Chapter 7 Test Bank: ©2009 Pearson Education, Inc. Publishing As Prentice Hall 7-1

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Chapter 7 Test Bank
INTERCOMPANY PROFIT TRANSACTIONS – BONDS
Multiple Choice Questions
LO1
1. The intercompany purchase of the parent company bonds by a
subsidiary has the same effect on the consolidated financial
statements as the
a. purchase of the bonds by a non-affiliate.

b. parent's retirement of the bonds using funds from newly
issued common stock.
c. parent's retirement of the bonds using funds from a
subsidiary loan.
d. parent's retirement of the bonds using funds from the sale
of new bonds to non-affiliates.
LO1
2. If an affiliate purchases bonds in the open market, the
intercompany bond liability book value is
a. always assigned to the parent company because it has

control.
b. the par value of the bonds less the discount or plus the
premium and issuance costs at the time of issuance.
c. par value.
d. the par value of the bonds plus unamortized discount.
LO2
3. Material constructive gains and losses from intercompany bond
holdings are
a. realized gains and losses from the issuing affiliate’s

perspective.
b. always assigned to the parent company because it has
control.
c. realized and recognized from the consolidated entity’s
perspective.
d. excluded from the consolidated income statement until the
period in which they become realized.
©2009 Pearson Education, Inc. publishing as Prentice Hall

7-1
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Use the following information in answering questions 4 and 5.
Australian Owl Company owns an 80% interest in Glider Company. On

January 1, 2006, Australian Owl had $600,000, 8% bonds outstanding
with an unamortized premium of $9,000. The bonds mature on December
31, 2010. Glider acquired one-third of Australian Owl’s bonds in the
open market for $198,000 on January 1, 2006. On December 31, 2006,
the books of the two affiliates held the following balances:
Australian Owl’s books

8% bonds payable $600,000
Premium on bonds 7,200
Interest expense 46,200
Glider’s books
Investment in Australian Owl bonds $198,400
Interest income 16,400
LO2
4. The gain from the bond purchase that appeared on the December
31, 2006 consolidated income statement was
a. $ 0.
b. $4,400.
c. $4,800.
d. $5,000.
LO2
5. Consolidated Interest Expense and consolidated Interest Income,
respectively, that appeared on the consolidated income
statement for the year ended December 31, 2006 was
a. $30,800 and $ 0.
b. $30,800 and $16,400.
c. $46,200 and $ 0.
d. $46,200 and $16,400.

7-2
LO2
6. Kingfisher Corporation owns 80% the voting stock of Tunnel
Corporation. On January 1, 2006, Kingfisher paid $391,000 cash
for $400,000 par of Tunnel’s 10% $1,000,000 par value
outstanding bonds, due on April 1, 2011. Tunnel’s bonds had a
book value of $1,045,000 on January 1, 2006. Straight-line
amortization is used. The gain or loss on the constructive
retirement of $400,000 of Tunnel bonds on January 1, 2006 was
reported in the 2006 consolidated income statement in the
amount of
a. $14,000.
b. $21,000.
c. $23,000.
d. $27,000.
Use the following information in answering questions 7, 8, and 9.
Rufous Owl Inc. had $800,000 par of 10% bonds payable outstanding on
January 1, 2006 due January 1, 2010 with an unamortized discount of
$16,000. Bird is a 90%-owned subsidiary of Rufous. On January 1,
2006, Bird Corporation purchased $160,000 par value of Rufous’s
outstanding bonds for $152,000. The bonds have interest payment dates
of January 1 and July 1, and mature on January 1, 2009. Straight-line
amortization is used.
LO2
7. With respect to the bond purchase, the consolidated income
statement of Rufous Owl Corporation and Subsidiary for 2006
showed a gain or loss of
a. $ 4,000.
b. $ 4,800.
c. $ 8,000.
d. $10,200.
LO2
8. Bond Interest Receivable for 2006 of Owl’s bonds on Bird’s
books was
a. $ 7,600.
b. $ 8,000.
c. $15,200.
d. $16,000.

