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CHAPTER 5
UNDERSTANDING THE ISSUES
1. The first approach that could be used to
reduce the overall consolidated interest
cost but maintain the subsidiary as the deb-
tor would have the parent advancing
the debt is retired. Therefore, interest ex-
pense would be eliminated during the con-
solidation process.
2. At the 6% annual interest rate, a loss on
retirement of bonds will occur in the current
year since the parent paid a premium to re-
tire the subsidiary’s bonds. In the current
and future years, consolidated net income
will be increased by the difference between
interest expense and interest revenue. This
amount represents the amortization of the
3. Since Company S was the original issuer of
the bonds, it will absorb the loss that results
in the current year from the parent retiring
the bonds at a premium. The noncontrolling
4. In the current year, consolidated net in-
come will include a gain on retirement of
bonds of $4,000 ($100,000 – $96,000). In
the current and each of the next four years,
5. It is true that intercompany operating leas-
es eliminated during the consolidation
process will not have an effect on consoli-
dated income. However, the excessive rent
expense amounts will still appear on the
subsidiary’s separately stated income
statement and will reduce the NCI share of
consolidated income. The high lease rates
will shift income from the NCI to the control-
ling interest.
6. Either type of lease can shift income to the
it is deferred and amortized over the life of
the asset or life of the lease. The controlling
interest has the opportunity to increase its
profit by leasing the asset to the subsidiary.
Ch. 5—Exercises 5–2
EXERCISES
EXERCISE 5-1
It is desirable to refinance for two reasons. First, interest rates are down, and it would be wise to
lock in at the lower rate. Second, the parent firm can borrow funds at a lower interest rate. The
simplest way to accomplish the refinancing is to have the parent incur the new debt and loan the
proceeds to the subsidiary; the subsidiary would use the funds to retire its debt with a gain on
retirement being recognized that would flow to the consolidated statements. The parent would
not only enjoy a lower interest rate, but it could also structure the loan terms, including the ma-
EXERCISE 5-2
(a) (1) The consolidated income statement for 2017 will include a gain on retirement of the
(2) The subsidiary income distribution schedule will get the benefit of the retirement gain of
$25,000 in the year the bonds are purchased, but subsidiary income will be reduced
each year for the amortization of the purchase discount recorded by the parent
(2) The income distribution of the subsidiary is reduced by $3,125 for the amortization of
5–3 Ch. 5—Exercises
EXERCISE 5-3
(1) Eliminations and Adjustments at December 31, 2015:
Interest Revenue ...................................................................... 7,750
Bonds Payable ......................................................................... 100,000
Loss on Retirement................................................................... 3,900c
Interest Expense .................................................................. 8,400
Investment in Bonds ............................................................. 101,250a
Discount on Bonds Payable ................................................. 2,000b
(2) Eliminations and Adjustments at December 31, 2016:
Interest Revenue ...................................................................... 7,750
Bonds Payable ......................................................................... 100,000
Retained Earnings—Dove (80% × $3,250*) ............................. 2,600
Retained Earnings—Cardinal (20% × $3,250*) ........................ 650
EXERCISE 5-4
Gain on retirement (January 2, 2016):
Balance on issuer’s books ......................................................... $48,734
Schedule of interest adjustments:
Intercompany Interest, Recorded Interest, Interest Expense
Year Effective Interest Effective Interest Adjustment to Issuer
Ending on Purchase (10%) on Issuance (9%) Income Distribution Schedule
12/31/16 $4,751 $4,386 $ 365
EXERCISE 5-5
(1) Eliminations and Adjustments at December 31, 2017:
Interest Revenue [(7% × $60,000) + ($6,400 ÷ 8)] ......................... 5,000
Bonds Payable (60% × $100,000) .................................................. 60,000
Premium on Bonds Payable (60% × $700) .................................... 420
Interest Expense [($4,200 – (60% × $100)] ............................... 4,140
Investment in Bonds [balance at year-end $53,600 + ($6,400/8)] 54,400
Gain on Retirement* ................................................................... 6,880
Exercise 5-5, Concluded
(2) Eliminations and Adjustments at December 31, 2018:
Interest Revenue ............................................................................ 5,000
Bonds Payable ............................................................................... 60,000
Premium on Bonds Payable (60% × $600) .................................... 360
Interest Expense ........................................................................ 4,140
EXERCISE 5-6
Partial Schedule of Bond Premium Amortization
10-Year, 6% Bonds Sold to Yield 8% (Linco)
