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Chapter 9
Intercompany Bond Holdings and Miscellaneous Topics—
Consolidated Financial Statements
Multiple Choice
1. Which of the following methods of allocating the gain or loss on an intercompany bond retirement
is the soundest conceptually?
a. The gain (loss) is allocated to the company that issued the bonds.
b. The gain (loss) is allocated to the company that purchased the bonds.
c. The gain (loss) is allocated to the parent company.
d. The gain (loss) is allocated between the purchasing and issuing companies.
2. The constructive gain or loss on an intercompany bond retirement is recognized in the consolidated
income statement _________ the recognition of the gain or loss on the individual companies' books.
a. after
b. before
c. at the same time as
d. before or after
3. The constructive gain or loss to the purchasing company is the difference between the
a. book value of the bonds and their par value.
b. book value of the bonds and their purchase price.
c. cost of the bonds and their par value.
d. cost of the bonds and their purchase price.
4. The workpaper eliminating entry for a stock dividend declared by the subsidiary includes a
a. debit to Stock Dividends Declared - S Co.
b. debit to Noncontrolling interest.
c. credit to Stock Dividends Declared - S Co.
d. debit to Dividend Income.
5. The parent company records the receipt of shares from a subsidiary's stock dividend as
a. dividend income.
b. a reduction of the investment account.
c. an increase in the investment account.
d. none of these.
6. If the book value of preferred stock is greater than its implied value, the difference is accounted for
as an increase in
a. consolidated retained earnings.
b. consolidated net income.
c. other contributed capital.
d. investment in subsidiary preferred stock.
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9-2 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
7. If a subsidiary has both common and preferred stock outstanding, a parent must own a controlling
interest in
a. both the subsidiary's common and preferred stock to justify consolidation.
b. the subsidiary's common stock to justify consolidation.
c. the subsidiary's common stock and at least 20% of the subsidiary's preferred stock to justify
consolidation.
d. the subsidiary's common stock and more than 50% of the subsidiary's preferred stock to justify
consolidation.
Use the following information to answer Questions 8, 9, and 10.
Pollard Corporation owns 90% of the outstanding common stock of Steele Company. On January 1, 2008,
Steele Company issued $500,000, 12%, ten-year bonds.
On January 1, 2010, Pollard Corporation paid $412,000 for Steele Company bonds with a par value of
$400,000 and a carrying value of $393,600. Both companies use the straight-line method to amortize bond
premiums and discounts. Pollard Corporation accounts for the investment using the cost method of
accounting.
8. The total gain or loss on the constructive retirement of the debt to be reported in the 2010
consolidated income statement is
a. $12,000 loss.
b. $12,000 gain.
c. $18,400 loss.
d. $18,400 gain.
e. $6,400 loss.
9. Pollard Corporation would report a balance in the Investment in Steele Company Bonds account on
December 31, 2010, of
a. $412,000.
b. $393,600.
c. $410,500.
d. $400,000.
e. none of these.
10. Compute the noncontrolling interest in the 2010 consolidated income assuming that Pollard
Corporation reported a net income of $300,000 (includes dividend income from Steele Company).
Steele Company reported net income of $180,000 and declared and paid cash dividends of
$100,000.
a. $18,000
b. $17,440
c. $17,360
d. $18,560
e. none of these.
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Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-3

