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Advanced Accounting, 11e (Beams/Anthony/Bettinghaus/Smith)
Chapter 7 Intercompany Profit Transactions - Bonds
Multiple Choice Questions
1) If the price paid by a parent company to acquire the debt of a subsidiary is greater than the book value of the liability, a ________ occurs.
A) realized loss on the retirement of debt from the viewpoint of the subsidiary
B) realized gain on the retirement of debt from the viewpoint of the subsidiary
C) constructive loss on the retirement of debt from the viewpoint of the consolidated entity
D) constructive gain on the retirement of debt from the viewpoint of the consolidated entity
Answer: C
Objective: LO1
Difficulty: Easy
2) If an affiliate purchases bonds in the open market, the book value of the intercompany bond liability at the time of purchase is
A) always assigned to the parent company because it has control.
B) the par value of the bonds less the unamortized discount or plus the unamortized premium.
C) par value.
D) the par value of the bonds plus the unamortized discount or less the unamortized premium.
Answer: B
Objective: LO1
Difficulty: Easy
3) Bonds issued by a company remain on their books as a liability, but are considered constructively retired when
A) the company borrows money from unaffiliated entities to re-purchase its own bonds at a gain.
B) The company borrows money from an affiliate to re-purchase its own bonds at a gain.
C) The company's parent or subsidiary purchases the bonds from outside entities.
D) The company borrows money from an affiliate to repurchase its own bonds at a gain or at a loss.
Answer: C
Objective: LO1
Difficulty: Easy
Use the following information to answer the question(s) below.
Pascalian Company owns a 90% interest in Sapp Company. On January 1, 2023, Pascalian had $300,000, 6% bonds outstanding with an unamortized premium of $9,000. The bonds mature on December 31, 2023. Sapp acquired one-third of Pascalian's bonds in the open market for $97,000 on January 1, 2023. Both companies use straight-line amortization of bond discounts/premiums. Interest is paid on December 31. On December 31, 2023, the books of the two affiliates held the following balances:
Pascalian's books
6% bonds payable $300,000
Premium on bonds 7,200
Interest expense 16,200
Sapp's books
Investment in Pascalian bonds $ 97,600
Interest income 6,600
4) The gain from the bond purchase that appeared on the December 31, 2023 consolidated income statement was
A) $4,320.
B) $4,800.
C) $5,400.
D) $6,000.
Answer: D
Explanation: D)
Book value of Pascalian's bonds
acquired by Sapp equals 1/3
times ($300,000 + $9,000) $103,000
Less: Cost of acquiring
Pascalian bonds ( 97,000)
Constructive gain on bonds $ 6,000
Objective: LO2
Difficulty: Moderate
5) Consolidated Interest Expense and consolidated Interest Income, respectively, that appeared on the consolidated income statement for the year ended December 31, 2023 was
A) $10,800 and $0.
B) $10,800 and $6,600.
C) $0 and $0.
D) $16,200 and $6,600.
Answer: A
Explanation: A) Consolidated interest expense =
$16,200 × 2/3 $10,800
Objective: LO2
Difficulty: Moderate
6) Prussia Corporation owns 80% the voting stock of Stad Corporation. On January 1, 2023, Prussia paid $391,000 cash for $400,000 par of Stad's 10% $1,000,000 par value outstanding bonds, due on April 1, 2023. Stad's bonds had a book value of $1,045,000 on January 1, 2023. Straight-line amortization is used. The gain or loss on the constructive retirement of $400,000 of Stad bonds on January 1, 2023 was reported in the 2023 consolidated income statement in the amount of
A) $14,000.
B) $21,600.
C) $23,000.
D) $27,000.
Answer: D
Objective: LO2
Difficulty: Moderate
Use the following information to answer the question(s) below.
Pfadt Inc. had $600,000 par of 8% bonds payable outstanding on January 1, 2023 due January 1, 2023 with an unamortized discount of $12,000. Senat is a 90%-owned subsidiary of Pfadt. On January 2, 2023, Senat Corporation purchased $150,000 par value of Pfadt's outstanding bonds for $152,000. The bonds have interest payment dates of January 1 and July 1. Straight-line amortization is used.
7) With respect to the bond purchase, the consolidated income statement of Pfadt Corporation and Subsidiary for 2023 showed a gain or loss of
A) $ 4,500.
B) $ 5,000.
C) $10,800.
D) $12,000.
Answer: B
Explanation: B) [($588,000 × 0.25) -$152,000]
Objective: LO2
Difficulty: Moderate
8) Bond Interest Receivable for 2023 of Pfadt's bonds on Senat's books was
A) $5,400.
B) $6,000.
C) $10,800.
D) $12,000.
Answer: B
Explanation: B) [$150,000 × 8% × 1/2]
Objective: LO2
Difficulty: Moderate
9) Bonds Payable appeared in the December 31, 2023 consolidated balance sheet of Pfadt Corporation and Subsidiary in the amount of
A) $398,925.
B) $441,000.
C) $443,250.
D) $450,000.