Carrying
Interest Premium Amount
Date Cash Paid Expense Amortized of Bonds
January 1, 2015 ........ ....... ........ $86,580
January 1, 2016 $6,000 $6,926 $ 926 87,506
Partial Schedule of Bond Discount Amortization
7-Year (remaining), 6% Bonds Sold to Yield 9% (Sharp)
Carrying
Cash Interest Discount Value
Date Received Revenue Amortized of Bonds
Exercise 5-6, Concluded
(1) Eliminations and Adjustments at December 31, 2018:
Interest Revenue ...................................................................... 7,641
Bonds Payable ......................................................................... 100,000
Discount Bonds Payable ...................................................... 9,247
Gain on Retirement ($89,586 – $84,901) ............................. 4,685
(2)
Subsidiary Linco Industries Income Distribution
Interest adjustment Internally generated net
($7,641 – $7,167) ................... $474 income ................................. $500,000
Retirement gain on bonds ......... 4,685
5–7 Ch. 5—Exercises
EXERCISE 5-7
(1) 2015 entries for Grande Machinery Company:
Machine .......................................................................................... 60,000
Cash ........................................................................................... 60,000
(2) 2015 entry for Sunshine Engineering Company:
(3) 2015 consolidation worksheet eliminations and adjustments:
Machine .......................................................................................... 60,000
Accumulated Depreciation—Asset Under Operating Lease ........... 12,000
EXERCISE 5-8
(1)
Lease Payment Amortization Schedule
Interest at 12% on Reduction Principal
Date Payment Previous Balance of Principal Balance
January 1, 2015 $40,822
January 1, 2015 $12,000 $12,000 28,822
January 1, 2016 12,000 $3,459 8,541 20,281
Exercise 5-8, Concluded
(2) Eliminations and Adjustments at December 31, 2015:
Interest Revenue (see amortization schedule) ............................... 3,459
Interest Expense ........................................................................ 3,459
To eliminate intercompany interest revenue and expense.
Obligations Under Capital Lease ($40,822 – $12,000 first payment) 28,822
Interest Payable .............................................................................. 3,459
(3) Eliminations and Adjustments at December 31, 2016:
Interest Revenue (see amortization schedule) ............................... 2,434
Interest Expense ........................................................................ 2,434
To eliminate intercompany interest revenue and expense.
Obligations Under Capital Lease .................................................... 20,281
5–9 Ch. 5—Exercises
EXERCISE 5-9
Eliminations and Adjustments at December 31, 2015:
Interest Income (see amortization schedule) ................................... 2,690
Interest Revenue ........................................................................ 2,690
To eliminate intercompany interest revenue and expense.
($35,000/8 yrs.) ............................................................................. 4,375
Assets Under Capital Lease ....................................................... 35,000
Accumulated Depreciation—Property, Plant, and Equipment .... 4,375
To reclassify asset under capital lease and related
accumulated depreciation as a productive asset owned
by the consolidated entity. Asset is depreciated over
8-year life.
Sales Profit on Leases ..................................................................... 10,000
Property, Plant, and Equipment ................................................. 10,000
To eliminate unrealized profit on intercompany “sale” and
to reduce asset to its cost to the consolidated entity.
Ch. 5—Problems 5–10
PROBLEMS
PROBLEM 5-1
(1) Bonds Payable ............................................................................... 50,000
Interest Income ($3,500 + $250 amortization) ................................ 3,750
(2) Jones Corporation and Subsidiary Dancer Corporation
Consolidated Income Statement
For Year Ended December 31, 2016
Sales ..................................................................................................... $3,040,000
Cost of goods sold ................................................................................ 1,405,000
5–11 Ch. 5—Problems
PROBLEM 5-2
Parker Company and Subsidiary Stride Company
Worksheet for Consolidated Financial Statements
For Year Ended December 31, 2016
Eliminations Consolidated Controlling Consolidated
Trial Balance
and Adjustments Income Retained Balance
Parker Stride Dr. Cr. Statement NCI Earnings Sheet
Interest Receivable ................................ 4,000 .......... .......... (B2) 4,000 ......... .......... .......... ..........
Other Current Assets ............................. 246,400 315,200 .......... .......... ......... .......... .......... 561,600
Accumulated Depreciation ..................... (120,000) (60,000) .......... .......... ......... .......... .......... (180,000)
Goodwill ................................................. .......... .......... (D) 40,000 .......... ......... .......... .......... 40,000
Interest Payable ..................................... .......... (4,000) (B2) 4,000 .......... ......... .......... .......... ..........