Topics—Consolidated Financial Statements
11. Sousa Corporation is an 80% owned subsidiary of Phillips Company. Sousa purchased bonds of
Phillips Company for $103,000. Phillips Company reported the bond liability on the date of
purchase at $100,000 less unamortized discount of $5,000. Assuming that the constructive gain or
loss is material, the consolidated income statement should report an
a. ordinary loss of $8,000.
b. ordinary gain of $8,000.
c. extraordinary loss of $8,000 adjusted for income tax effects.
d. extraordinary gain of $8,000 adjusted for income tax effects.
12. From a consolidated entity point of view, the constructive gain or loss on the open market purchase
of a parent company's bonds by a subsidiary company is
a. considered realized at the date of the open market purchase.
b. realized in future periods through discount and premium amortization on the books of the
individual companies.
c. realized only to the extent of the parent company's interest in the subsidiary.
d. deferred and recognized in the consolidated income statement when the bonds are retired.
13. Stage Company is a 90% owned subsidiary of Princeton Company. On January 1, 2010, Stage
Company purchased for $680,000 bonds of Princeton Company that had a carrying value of
$725,000 (par value $700,000). The bonds mature on December 31, 2014. Both companies use the
straight-line method of amortization and have a December 31 year-end. The increase in 2010
consolidated income (i.e., income before subtracting noncontrolling interest) is
a. $45,000.
b. $44,000.
c. $54,000.
d. $36,000.
e. $46,000.
Use the following information to answer Questions 14 and 15.
Parkes Company acquired 90% of Stanton Company's common stock for $780,000 and 40% of its preferred
stock for $180,000. On January 1, 2010, the date of acquisition, the companies reported the following
account balances:
Parkes Company Stanton Company
Preferred stock, $100 par value $ 500,000 $ 360,000
Common stock, $10 par value 1,200,000 600,000
Other contributed capital 190,000 140,000
Retained earnings 210,000 110,000
Total stockholders' equity $2,100,000 $1,200,000
The preferred stock is 10%, cumulative, nonparticipating, and has a liquidation value equal to 104% of par
value. Dividends were not paid during 2009. During 2010, Stanton Company reported net income of
$120,000 and declared and paid cash dividends in the amount of $70,000.
14. The difference between the implied value of the preferred stock and its book value is
a. $40,000.
b. $39,600.
c. $34,400.
d. $26,000.
e. 15,840.
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15. Noncontrolling interest in the 2010 reported net income of Stanton Company is
a. $29,500.
b. $12,000.
c. $34,000.
d. $21,000.
e. $30,000.
16. Constructive gains and losses from intercompany bond transactions are:
a. treated as extraordinary items on the consolidated income statement
b. included as other revenues and expenses on the consolidated income statement.
c. excluded from the consolidated income statement until realized.
d. eliminated from the consolidated income statement.
17. Pittsford Company purchased bonds from Shay Company on the open market at a premium. Shay
Company is a 100% owned subsidiary of Pittsford Company. Pittsford intends to hold the bonds
until maturity. In a consolidated balance sheet, the difference between the bond carrying values in
the two companies would be:
a. included as a decrease to retained earnings.
b. included as an increase to retained earnings.
c. reported as a deferred debit to be amortized over the remaining life of the bonds.
d. reported as a deferred credit to be amortized over the remaining life of the bonds.
18. On January 1, 2010, Plueger Company has $700,000 of 6%, 10-year bonds with an unamortized
discount of $28,000. Steiner Company, an 80% subsidiary, purchased $350,000 of these bonds at
102. The gain or (loss) on the retirement of Plueger’s bonds is:
a. $14,000 loss.
b. $14,000 gain.
c. $21,000 loss.
d. $21,000 gain.
19. On a consolidated balance sheet, subsidiary preferred stock will be shown:

a. as part of consolidated stockholder’s equity.
b. combined with any preferred stock of the parent.
c. as part of the noncontrolling interest amount to the extent such balance represents preferred
stock held by the parent.
d. as part of the noncontrolling interest amount to the extent such balance represents preferred
stock held by outside interests.
20. Pettijohn Company has total stockholders’ equity of $2,000,000 consisting of $400,000 of $1 par
value common stock, $400,000 of other contributed capital, and $1,200,000 of retained earnings.
Pettijohn owns 80% of Spencer Company purchased at book value. Spencer has $800,000 of 5%
cumulative preferred stock outstanding. Pettijohn acquired 40% of the preferred stock of Spencer
for $200,000. After this transaction the balances in Pettijohn’s retained earnings and other
contributed capital accounts are:
a. $1,200,000 and $400,000.
b. $1,200,000 and $520,000.
c. $1,320,000 and $400,000.
d. $1,080,000 and $400,000.
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Use the following information to answer Questions 21-23.
Parkinson Company owns 90% of the outstanding common stock of Staggs Company. On January 1, 2008,
Staggs Company issued $500,000, 12%, ten-year bonds.
On January 1, 2010, Parkinson Company paid $315,000 for Staggs Company bonds with a par value of
$300,000 and a carrying value of $297,600. Both companies use the straight-line method to amortize bond
premiums and discounts. Parkinson Company accounts for the investment using the cost method of
accounting.
21. The total gain or loss on the constructive retirement of the debt to be reported in the 2010
consolidated income statement is
a. $15,000 loss.
b. $15,000 gain.
c. $17,400 loss.
d. $17,400 gain.
e. $ 2,400 loss.
22. Parkinson Company would report a balance in the Investment in Staggs Company Bonds account on
December 31, 2010, of
a. $315,000.
b. $297,600.
c. $313,125.
d. $300,000
e. None of these.
23. Compute the noncontrolling interest in the 2010 consolidated income assuming that Parkinson
Company reported a net income of $240,000 (includes dividend income from Staggs Company).
Staggs Company reported net income of $150,000 and declared and paid cash dividends of $90,000.
a. $15,000.
b. $14,790.
c. $14,760.
d. $15,210.
e. None of these.
Use the following information to answer Questions 24 and 25.
Penner Company acquired 90% of Skulley Company's common stock for $1,300,000 and 40% of its
preferred stock for $300,000. On January 1, 2010, the date of acquisition, the companies reported the
following account balances:
Penner Company Skulley Company
Preferred stock, $100 par value $ 800,000 $ 600,000
Common stock, $10 par value 2,000,000 1,000,000
Other contributed capital 320,000 230,000
Retained earnings 350,000 180,000
Total stockholders' equity $3,470,000 $2,010,000
The preferred stock is 10%, cumulative, nonparticipating, and has a liquidation value equal to 102% of par
value. Dividends were not paid during 2009. During 2010, Skulley Company reported net income of
$200,000 and declared and paid cash dividends in the amount of $120,000.
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24. The difference between the implied value of the preferred stock and its book value is
a. $60,000.
b. $78,000
c. $55,200.
d. $36,000.
e. none of these.
25. Noncontrolling interest in the 2010 reported net income of Skulley Company is
a. $50,000.
b. $20,000.
c. $80,000.
d. $56,000.
e. none of these.
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Problems
9-1 On January 1, 2010, Page Company acquired an 80% interest in Sterling Company for $1,070,000.
Sterling reported common stock of $1,000,000 and retained earnings of $400,000 on this date. Any
difference between implied value and the book value interest acquired is attributable to land.
Other information available for Sterling Company is shown below:
Net Income Cash Dividends

