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Chapter 08 - INTERCOMPANY INDEBTEDNESS
CHAPTER 8
INTERCOMPANY INDEBTEDNESS
OVERVIEW OF CHAPTER
Chapter 8 illustrates the consolidation procedures needed to eliminate the financial
statement effects of direct and indirect intercorporate debt transfers. Elimination of direct sale of
bonds between the parent and subsidiary are discussed at the beginning of the chapter. Transfers
occurring at par value and at a discount or premium are illustrated. For transfers at a premium or
discount, the journal entries recorded by both the debtor and bond investor are given before the
consolidation entries are presented.
Consolidation procedures following a purchase of an affiliate's bonds from a nonaffiliate
are discussed in detail. Consolidation entries needed to provide recognition of a gain or loss on
the constructive retirement in the consolidated income statement in the period of purchase and
the appropriate entries in subsequent periods are illustrated. Computations are presented to aid
the student in gaining an understanding of the effect of a constructive gain or loss on
consolidated net income and the income and net assets assigned to the noncontrolling interest.
The effective interest method is used for amortization of the bond discount/premium.
Appendix 8A discusses and illustrates consolidation procedures to eliminate the effects of
intercompany indebtedness assuming that the parent utilizes the fully adjusted equity method to
account for its investment and that bond discounts and premiums are amortized on a straight line
basis.
Appendix 8B discusses and illustrates consolidation procedures to eliminate the effects of
intercompany indebtedness assuming that the parent utilizes the modified equity method or the
cost method to account for its investment and that bond discounts and premiums are amortized
on a straight line basis.
LEARNING OBJECTIVES
When students finish studying this chapter, they should be able to:
LO 8-1 Understand and explain concepts associated with intercompany debt transfers.
LO 8-2 Prepare journal entries and consolidation entries related to direct intercompany debt
transfers.
LO 8-3 Prepare journal entries and consolidation entries related to debt purchased from a
Chapter 08 - INTERCOMPANY INDEBTEDNESS
8-2
nonaffiliate at an amount less than book value.
LO 8-4 Prepare journal entries and consolidation entries related to debt purchased from a
nonaffiliate at an amount more than book value.
SYNOPSIS OF CHAPTER 8
Intercompany Indebtedness
Ford’s Debt Transfers
LO 8-1 Understand and explain concepts associated with intercompany debt transfers.
Consolidation Overview
LO 8-2 Prepare journal entries and consolidation entries related to direct intercompany
debt transfers.
Bond Sale Directly to an Affiliate
Transfer at Par Value
Transfer at a Discount or Premium
Bonds of Affiliate Purchased from a Nonaffiliate
Purchase at Book Value
LO 8-3 Prepare journal entries and consolidation entries related to debt purchased from a
nonaffiliate at an amount less than book value.
Purchase at an Amount Less than Book Value
LO 8-4 Prepare journal entries and consolidation entries related to debt purchased from a
nonaffiliate at an amount more than book value.
Purchase at an Amount Higher than Book Value
Appendix 8A: Intercompany Indebtedness—Fully Adjusted Equity Method
Using Straight-Line Interest Amortization
Transfer at a Discount or Premium
Bonds of Affiliate Purchased from a Nonaffiliate
Purchase at Book Value
Purchase at an Amount Less than Book Value
Purchase at an Amount Higher than Book Value
Appendix 8B: Intercompany Indebtedness – Modified Equity Method and Cost Method
Modified Equity Method
Modified Equity Method Entries – 20X1
Chapter 08 - INTERCOMPANY INDEBTEDNESS
8-3
Consolidation Entries – 20X1
Modified Equity Method Entries – 20X2
Consolidation Entries – 20X2
Cost Method
Consolidation Entries – 20X1
Consolidation Entries – 20X2
NOTES ON POWERPOINT SLIDES
We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since
instructors often have different styles and preferences, we have attempted to include slides that
will accommodate different approaches and that can be adapted to classes with different levels of
preparation. For example, some instructors prefer to introduce the material before students have
read the chapter. We have tried to facilitate these types of introductory discussions by including
slides that replicate key points from the chapter. Other instructors expect students to have read
the chapter and attempted homework problems before coming to class. As a result, they may not
find it useful to review all of the topics in the chapter or to include slides that simply review
many of the details they expect students to study before class. However, instructors following
this approach often like to use sample exercises and problems built into the slides that allow
them to have extended discussions or to facilitate group interaction in class.
If instructors elect to spend two class periods on the same subject, they might find a combination
of both styles to be useful by first introducing foundational material before students have read
the chapter and studied the topic, followed by an extended discussion the next class period after
students have read the chapter and attempted homework problems.
We have tried to develop slides that can facilitate a flexible approach to allow instructors to
select the slides that best match their objectives and style for class discussions. This is the reason
we are including over 100 slides for some chapters in the text. We do not expect all instructors
to use all slides, but the slide files should help support different teaching approaches and allow
instructors to select the subset of slides that best matches their specific discussion objectives.