Other Current Liabilities ......................... (98,000) (56,000) .......... .......... ......... .......... .......... (154,000)
Bonds Payable (8%) .............................. .......... (100,000) (B1) 100,000 .......... ......... .......... .......... ..........
.......... .......... (B1) 360 (NCI) 4,000 ......... (29,640) .......... ..........
Net Sales ............................................... (640,000) (350,000) .......... .......... (990,000) .......... .......... ..........
Cost of Goods Sold ................................ 360,000 200,000 .......... .......... 560,000 .......... .......... ..........
Operating Expenses ............................... 168,400 71,400 .......... .......... 239,800 .......... .......... ..........
Interest Expense .................................... .......... 8,600 .......... (B1) 8,600 ......... .......... .......... ..........
Problem 5-2, Continued
Eliminations and Adjustments:
(CV) Convert to simple equity method as of January 1, 2016.
(B1) Eliminate intercompany interest revenue and expense. Eliminate the balance in
the investment in bonds against bonds payable and the discount on bonds paya-
ble. The loss on retirement at the start of the year is calculated as follows:
Loss remaining at year-end:
Investment in bonds at
December 31, 2016 .......................... $98,400
Bonds payable ........................................ $100,000
5–13 Ch. 5—Problems
Problem 5-2, Concluded
Determination and Distribution of Excess Schedule
Company Parent NCI
Implied Price Value
Fair Value (90%) (10%)
Fair value of subsidiary ..................... $390,000 $351,000 $ 39,000
Less book value of interest acquired:
Adjustment of identifiable accounts:
Worksheet Amortization
Adjustment Key Life per Year
Goodwill ............................................ $ 40,000 debit D
Subsidiary Stride Company Income Distribution
Internally generated net
income ................................... $70,000
Interest adjustment ..................... 400
PROBLEM 5-3
Determination and Distribution of Excess Schedule
Company Parent NCI
Implied Price Value
Fair Value (80%) (20%)
Fair value of subsidiary ..................... $2,125,000 $1,700,000 $ 425,000
Less book value of interest acquired:
Total equity.................................. 1,875,000 $1,875,000 $1,875,000
Problem 5-3, Continued
General Appliances and Subsidiary Appliance Outlets
Worksheet for Consolidated Financial Statements
For Year Ended December 31, 2016
Trial Balance
Eliminations Consolidated Controlling Consolidated
General Appliance and Adjustments
Income Retained Balance
Appliances Outlets Dr. Cr. Statement NCI Earnings Sheet
Cash ................................................................ 404,486 72,625 ........... ........... ........... ........... ........... 477,111
Property, Plant, and Equipment ...................... 9,000,000 2,950,000 ........... (F1) 27,500 ........... ........... ........... 11,922,500
Accumulated Depreciation .............................. (1,695,000) (940,000) (F2) 1,375 ........... ........... ........... ........... (2,633,625)
Goodwill .......................................................... ........... ............ (D) 250,000 ........... ........... ........... ........... 250,000
Accounts Payable ........................................... (670,000) (80,000) ........... ........... ........... ........... ........... (750,000)
Paid-In Capital in Excess of Par—
Appliance Outlets ........................................ ........... (625,000) (EL) 500,000 ........... ........... (125,000) ........... ...........
Retained Earnings—Appliance Outlets ........... ........... (770,000) (EL) 616,000 (NCI) 50,000 ........... ........... ........... ...........
........... ............ (B) 2,500 ........... ........... (201,500) ........... ...........
0
0 2,822,125 2,822,125 ........... ........... ........... ...........
Consolidated Net Income ..................................................................................................................................................... (1,560,000) ........... ........... ...........
To NCI (see distribution schedule) ................................................................................................................................... 40,600 (40,600) ........... ...........
To Controlling Interest (see distribution schedule)........................................................................................................... 1,519,400 ............ (1,519,400) ...........
Problem 5-3, Concluded
Eliminations and Adjustments:
(CV) Convert investment to equity, 80% × ($770,000 – $450,000) = $256,000.
(CY2) Eliminate dividend income.
(EL) Eliminate 80% of the subsidiary equity balances.
(D)/(NCI) Distribute the excess and the NCI adjustment according to the determination and dis-
tribution of excess schedule.
(F1) Eliminate the intercompany gain on sale of building.
(F2) Reduce depreciation expense on the building for one-half year, ($27,500 ÷ 10) × 1/2.
(LN1) Eliminate the intercompany mortgage.
(LN2) Eliminate the intercompany interest payable and receivable on mortgage. Eliminate
the intercompany interest revenue and expense on mortgage, 1/2 × 11% × $175,000
= $9,625.