2010 $130,000 $160,000
Page Company uses the cost method to account for its investment in Sterling Company.
Required:
A. Prepare the general journal entries for 2010 to record the receipt of the cash dividends.
B. Prepare in general journal form the workpaper entries necessary in the consolidated statements
workpaper for the year end December 31, 2010.
9-2 Steinberger Company issued 10-year, 8% bonds with a par value of $1,000,000 on January 2, 2009,
for $1,040,000. Interest is payable semiannually on June 30 and December 31. On December 31,
2010, Potts Company purchased $700,000 of Steinberger par value bonds for $670,000. Steinberger
is an 80% owned subsidiary of Potts. Both companies use the straight-line method to amortize bond
discounts and premiums. Steinberger declared cash dividends of $100,000 in 2010 and reported net
income of $220,000 for the year.
Potts reported net income of $350,000 for 2010 and paid dividends of $160,000 during 2010.
Required:
A. Compute the total gain or loss on the constructive retirement of the debt.
B. Allocate the total gain or loss between Steinberger Company and Potts Company.
C. Compute the controlling interest in consolidated net income for 2010.
D. Prepare in general journal form the intercompany bond elimination entries for the consolidated
statements workpaper prepared on December 31, 2010.
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9-3 Prentice Company, who owns an 80% interest in Steffey Company, purchased $2,000,000 of
Steffey’s 8% bonds at 106 on December 31, 2010. The bonds pay interest on January 1 and July 1
and mature on December 31, 2013. Prentice Company uses the cost method to account for its
investment in Steffey. Selected balances from December 31, 2010 accounts of the two companies
are as follows:
Prentice _____Steffey____
Investment in Steffey 8% bonds $2,120,000 $ ----

Bond discount ---- 300,000
Interest payable ---- 800,000
8% bonds payable ---- 20,000,000
Interest expense ---- 1,700,000
Gain or loss on constructive
retirement of bonds ---- ----
Required:
Prepare in general journal form the workpaper eliminations related to the bonds to consolidated the
financial statements of Prentice and its subsidiary for the year ended December 31, 2010 and 2011.
9-4 On January 1, 2010, Powell Company purchased 80% of the common stock of Southern Company
for $400,000. Southern Company reported common stock of $200,000 ($10 par value), other
contributed capital of $60,000, and retained earnings of $120,000 on this date. The difference
between implied value and the book value interest acquired is attributable to the under-valuation of
land held by Southern Company. Southern Company reported net income for 2010 of $100,000.
During 2010 Southern Company declared and paid a 20% stock dividend and a $24,000 cash
dividend. Southern Company stock had a market value of $30 per share on the date the stock
dividend was declared. Powell Company uses the cost method to account for its investment in
Southern Company.
Required:
A. Prepare the journal entries required in the books of Powell Company to account for the
investment in Southern Company.
B. Prepare in general journal form the workpaper entries necessary in the consolidated statements
workpaper for the year ended December 31, 2010.
C. Prepare the workpaper entry to establish reciprocity in the 2011 consolidated statements
workpaper.
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9-5 On January 1, 2010, Proctor Company acquired 90% of the common stock of Styles Company for
$720,000 and 20% of the preferred stock for $70,000. On this date, Styles Company reported the
following account balances:
Common stock ($10 par value) $600,000