The slides are organized by learning objective. We have included a slide at the beginning of
each learning objective to show where the new material begins. Instructors may or may not want
to use these learning objective slides in class. We provide them primarily as a way of organizing
the material. We also include short multiple choice questions at the end of most learning
objectives. Some instructors find it useful to pause periodically during class to assess students’
level of understanding. For this reason, we include several “practice quiz questions” that can be
used throughout class discussions to engage students, help them focus on key points, or to
facilitate group interaction. Finally, we provide longer exercises and problems that many
instructors find useful in assessing understanding and encouraging group learning.
In addition to the power point slides for the Chapter proper, we have also included a set of slides
which are a companion to Appendix 8A which addresses the accounting for Intercompany
Indebtedness assuming straight line amortization rather than effective interest rate amortization
as used in the body of the chapter.
Chapter 08 - INTERCOMPANY INDEBTEDNESS
8-4
LO 8-1 Understand and explain concepts associated with intercompany debt transfers.
• Slides 3-5 provide a basic definition of direct and indirect intercompany debt
transfers.
LO 8-2 Prepare journal entries and consolidation entries related to direct intercompany debt
transfers.
• Slide 9 introduces the accounting for bond transfers directly to an affiliate when the
transfer is made at par value.
• Slide 10 provides a simple example of a bond transfer directly to an affiliate at par
value. The accounting for this scenario is very easy for students to understand. Thus,
it can easily be covered with just one slide.
• Slide 11 explains how the accounting differs if the bonds are issued directly to an
affiliate, but at a discount or premium.
• Slides 12-17 modify the fact pattern of the original example so that the bonds are
transferred at a discount.
• Slides 18 and 19 introduce the general concept of purchasing an affiliate’s bonds
from a non-affiliate.
LO 8-3 Prepare journal entries and consolidation entries related to debt purchased from a
nonaffiliate at an amount less than book value.
• Slide 23 (slide 22 in straight line file) explains how the accounting differs when
bonds of an affiliate are purchased from a nonaffiliated at an amount less than book
value.
• Slides 24-55 (slides 23-50 in straight line file) provide a comprehensive example of
the accounting for bonds purchased from a nonaffiliated at an amount less than book
value. It follows the Peerless/Special Foods example presented in the chapter over
multiple years.
LO 8-4 Prepare journal entries and consolidation entries related to debt purchased from a
nonaffiliate at an amount more than book value.
• Slide 59 (slide 54 in straight line file) explains how the accounting differs when
bonds of an affiliate are purchased from a nonaffiliated at an amount more than book
value.
• Slides 60-63 (slides 55-58 in straight line file) provide a comprehensive example of
the accounting for bonds purchased from a nonaffiliated at an amount more than book
value. It follows the Peerless/Special Foods example presented in the chapter over
multiple years.
TEACHING IDEAS
Chapter 08 - INTERCOMPANY INDEBTEDNESS
8-5
1. Students could be assigned to write a brief memo discussing why a company would
acquire the debt instruments of an affiliated company. What economic circumstances
would have to exist to make this a good business decision? Would the motivations differ
if the consolidated entity would report a loss on the constructive retirement of debt rather
than a gain?
2. Students could be asked to review the financial statements and financial statement notes
of a large consolidated entity and describe the nature of the company’s intercompany
debt and the type of disclosures made regarding the intercompany debt.
Chapter 08 - INTERCOMPANY INDEBTEDNESS
8-6
DESCRIPTIONS OF CASES, EXERCISES, AND PROBLEMS
C8-1
LO 8-4
15 min.
E
A
Recognition of Retirement Gains and Losses
In the situation presented, a parent purchases the bonds of a subsidiary from a
nonaffiliate and the subsidiary then retires the bonds. The recording processes
used by the individual companies, timing of the recognition of a retirement gain
or loss in the consolidated income statement, and assignment of income to
noncontrolling interest are discussed.
C8-2
LO 8-2
15 min.
M
R
Borrowing by Variable Interest Entities
An entity finances its new building by establishing a joint venture, whereas it
holds none of the equity, but solely guarantees the debt. Students must
investigate the applicable accounting rules and determine whether the entity may
exclude this venture from its financial reports. A memorandum must be prepared
outlining the findings and including authoritative cites.
C8-3
LO 8-3
40 min.
M
R
Subsidiary Bond Holdings
Intercompany corporate bond ownership exists between two subsidiaries.
Students must prepare a memorandum outlining the appropriate accounting and
reporting from the perspective of the consolidated entity.
C8-4
LO 8-4
30 min.
M
U
Interest Income and Expense
Students must explain the nature of several intercompany bond transactions and
explore their effect on consolidated financial statements.
C8-5
LO 8-1,
LO 8-2
30 min.
M
A
Intercompany Debt
Students must explain the major problem that may arise from intercompany
borrowing transactions. In addition, students must investigate the nature of
Hershey Foods’ intercompany liabilities.
E8-1
LO 8-2
15 min.
E
Bond Sale from Parent to Subsidiary (Effective Interest Method)
Journal entries for the parent and subsidiary and elimination entries at the end of
the first period of ownership are required following a direct placement of
subsidiary bonds with the parent at a premium.