Subsidiary Appliance Outlets Income Distribution
Internally generated net
income ................................... $200,000
Interest adjustment
($29,000 – $26,000) .............. 3,000
PROBLEM 5-4
Determination and Distribution of Excess Schedule
Company Parent NCI
Implied Price Value
Fair Value (80%) (20%)
Fair value of subsidiary ..................... $500,000 $400,000 $100,000
Less book value of interest acquired:
Adjustment of identifiable accounts:
Worksheet Amortization
Adjustment Key Life per Year
Buildings ........................................... $ 80,000 debit D1 20 $ 4,000
Account Adjustments Annual Current Prior
to Be Amortized Life Amount Year Years Total Key
Buildings ............................... 20 $ 4,000 $ 4,000 $ 4,000 $ 8,000 (A1)
Intercompany Inventory Profit Deferral
Parent Parent Parent Sub Sub Sub
Amount Percent Profit Amount Percent Profit
Problem 5-4, Continued
Subsidiary Stark Company Income Distribution
Loss on bond retirement ............... $ 6,739 Internally generated net
Buildings depreciation ................... 4,000 income ..................................... $24,672
Equipment depreciation ................ 10,000 Interest adjustment—bonds .......... 1,123
Parent Pontiac Company Income Distribution
Ending inventory profit .................. $6,000 Internally generated net
income ..................................... $42,845
Proof for Bond Elimination
Loss remaining at year-end:
Investment in bonds at December 31, 2015 .............................. $103,975
Carrying value at December 31, 2015 ....................................... 98,359 $5,616
5–19 Ch. 5—Problems
Problem 5-4, Continued
Pontiac Company and Subsidiary Stark Company
Worksheet for Consolidated Financial Statements
For Year Ended December 31, 2015
Eliminations Consolidated Controlling Consolidated
Trial Balance
and Adjustments Income Retained Balance
Pontiac Stark Dr. Cr. Statement NCI Earnings Sheet
Cash ................................................................ 17,870 32,031 ........... ........... ........... ........... ........... 49,901
........... ............ ........... (EL) 196,000 ........... ........... ........... ...........
........... ............ ........... (D) 228,000 ........... ........... ........... ...........
Investment in Stark Bonds .............................. 103,975 ............ ........... (B) 103,975 ........... ........... ........... ...........
Buildings ......................................................... 500,000 250,000 (D1) 80,000 ........... ........... ........... ........... 830,000
Accumulated Depreciation .............................. (300,000) (70,000) ........... (A1) 8,000 ........... ........... ........... (378,000)
Equipment ....................................................... 200,000 120,000 (D2) 50,000 ........... ........... ........... ........... 370,000
Retained Earnings—Pontiac ........................... (400,000) ............ (A1–A2) 11,200 ........... ........... ........... ........... ...........
........... ............ (BI) 4,500 ........... ........... ........... (384,300) ...........
Loss (Gain) on Bond Retirement ........... ............ (B) 6,739 ........... 6,739 ........... ........... ...........
Sales ............................................................... (600,000) (220,000) (IS) 50,000 ........... (770,000) ........... ........... ...........
Totals .......................................................... 0 0 721,182 721,182 ........... ........... ........... ...........
Consolidated Net Income ..................................................................................................................................................... (46,401) ........... ........... ...........
To NCI (see distribution schedule) ................................................................................................................................... 1,011 (1,011) ........... ...........
To Controlling Interest (see distribution schedule)........................................................................................................... 45,390 ........... (45,390) ...........
Total NCI ....................................................................................................................................................................................................... (102,211) ........... (102,211)
Problem 5-4, Concluded
Eliminations and Adjustments:
(CY1) Current-year subsidiary income.
(CY2) Current-year dividend.
(EL) Eliminate controlling interest in subsidiary equity.
(D)/(NCI) Distribute excess and NCI adjustment.
PROBLEM 5-5
Determination and Distribution of Excess Schedule
Company Parent NCI
Implied Price Value
Fair Value (80%) (20%)
Fair value of subsidiary ..................... $500,000 $400,000 $100,000
Less book value of interest acquired:
Adjustment of identifiable accounts:
Worksheet Amortization
Adjustment Key Life per Year
Buildings ........................................... $ 80,000 debit D1 20 $ 4,000
Equipment ......................................... 50,000 debit D2 5 10,000
Account Adjustments Annual Current Prior
to Be Amortized Life Amount Year Years Total Key
Buildings ............................... 20 $ 4,000 $ 4,000 $ 8,000 $12,000 (A1)