Preferred stock ($100 par value, 8%,
cumulative, nonparticipating, liquidation
value equal to par value) 300,000
Other contributed capital - premium on
common stock 120,000
Retained earnings 80,000
Styles Company did not declare a cash dividend during 2009. Proctor Company uses the cost
method.
Required:
A. During 2010 Styles Company reported net income of $360,000 and declared cash dividends of
$160,000. Calculate the 2010 noncontrolling interest in net income and the amount of the cash
dividends Proctor Company should have received during the year from each of the stock
investments.
B. Prepare, in general journal form, the workpaper entries that would be made in the preparation of
the December 31, 2010, consolidated statements workpaper. The difference between the implied
value of the common stock and the book value interest acquired is attributable to an
undervaluation in the land of Styles Company. Any difference between the implied value of the
preferred stock and its book value is allocated to other contributed capital.
9-6 On January 1, 2010, Pippin Company acquired 80% of Skylark Company's common stock for
$210,000 and 70% of Skylark's preferred stock for $80,000. Skylark Company reported the
following stockholders' equity on this date:
Preferred stock, 8%, Par value $20 $ 100,000

Common stock, Par value $50 200,000
Premium on common stock 30,000
Retained earnings 80,000
Total $410,000
The preferred stock is cumulative, nonparticipating, and callable at 104% of par value plus
dividends in arrears. On January 1, 2010, dividends were in arrears for one year. Any difference
between the implied value of the preferred stock and its book value interest is to be allocated to
other contributed capital.
Changes in Skylark Company's retained earnings during 2010 and 2011 were as follows:
January 1, 2010 Balance $ 80,000