Answer: C
Explanation: C) [$591,000 × 75%]
Objective: LO2
Difficulty: Moderate
Use the following information to answer the question(s) below.
Plenty Corporation issued six thousand, $1,000 par, 6% bonds on January 1, 2023, at par. Interest is paid on January 1 and July 1 of each year; the bonds mature on January 1, 2023. On January 2, 2023, Scrawn Corporation, a 75%-owned subsidiary of Plenty, purchased 3,000 of the bonds on the open market at 102.50. Plenty's separate net income for 2023 included the annual interest expense for all 3,000 bonds. Scrawn's separate net income for 2023 was $400,000, which included the bond interest received on July 1 as well as the accrual of bond interest revenue earned on December 31. Both companies use straight-line amortization of bond discounts/premiums.
10) What was the amount of gain or (loss) from the intercompany purchase of Plenty's bonds on January 2, 2023?
A) $(56,250)
B) $(75,000)
C) $ 75,000
D) $ 56,250
Answer: B
Explanation: B)
Total book value acquired =
$6,000,000 × 50% $3,000,000
Purchase price 3,000 × $1,025 3,075,000
Loss on constructive retirement $ 75,000
Objective: LO2
Difficulty: Moderate
11) If the bonds were originally issued at 106, and 80% of them were purchased by Scrawn on January 2, 2023 at 98, the gain or (loss) from the intercompany purchase was
A) $(384,000).
B) $(211,200).
C) $ 211,200.
D) $ 384,000.
Answer: C
Explanation: C)
Book value at January 2, 2023 equals
$6,360,000 minus $216,000= $6,144,000
Percentage of bonds acquired 80%
Equals book value acquired 4,915,200
Purchase price 4,800 bonds × $980= 4,704,000
Gain on constructive retirement= $ 211,200
Objective: LO2
Difficulty: Moderate
12) If the bonds were originally issued at 103, and 70% of them were purchased on January 2, 2023 at 104, the constructive gain or (loss) on the purchase was
A) $(142,800).
B) $( 42,000).
C) $ 42,000.
D) $ 142,800.
Answer: A
Explanation: A)
Book value at January 2, 2023 equals
$6,180,000 minus $144,000 $6,036,000
Percentage of bonds acquired 70%
Equals book value acquired 4,225,200
Purchase price 4,200 bonds × $1,040 4,368,000
Loss on constructive retirement $ 142,800
Objective: LO2
Difficulty: Moderate
13) Using the original information, the amount of consolidated Interest Expense for 2023 was
A) $ 135,000.
B) $ 180,000.
C) $ 270,000.
D) $ 360,000.
Answer: B
Explanation: B) ($6,000,000 - $3,000,000) × 6%
Objective: LO2
Difficulty: Moderate
14) Using the original information, the balances for the Bonds Payable and Bond Interest Payable accounts, respectively, on the consolidated balance sheet for December 31, 2023 were
A) $3,000,000 and $ 90,000.
B) $3,000,000 and $180,000.
C) $6,000,000 and $ 90,000.
D) $6,000,000 and $180,000.
Answer: A
Explanation: A) Bonds payable $6,000,000 minus bonds held by Scrawn of $3,000,000. Interest accrued on December 31, 2023 will be the interest on bonds held by non-affiliates or $3,000,000 × 6% × 1/2 year
Objective: LO2, 3
Difficulty: Moderate
15) Using the original information, the elimination entries on the consolidation working papers prepared on December 31, 2023 included at least
A) debit to Bond Interest Expense for $360,000.
B) credit to Bond Interest Expense for $180,000 and a debit to Bond Interest Payable for $90,000.
C) credit to Bond Interest Receivable for $180,000.
D) debit to Bond Interest Revenue for $360,000.
Answer: B
Objective: LO2
Difficulty: Moderate
16) No constructive gain or loss arises from the purchase of an affiliate's bonds if the
A) affiliate is a 100%-owned subsidiary.
B) bonds are purchased at book value.
C) bonds are purchased with arm's-length bargaining from outside entities.
D) gain or loss cannot be reasonably estimated.
Answer: B
Objective: LO1
Difficulty: Easy
17) There are several theories for allocating constructive gains or losses between purchasing and issuing affiliates. The Agency Theory
A) does so based on the par value of the bonds purchased.
B) assigns the entire constructive gain or loss to the parent based on their control of the decision to purchase the bonds.
C) assigns the entire constructive gain or loss to the subsidiary based on the need to have the noncontrolling interest share in the retirement of the debt.
D) assigns the entire constructive gain or loss to whichever company issued the bonds.
Answer: D
Objective: LO1
Difficulty: Easy
18) Pickle Incorporated acquired a $10,000 bond originally issued by its 80%-owned subsidiary on January 2, 2023. The bond was issued in a prior year for $11,250, matures January 1, 2023, and pays 9% interest at December 31. The bond's book value at January 2, 2023 is $10,625, and Pickle paid $9,500 to purchase it. Straight-line amortization is used by both companies. How much interest income should be eliminated in 2023?
