
Share of reported income of Sum ($400,000 75%)
Add: Unrealized profit in beginning inventory of Sum
Less: Unrealized profit in ending inventory of Sum
Add: Piecemeal recognition of gain on sale of equipment
to Pad ($96,000/6 years) 75%
Less: Unrealized gain on sale of land to Sum
Less: Unrealized gain on sale of building to Sum less
piecemeal recognition through depreciation ($80,000 - $4,000)
Add: Gain on constructive retirement of Pad bonds
($400,000 - $376,000)
Income from Sum
$ 300,000
48,000
(60,000)
12,000
(40,000)
(76,000)
24,000
$ 208,000
$1,560,000
(60,000)
(36,000)
(40,000)
(76,000)
24,000
$1,372,000
Pad
Income Statement
Sales
Gain on land
Gain on building
Income from Sum
Gain on bonds
Cost of sales
$ 2,520
40
80
208
$ 2,000
1,400*
1,200*
Depreciation expense
304*
160*
Interest expense
Other expenses
Consolidated NI
Noncontrolling int. share
Controlling share of NI
80*
184*
Retained Earnings
Retained earnings Pad
Retained earnings Sum
Controlling share of NI
Dividends
b
f
f
h
200
40
80
208
60
880
600
400
400
400
320*
880
640*
840
480
108
324
20
120
200
280
720
360
160
320
360
600
560
1,372
_______
$ 3,480
$
200
40
800
1,600
840
$ 3,480
Consolidated
Statements
$4,320
g
b
c
e
f
24
200
48
16
4
24
2,412*
444*
80*
424*
984
104*
880
600
240*
k
Adjustments and
Eliminations
Sum 75%
104
400
880
h
k
c
e
h
40
48
48
32
376
$ 2,400
$
320
1,600
480
$ 2,400
240
80
j
20
a
40
d
60
f
40
f
76
e
48
i 1,500
376
i
k
500
24
3,296
j
20
g
400
i 1,600
e
16
_______
3,296
640*
840
472
240
460
600
1,244
872
______
$3,888
$ 520
20
400
1,600
840
508
$3,888
Solution P7-4
Preliminary Computations:
Acquisition price
Implied fair value of She ($640,000 / 80%)
Shes book value
Excess allocated to plant & equipment with 8 year life
$ 640,000
$ 800,000
(600,000)
$ 200,000
25,000
$212,000
206,000
$ 6,000
Consolidated sales
Combined sales
Less: Intercompany sales
Consolidated sales
$560,000
100,000
$460,000
$ 340,000
(100,000)
(40,000)
20,000
$ 220,000
40,000
$300,000
280,000
$ 20,000
$360,000
30,000
$330,000
$ 60,000
(25,000)
40,000
(20,000)
55,000
20%
$ 11,000
$164,000
(8,000)
(6,000)
11,000
$161,000
Alternative computation:
Ending equity of She ($700,000 + $125,000 unamortized
$165,000
excess)( 20%)
(4,000)
Less: Unrealized profit in ending inventory ($20,000 20%)
Noncontrolling interest December 31, 2013
$161,000
9
10
$640,000
56,000
(40,000)
(32,000)
$624,000
$640,000
(40,000)
24,000
$624,000
$ 60,000
(25,000)
40,000
(20,000)
$ 55,000
$ 44,000
(4,000)
$ 40,000
$ 65,000
$466,000
$100,000
$100,000
$272,000
$ 80,000
$810,000
$ 16,000
$ 38,000
10
11
9,000
Solution P7-6
Income from Sal for 2012:
Share of reported income of Sal ($100,000 75%)
Add: Unrealized profit in beginning inventory of Sal
Less: Unrealized profit in ending inventory of Sal
Add: Piecemeal recognition of gain on sale of equipment
to Par ($24,000/6 years) 75%
Less: Unrealized gain on sale of land to Sal
Less: Unrealized gain on sale of building to Sal less
piecemeal recognition through depreciation ($20,000 - $1,000)
Add: Gain on constructive retirement of Par bonds
($100,000 - $94,000)
Income from Sal for 2012
$ 75,000
12,000
(15,000)
3,000
(10,000)
(19,000)
6,000
$ 52,000
$390,000
(15,000)
(9,000)
(10,000)
(19,000)
6,000
$343,000
$100,000
4,000
104,000
25%
$ 26,000
500
b
f
h
50
30
52
350*
300*
15
Depreciation expense
76*
40*
Interest expense
Operating expense
Consolidated NI
Noncontrolling int. share
Controlling share of NI
20*
46*
Retained Earnings
Retained earnings Par
Retained earnings Sal
Controlling share of NI
Dividends
Retained earnings
December 31
Balance Sheet
Cash
Bond interest receivable
Other receivables
Inventories
Land
Buildings net
Equipment net
Investment in Sal stock
630
30
52
Adjustments and
Eliminations
Sal 75%
$
220
150
100
100
100
80*
220
160*
210
120
27
81
5
30
50
70
180
90
40
80
90
150
140
343
______
$ 870
Accounts payable
$
50
Bond interest payable
10
10% bonds payable
200
Common stock
400
Retained earnings
210
$ 870
Noncontrolling interest January 1
Noncontrolling interest December 31
Deduct
g
b
c
e
f
6
50
12
4
1
6
603*
111*
20*
106*
246
26*
220
150
$
$
26
i 100
220
h
k
c
e
h
$1,080
60*
k
Consolidated
Statements
10
12
12
8
94
600
80
400
120
600
60
20
$
210
118
j
5
a 10
d 15
f 10
f 19
e 12
i 375
94
j
5
g 100
i 400
e
4
_____
824
160*
i 125
k
6
824
60
115
150
311
218
______
$ 972
$ 130
5
100
400
210
127
972