2010 net income 20,000
2011 net income 16,000
2011 cash dividends (30,000)
December 31, 2011 Balance $ 86,000
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Required:
A. Compute the difference between the implied value and book value interest acquired for the
investment in preferred stock.
B. Compute the balance in the Investment in Preferred Stock account on December 31, 2011.
C. Compute the amount of Skylark Company's net income that will be included in the controlling
interest in consolidated net income for 2011.
9-7 On January 2, 2010, Preston, Inc. acquired an 80% interest in Simpson Corporation for $2,250,000.
Simpson reported total stockholders’ equity of $2,500,000 on this date. An examination of
Simpson’s books revealed that book value was equal to fair value for all assets and liabilities except
for inventory, which was undervalued by $150,000. All of the undervalued inventory was sold
during 2010.
Preston also purchased 30% of the $1,250,000 par value outstanding bonds of Simpson Corporation
for $350,000 on January 2, 2010. The bonds mature in 10 years, carry an 11% annual interest rate
payable on June 30 and December 31, and had a carrying value of $1,270,000 on the date of
purchase. Both companies use the straight-line method to amortize bond discounts and premiums.
Preston reported net income of $750,000 for 2010 and paid dividends of $325,000 during 2010.
Simpson Corporation reported net income of $800,000 for 2010 and paid dividends of $225,000
during the year.
Required:
Compute the following items at December 31, 2010.
1. Carrying value of the debt.
2. Interest revenue reported by Preston, Inc.
3. Interest expense reported by Simpson Corporation.
4. Balance in the Investment in Simpson Bonds account.
5. Controlling interest in consolidated net income for 2010 using the t-account approach.
6. Noncontrolling interest in consolidated income for 2010.
9-8 On January 2, 2010, Palmer Corporation purchased 80% of the outstanding common stock and 30%
of the outstanding cumulative, nonparticipating, preferred stock of Sears Company for $800,000 and
$140,000, respectively. At this date, Sears Company reported account balances of $800,000 in
common stock, $400,000 in preferred stock and $200,000 in retained earnings. No other contributed
capital accounts exist. The difference between implied and book value of the common stock is
attributable to under- or overvalued land. Dividends on the 12% cumulative preferred stock (par
$10) were not paid during 2009.
Palmer Sears
Corporation Company
1/2/2010 Retained Earnings $ 90,000 $200,000
2010 Reported Net Income 169,200 180,000
2010 Dividends Declared 50,000 100,000
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Required:
A. Prepare the journal entries made by Palmer Corporation in 2010 to account for the investments
assuming the partial equity method is used.
B. Compute the noncontrolling interest in Sears Company’s net income.
C. Prepare the 2010 workpaper entries related to the foregoing investments assuming the partial
equity method is used to account for the investment.
Short Answer Questions from Textbook
1. Define ―constructive retirement of debt.‖ How is the total constructive gain or loss computed?
2. The gain or loss on the constructive retirement of debt is recognized subsequently by the individual
companies. Explain.
3. Allocating the gain or loss on constructive bond retirement between the purchasing and issuing
companies is preferred conceptually. Describe how this allocation would be made.
4. Give the primary argument(s) in favor of assigning the total gain or loss on constructive bond
retirement to the company that issued the bonds.
5. Under the allocation method followed in this text, how is the noncontrolling interest in consolidated
income affected by intercompany bondholdings?
6. Investor Company purchased 70% of the$500,000 par value outstanding bonds of Investee
Company, a 70% owned subsidiary. The bonds cost $338,000 and had a carrying value of$360,000
on the date of purchase. a.What portion of the gain or loss resulting from the constructive bond
retirement should be allocated to Investor Company? b. What portion of the constructive gain or
loss should be allocated to Investee Company?
7. An outside party issued a note to Affiliate X, who then sold the note to Affiliate Y. Y discounted the
note at an unaffiliated bank, endorsing it with recourse. Which party is primarily liable and which
party is contingently liable for the note?
8. Cash dividends are viewed as a distribution of the most recent earnings. How are stock dividends
viewed?
9. Explain how the reciprocity calculation is modified in periods after the declaration of a stock
dividend for firms using the cost method.
10. What journal entry, if any, would the parent company make to record the receipt of a stock
dividend?
11. What effect does a stock dividend have on the consolidated statements work paper in the year of
declaration? In subsequent periods?
12. How does the existence of preferred stock affect the calculation of noncontrolling interest?
13. Explain how to account for the difference between implied and book value interest of an in-
vestment in preferred stock of a subsidiary.
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14. What effect would cumulative preferred stock have on the allocation of a net loss to the common
stockholders?
Business Ethics Question from the Textbook
The company that you work for is a subsidiary of a larger company. At the beginning of each year, the
subsidiary prepares a budget for the year that includes a forecast of revenues for the coming year. The
subsidiary sells a significant amount of inventory to the parent to be used in the manufacture of another
product. The subsidiary’s revenues for the current year are short of the budgeted amount. An error in the
books has misclassified an intercompany sale as an ordinary sale. The manager of the subsidiary asks you
not to fix the error until after the books are closed. What is your responsibility? What action, if any, should
you take? Why?
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ANSWER KEY
Multiple Choice
1. d 8. c 15. e 22. c
2. b 9. c 16. b 23. b
3. c 10. b 17. a 24. b
4. c 11. a 18. c 25. a
5. d 12. a 19. d
6. c 13. a 20. b
7. b 14. b 21. c
Problems
9-1 A. Cash (160,000 × 0.8) 128,000

Dividend Income (130,000 × 0.8) 104,000
Investment in Sterling Company 24,000
B. Dividend Income 104,000

Dividends Declared 104,000
Investment in Sterling Company 24,000

Common Stock–Sterling 1,000,000

Beginning R/E–Sterling 400,000
Difference Between Implied and Book Value 62,500
Investment in Sterling Company 1,070,000
Noncontrolling Interest in Equity 267,500

Land 62,500
9-2 A. Cost of bond investment $670,000

Par value $1,000,000
Unamortized prem. (40,000 × 16/20) 32,000
Carrying value of bonds 1,032,000
Percent of bonds purchased (700/1,000) 0.70 722,400
Total constructive gain $52,400
B. Potts Company Steinberger Company

---------------- ---------------
Cost of bond investment $670,000 Carrying value of
bonds purchased $722,400
Par value 700,000 Par value 700,000
Constructive gain $ 30,000 Constructive gain $ 22,400
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C. 2010
Reported net income – Potts $350,000
- Dividend income ($100,000 × 0.8) - 80,000
Net income from independent oper. – Potts 270,000
+ Constructive gain on bond retirement 30,000
Potts's contribution to consolidated income 300,000
Reported net income – Steinberger $220,000
+ Constructive gain on bond retirement 22,400
Steinberger’s contribution to consolidated income 242,400
× 0.8 193,920
Controlling interest in consolidated net income $493,920
D. December 31, 2010