A) $720
B) $800
C) $900
D) $1,000
Answer: D
Explanation: D) $9,500 - $10,000 = discount to amortize as interest expense over 5 years, or $100 per year + $900 paid by issuer.
Objective: LO2, 3
Difficulty: Moderate
Use the following information to answer the question(s) below.
Poe Corporation owns an 80% interest in Seri Company acquired at book value several years ago. On January 2, 2023, Seri purchased $100,000 par of Poe's outstanding 10% bonds for $103,000. The bonds were issued at par and mature on January 1, 2023. Straight-line amortization is used. Separate incomes of Poe and Seri for 2023 are $350,000 and $120,000, respectively. Poe uses the equity method to account for the investment in Seri.
19) Controlling interest share of consolidated net income for 2023 was
A) $443,600.
B) $444,000.
C) $444,400.
D) $448,000.
Answer: B
Explanation: B)
Poe's separate income $ 350,000
Income from Seri ($120,000 × 80%) 96,000
Less: Loss on constructive retirement of Poe bonds (3,000)
Plus: Piecemeal recognition of the
constructive loss ($3,000/3 years) 1,000
Controlling interest share $ 444,000
Objective: LO4
Difficulty: Moderate
20) Noncontrolling interest share for 2023 was
A) $23,000.
B) $23,600.
C) $24,000.
D) $24,400.
Answer: C
Explanation: C) Since Poe is the issuing entity, the gain or loss is not allocated to the noncontrolling interest. The noncontrolling interest share is ($120,000 × 20%) = $24,000.
Objective: LO4
Difficulty: Moderate
Exercises
1) Separate company and consolidated income statements for Pitta and Sojourn Corporations for the year ended December 31, 2023 are summarized as follows:
Pitta Soujourn Consolidated
Sales Revenue $ 500,000 $ 100,000 $ 600,000
Income from Sojourn 19,900
Bond interest income 6,000
Gain on bond retirement 3,000
Total revenues 519,900 106,000 603,000
Cost of sales $ 280,000 $ 50,000 $ 330,000
Bond interest expense 9,000 3,600
Other expenses 120,900 31,000 151,900
Total expenses 409,900 81,000 485,500
Consolidated net income 117,500
Noncontrolling interest share 7,500
Separate net income and
Control. interest share in
consolidated net income $ 110,000 $ 25,000 $ 110,000
The interest income and expense eliminations relate to a $100,000, 9% bond issue that was issued at par value and matures on January 1, 2023. On January 2, 2023, a portion of the bonds was purchased and constructively retired.
Required: Answer the following questions.
1. Which company is the issuing affiliate of the bonds payable?
2. What is the gain or loss from the constructive retirement of the bonds payable that is reported on the consolidated income statement for 2023?
3. What portion of the bonds payable is held by nonaffiliates at December 31, 2023?
4. Is Sojourn a wholly-owned subsidiary? If not, what percentage does Pitta own?
5. Does the purchasing affiliate use straight-line or effective interest amortization?
6. Explain the calculation of Pitta's $19,900 income from Sojourn.
Answer:
1. Pitta is the issuing affiliate.
2. Effect on consolidated net income:
Gain on constructive retirement of bonds $ 3,000
3. Percent of bonds held by nonaffiliates at December 31, 2023 is 40%, computed as $3,600 consolidated interest expense divided by $9,000 interest expense of Pitta.
4. Sojourn is partially owned as evidenced by the noncontrolling interest share. The ownership percentage is 70% ($7,500 noncontrolling interest share divided by $25,000 income of Sojourn = 30% noncontrolling interest.)
5. Straight-line amortization
$100,000 par × 60% purchased $60,000
Purchase price 5 years before maturity 57,000
Gain 3,000
Nominal interest ($60,000 × 9%) $ 5,400
Discount amortization ($3,000/5 years) 600
Bond interest income $ 6,000
6. Pitta's income from Sojourn
Share of Sojourn's reported income
($25,000 × 70%) = $17,500
Add: Constructive gain 3,000
Less: Piecemeal recognition of constructive
gain (600)
Income from Sojourn $19,900
Objective: LO1, 2, 4
Difficulty: Moderate
2) Platts Incorporated purchased 80% of Scarab Company several years ago when the fair value equaled the book value. On January 1, 2023, Scarab has $100,000 of 8% bonds that were issued at face value and have five years to maturity. Interest is paid annually on December 31. Both Platts and Scarab would use the straight-line method to amortize any premium or discount incurred in the issuance or purchase of bonds. On January 1, 2023, Platts purchased all of Scarab's bonds for $96,000.
Required:
1. Prepare the journal entries in 2023 that would be recorded by Platts and Scarab on their separate financial records.
2. Prepare the consolidating working paper entries required for the year ending December 31, 2023.
Answer:
Requirement 1:
Platts entries:
1/1/11 Investment in bonds $96,000
Cash $96,000
12/31/11 Cash 8,000
Interest income 8,000
Investment in bond
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