E8-1A
LO 8-2
15 min.
E
Bond Sale from Parent to Subsidiary (Straight-Line Method)
Journal entries for the parent and subsidiary and elimination entries at the end of
the first period of ownership are required following a direct placement of
subsidiary bonds with the parent at a premium.
Chapter 08 - INTERCOMPANY INDEBTEDNESS
8-7
E8-2
LO 8-2
10 min.
E
Computation of Transfer Price (Effective Interest Method)
Given the interest accrual entry recorded by the parent on bonds purchased
directly from its subsidiary in an earlier period, the original purchase price, the
current balance in the parent's investment account and the elimination entries to
remove the effects of the intercorporate bond ownership are required.
E8-2A
LO 8-2
10 min.
E
Computation of Transfer Price (Straight-Line Method)
Given the interest accrual entry recorded by the parent on bonds purchased
directly from its subsidiary in an earlier period, the original purchase price, the
current balance in the parent's investment account and the elimination entries to
remove the effects of the intercorporate bond ownership are required.
E8-3
LO 8-2
15 min.
E
Bond Sale at Discount (Effective Interest Method)
A parent purchases directly from its subsidiary a portion of a bond issue sold at a
discount. Consolidated interest expense, journal entries recorded on the bond
issue by the parent, and the elimination entries needed to remove the effects of
the intercorporate bond ownership are required.
E8-3A
LO 8-2
15 min.
E
Bond Sale at Discount (Straight-Line Method)
A parent purchases directly from its subsidiary a portion of a bond issue sold at a
discount. Consolidated interest expense, journal entries recorded on the bond
issue by the parent, and the elimination entries needed to remove the effects of
the intercorporate bond ownership are required.
E8-4
LO 8-3,
LO 8-4
15 min.
E
Evaluation of Intercorporate Bond Holdings (Effective Interest Method)
A loss on bond retirement is reported in the consolidated income statement when
the parent purchases subsidiary bonds from a nonaffiliate at par value. Students
must determine whether the bonds were issued at a premium or discount, whether
annual interest payments by the subsidiary are more or less than the amount
reported as interest expense, and whether consolidated net income in the
following period will be increased or decreased when the intercorporate bond
holding is eliminated.
E8-5
LO 8-2,
LO 8-3,
LO 8-4
15 min.
M
Multiple-Choice Questions (Effective Interest Method)
[AICPA adapted] Six multiple-choice questions cover a constructive retirement
of parent company bonds. The effect of the retirement on consolidated retained
earnings and noncontrolling interest, interest income and interest expense
recorded by the companies, the amount of constructive loss on bond retirement,
and consolidated net income for the period are considered.
Chapter 08 - INTERCOMPANY INDEBTEDNESS
8-8
E8-5A
LO 8-2,
LO 8-3,
LO 8-4
15 min.
M
Multiple-Choice Questions (Straight-Line Method)
[AICPA adapted] Four multiple-choice questions cover a constructive retirement
of parent company bonds. The effect of the retirement on consolidated retained
earnings and noncontrolling interest, interest income and interest expense
recorded by the companies, the amount of constructive loss on bond retirement,
and consolidated net income for the period are considered.
E8-6
LO 8-2
15 min.
M
Multiple-Choice Questions (Effective Interest Method)
Three multiple-choice questions cover a constructive retirement of subsidiary
bonds. Interest expense recorded by the companies, the amount of the gain on
bond retirement, and income assigned to noncontrolling interest are computed.
E8-6A
LO 8-2
15 min.
M
Multiple-Choice Questions (Straight-Line Method)
Three multiple-choice questions cover a constructive retirement of subsidiary
bonds. Interest expense recorded by the companies, the amount of the gain on
bond retirement, and income assigned to noncontrolling interest are computed.
E8-7
LO 8-2
15 min.
M
Constructive Retirement at End of Year (Effective Interest Method)
Elimination entries in the period of a constructive bond retirement and the year
following are required. A gain results when the parent purchases subsidiary
bonds at the end of the first period.
E8-7A
LO 8-2
15 min.
M
Constructive Retirement at End of Year (Straight-Line Method)
Elimination entries in the period of a constructive bond retirement and the year
following are required. A gain results when the parent purchases subsidiary
bonds at the end of the first period.
E8-8
LO 8-2
15 min.
M
Constructive Retirement at Beginning of Year (Effective Interest Method)
Elimination entries in the period of a constructive bond retirement and the year
following are required. A gain results when a parent purchases subsidiary bonds
at the start of the first period.
E8-8A
LO 8-2
15 min.
M
Constructive Retirement at Beginning of Year (Straight-Line Method)
Elimination entries in the period of a constructive bond retirement and the year
following are required. A gain results when a parent purchases subsidiary bonds
at the start of the first period.
E8-9
LO 8-3
15 min.
M
Retirement of Bonds Sold at a Discount (Effective Interest Method)
Parent company bonds issued at a discount are purchased by a subsidiary from a
nonaffiliate seven years after the date of issue. A constructive loss is recognized.
The elimination entry at the end of the year in which the subsidiary purchases the
bonds is required.