Investment in Steinberger Co. Bonds 30,000
Constructive Gain on Bond Retirement 30,000
Premium on Bonds Payable ($32,000 × 0.70) 22,400

Constructive Gain on Bond Retirement 22,400
Bonds Payable 700,000

Investment in Steinberger Co. Bonds 700,000
9-3 2010 1. Loss on Constructive Retirement of Bonds 120,000

Investment in Steffey Company Bonds 120,000
2. Loss on Constructive Retirement of Bonds 30,000

Bond Discount 30,000
3. Bonds Payable 2,000,000

Investment in Steffey Company Bonds 2,000,000
2011 1. Beginning Retained Earnings-Prentice 120,000

Investment in Steffey Company Bonds 120,000
2. Beginning Retained Earnings-Prentice ($30,000 × 0.80) 24,000

Noncontrolling interest 6,000
Bond Discount 30,000
3. Investment in Steffey Company Bonds ($120,000/3) 40,000

Interest Revenue 40,000
4. Bond Discount [($300,000/3) × 0.10] 10,000

Interest Expense 10,000
5. Interest Revenue 160,000

Interest Expense 160,000
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6. Bonds Payable 2,000,000

Investment in Steffey Company Bonds 2,000,000
7. Interest Payable 80,000

Interest Receivable 80,000
9-4 A. Investment in Southern Company 400,000

Cash 400,000
Memorandum entry – Received stock dividend of 3,200 shares of Southern Company stock (16,000
× 0.20)
Cash 19,200
Dividend Income 19,200
B. Common Stock – Southern 32,000

Other Contributed Capital – Southern 64,000
Stock Dividends Declared – Southern 96,000
Dividend Income 19,200

Beginning Retained Earnings – Southern 120,000

Common Stock – Southern 200,000
Other Contributed Capital – Southern 60,000
Investment in Southern Company 400,000
Land 120,000
C. Investment in Southern Company 28,800

Beginning Retained Earnings – Powell Company 28,800
9-5 A. Noncontrolling interest in net income

Net income reported by Styles $360,000
Allocated to preferred stock ($300,000 × 0.08) 24,000 × 0.80 = 19,200
Residual to common stock 336,000 × 0.10 = 33,600
Noncontrolling interest in income $52,800
Cash dividends to Proctor Company

Preferred stock dividend ($24,000 × 2) $ 48,000 × 0.20 = $ 9,600
Residual to common stock 112,000 × 0.90 = 100,800
Total dividends received by Proctor Company $110,400
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B. Dividend Income 110,400

Dividends Declared – Preferred Stock 9,600
Dividends Declared – Common Stock 100,800
Beginning Retained Earnings - Styles Company 24,000

Preferred Stock - Styles Company 300,000
Investment in Styles Company Preferred Stock 70,000
Other Contributed Capital—Proctor Company 5,200

Beginning Retained Earnings – Styles Company 56,000

Common Stock – Styles Company 600,000
Other Contributed Capital – Styles Company 120,000
Investment in Styles Company Common Stock 720,000
Land 24,000
9-6 A. Preferred stock $100,000

Call premium ($100,000 × 4%) 4,000
Dividends in arrears ($100,000 × 0.08) 8,000
Book value interest of preferred stock 112,000
Implied value ($80,000/.7) 114,286
Difference between implied and book value $ 2,286
B. Cost of investment $80,000

Less: Liquidating dividend ($8,000 × 0.70) 5,600
Balance – 12/31/10 $74,400
C. Percentage Controlling interest in

Net Income Interest Consolidated Income
Preferred stock $ 8,000 70 $ 5,600
Common stock
($16,000 - $8,000) 8,000 80 6,400
Total $16,000 $12,000
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9-7 1. Carrying value of debt – 1/2/2010 $1,270,000

Less: Premium amortization – [($20,000/20) × 2 periods) 2,000
Carrying value of debt – 12/31/2010 $1,268,000
2. Stated interest (30% of $1,250,000 × 0.11) $41,250

Add: Discount amortization [($25,000/20) × 2 periods)] 2,500
Interest revenue $43,750
3. Stated interest ($1,250,000 × 0.11) $137,500

Less: Premium amortization [($20,000/20) × 2] 2,000
Interest expense $135,500
4. Cost of bond investment (1/2/2010) $350,000

Add: Discount amortization* 2,500
Investment account balance – 12/31/2010 $352,500
*$1,250,000 par × 30% less $350,000 paid divided by 10 years = $2,500.
5. Reported net income – Preston $750,000

Less: Dividend income ($225,000 × 0.80) 180,000
Independent net income 570,000
Add: Constructive gain on bond retirement 25,000
Less: Constructive gain recorded during year (2,500)
Contribution of Preston to consolidated income 592,500
Reported net income – Simpson $800,000
Less: Amortization of difference between
implied and book value:
Cost of goods sold (150,000)
Add: Constructive gain on bond retirement 650,000
[($1,270,000 - $1,250,000) × 0.30] = 6,000
Less: Constructive gain recorded during year (600)
Income after adjustment in constructive gain 655,400
× 0.80
Preston’s share of adjusted income 524,320
Controlling interest in consolidated net income $1,116,820
Implied value of investment ($2,250,000/0.80) $2,812,500

Book value of equity acquired 2,500,000
Difference between implied and book value 312,500
Allocated to inventory 150,000
Goodwill (Excess implied value over fair value) $ 162,500
6. Noncontrolling interest in consolidated income ($2,250,000/0.80) – $2,250,000 = $562,500
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9-8 A. Investment in Sears Company Preferred Stock 140,000

Investment in Sears Company Common Stock 800,000
Cash 940,000
Cash (preferred stock) 28,800

Equity in Subsidiary Income – Preferred Stock 14,400
Cash 3,200

Equity in Subsidiary Income {[($180,000 –
($400,000 × 0.12)] × (.80)} 105,600
Preferred Common
Stock Stock
Arrears $48,000
Current year 48,000 $4,000
Total 96,000 4,000
Percentage interest 0.30 0.80
$28,800 $3,200
B. Reported net income – 2010 $180,000

Allocation to preferred stock interest ($400,000 × 0.12) 48,000 × 0.70 = $33,600
Residual to common stock interest $132,000 × 0.20 = 26,400
Noncontrolling interest in 2010 net income $60,000
C. Investment in Sears Company Preferred Stock 14,400

Dividends Declared – Preferred Stock 28,800
Equity in Subsidiary Income 105,600

Dividends Declared – Common Stock 3,200
Beginning Retained Earnings – Sears Company 48,000

Preferred Stock 400,000
Other Contributed Capital (or Retained Earnings) 5,600
Investment in Sears Company Preferred Stock 140,000
Noncontrolling Interest in Equity* 313,600
*($400,000 + $48,000)] × 0.7 = $313,600
Beginning Retained Earnings – Sears Company 152,000

Common Stock 800,000
Difference between Implied and Book Value 48,000
Investment in Sung Company Common Stock 800,000
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Short Answer Questions from the Textbook Solutions
1. Constructive retirement refers to the purchase of an affiliate's outstanding bonds from outsiders. From
a consolidated entity viewpoint, the consolidated entity has retired its outstanding debt, and is thus
treated as an early extinguishment of debt. The difference between the carrying value of the bonds and
the purchase price to the purchasing affiliate is the constructive gain or loss on bond retirement.
2. The gain or loss is composed of two elements: (1) the discount or premium on the books of the issuer,
and (2) the discount or premium paid by the purchaser. Discounts and/or premiums on the books of the
two affiliates will be subsequently amortized to income. The cumulative effect on income of the
amortization of the discount or premium by the two affiliates is equal to the constructive gain or loss.
3. The allocation of a gain or loss would be made to each affiliate based on whether the affiliate paid or
issued the bonds for more or less than book value or par value. A discount (premium) to the issuer
would be allocated to the issuing company as a loss (gain), whereas a discount (premium) to the
purchasing affiliate would be a gain (loss). The sum of the two is the total constructive gain or loss.
4. Support for allocating the total gain or loss to the issuing company is based on the contention that the
purchasing affiliate is acting as an agent for the issuing company. Since both companies are under the
control of the management of the parent company, the bonds could be transferred to the issuing
company. Thus, the purchase is in substance a retirement by the issuing company.
5. The noncontrolling interest is affected by the portion of the constructive gain or loss allocated to the
subsidiary. Because the loss is recognized in the consolidated income statement in the year the bonds
are purchased, a discount or premium amortization related to bonds that is made subsequent to the
purchase is added back or is subtracted from the subsidiary's reported income. Such adjustments will
increase or decrease the noncontrolling interest in the income of the subsidiary.
6. a. Investor Company b. Investee Company

Purchase price $338,000 Carrying value $360,000
Par value 350,000 Par value 350,000
Constructive gain $ 12,000 Constructive gain $ 10,000
7. The outside party (the maker of the note) is primarily liable; and Affiliate Y, who discounted the note
with an outside party, is contingently liable for it.
8. Stock dividends are viewed as a distribution of the earliest earnings accumulated in the retained
earnings account.
9. The retained earnings balance at the date of acquisition is reduced since the issuance of a stock
dividend is viewed as a distribution of the earliest earnings accumulated.
10. A memorandum entry is required to recognize the number of shares received since a dividend in stock
is not considered income to the recipient.
11. In the year of declaration, one additional elimination entry is required to eliminate the effects of the
dividend. In subsequent periods the amounts of this entry are combined with the investment
elimination entry.
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12. Preferred stock of a controlled corporation held by others not in the controlled group represents
noncontrolling interest in the controlled corporation. The rights of these shareholders depend on the
stock's preference; possibilities are an interest in net assets, earnings, and retained earnings of the
controlled corporation.
13. Excess of cost over book value is debited to Other Contributed Capital or to Retained Earnings; excess
of book value acquired over cost is credited to Other Contributed Capital.
14. The preferred stock's cumulative preference would increase the net loss allocable to the common
stockholders.
Business Ethics Case from the Textbook Solution
The responsibility of the management of the company is to present accurately the financial statements to the
shareholders and investors. Accordingly if an error is detected in the books, it should be rectified as soon as
it is discovered so that shareholders and investors are not misled. Intercompany sales are eliminated in the
consolidating process. Failure to do so is a material omission, particularly when the inventories in question
have not been sold to outsiders but remain in the inventories of the consolidated entity. You should not
succumb to the pressure exerted by the manager of the subsidiary.

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Use the following information to answer Questions 8, 9, and 10.

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-3

Use the following information to answer Questions 14 and 15.

19. On a consolidated balance sheet, subsidiary preferred stock will be shown:

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-5

Use the following information to answer Questions 21-23.

Use the following information to answer Questions 24 and 25.

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-7

Other information available for Sterling Company is shown below:

Net Income Cash Dividends

C. Compute the controlling interest in consolidated net income for 2010.

Investment in Steffey 8% bonds $2,120,000 $ ----

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-9

Common stock ($10 par value) $600,000

Preferred stock, 8%, Par value $20 $ 100,000

January 1, 2010 Balance $ 80,000

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-11

Short Answer Questions from Textbook

Business Ethics Question from the Textbook

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-13

9-1 A. Cash (160,000 × 0.8) 128,000

B. Dividend Income 104,000

Investment in Sterling Company 24,000

Common Stock–Sterling 1,000,000

Difference Between Implied and Book Value 62,500

9-2 A. Cost of bond investment $670,000

B. Potts Company Steinberger Company

D. December 31, 2010

Premium on Bonds Payable ($32,000 × 0.70) 22,400

Bonds Payable 700,000

9-3 2010 1. Loss on Constructive Retirement of Bonds 120,000

2. Loss on Constructive Retirement of Bonds 30,000

3. Bonds Payable 2,000,000

2011 1. Beginning Retained Earnings-Prentice 120,000

2. Beginning Retained Earnings-Prentice ($30,000 × 0.80) 24,000

3. Investment in Steffey Company Bonds ($120,000/3) 40,000

4. Bond Discount [($300,000/3) × 0.10] 10,000

5. Interest Revenue 160,000

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-15

6. Bonds Payable 2,000,000

7. Interest Payable 80,000

9-4 A. Investment in Southern Company 400,000

B. Common Stock – Southern 32,000

Dividend Income 19,200

Beginning Retained Earnings – Southern 120,000

C. Investment in Southern Company 28,800

9-5 A. Noncontrolling interest in net income

Cash dividends to Proctor Company

B. Dividend Income 110,400

Beginning Retained Earnings - Styles Company 24,000

Other Contributed Capital—Proctor Company 5,200

Beginning Retained Earnings – Styles Company 56,000

9-6 A. Preferred stock $100,000

B. Cost of investment $80,000

C. Percentage Controlling interest in

Chapter 9 Intercompany Bond Holdings and Miscellaneous 9-17

9-7 1. Carrying value of debt – 1/2/2010 $1,270,000

2. Stated interest (30% of $1,250,000 × 0.11) $41,250

3. Stated interest ($1,250,000 × 0.11) $137,500

4. Cost of bond investment (1/2/2010) $350,000

*$1,250,000 par × 30% less $350,000 paid divided by 10 years = $2,500.