7-3
LO2
9. Bonds Payable appeared in the December 31, 2006 consolidated
balance sheet of Rufous Owl Corporation and Subsidiary in the
amount of
a. $624,000.
b. $628,000.
c. $630,400.
d. $637,800.
Use the following information for questions 10 through 15.
Dollarbird Corporation issued five thousand, $1,000 par, 12% bonds on

January 1, 2004. Interest is paid on January 1 and July 1 of each
year; the bonds mature on January 1, 2009. On January 1, 2006, Branch
Corporation, an 80%-owned subsidiary of Dollarbird, purchased 3,000
of the bonds on the open market at 101.50. Dollarbird's separate net
income for 2006 included the annual interest expense for all 3,000
bonds. Branch’s separate net income was $300,000, which included the
bond interest received on July 1 as well as the accrual of bond
interest revenue earned on December 31.
LO2
10. What was the amount of gain or (loss) from the intercompany
purchase of Dollarbird’s bonds on January 1, 2006?
a. $(60,000).
b. $(45,000).
c. $ 45,000.
d. $ 60,000.
LO2
11. If the bonds were originally issued at 106, and 80% of them
were purchased by Branch on January 1, 2007 at 98, the gain or
(loss) from the intercompany purchase was
a. $(224,000).
b. $(176,000).
c. $ 176,000.
d. $ 224,000.

7-4
LO2
12. If the bonds were originally issued at 103, and 70% of them
were purchased on January 1, 2008 at 104, the constructive gain
or (loss) on the purchase was
a. $(119,000).
b. $(35,000).
c. $35,000.
d. $119,000.
LO2
13. Using the original information, the amount of consolidated
Interest Expense for 2006 was
a. $ 120,000.
b. $ 240,000.
c. $ 300,000.
d. $ 600,000.
LO2
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, 2007 were
a. $2,000,000 and $120,000.

b. $2,000,000 and $240,000.
c. $5,000,000 and $120,000.
d. $5,000,000 and $240,000.
LO2
15. The elimination entries on the consolidation working papers
prepared on December 31, 2006 included at least
a. debit to Bond Interest Expense for $360,000.

b. credit to Bond Interest Expense for $360,000 and a debit to
Bond Interest Payable for $180,000.
c. credit to Bond Interest Receivable for $360,000.
d. debit to Bond Interest Revenue for $360,000.
LO3
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.

7-5
LO3
17. Constructive gains or losses are allocated between purchasing
and issuing affiliates according to
a. the agency theory.

b. the par value theory.
c. either the agency theory or the par value theory.
d. neither the agency theory nor the par value theory.
LO3
18. No allocation of gain or loss on the constructive retirement of
intercompany bonds will occur
a. when the subsidiary is the issuing affiliate.

b. when the effective interest rate method is applied.
c. in the consolidated income statement.
d. when the parent company is the issuing affiliate.
Use the following information in answering questions 19 and 20.
Mistletoebird Corporation owns an 80% interest in Berries Company

acquired at book value several years ago. On January 1, 2006, Berries
purchased $100,000 par of Mistletoebird’s outstanding bonds for
$103,000. The bonds were issued at par and mature on January 1, 2009.
Straight-line amortization is used. Separate incomes of Mistletoebird
and Berries for 2006 are $350,000 and $120,000, respectively.
LO4
19. Consolidated net income for 2006 was
a. $443,600.
b. $444,000.
c. $444,400.
d. $448,000.
LO4
20. Minority interest income for 2006 was
a. $23,000.
b. $23,600.
c. $24,000.
d. $24,400.

7-6
LO1
Exercise 1
Separate company and consolidated income statements for Pitta and New
Guinea Corporations for the year ended December 31, 2006 are
summarized as follows:
Consoli-
Pitta New dated
Guinea
Sales Revenue $ 500,000 $ 100,000 $ 600,000
Income from New Guinea 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
Minority interest income 7,500
Total expenses 409,900 81,000 493,000
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,
2011. On January 1, 2006, a portion of the bonds was purchased and
constructively retired.
Required: Answer the following questions.
1. Which company is the issuing affiliate?
2. What is the dollar effect of the constructive retirement on

consolidated net income for 2006?
3. What portion of the bonds remains outstanding at December 31,

2006?
4. Is New Guinea 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 New

Guinea.

7-7
LO1
Exercise 2
Jacky Winter Corporation owns a 90% interest in Park Company. The

following information is from the adjusted trial balances at December
31, 2005, at which time the bonds have four years to maturity. Jacky
Winter acquired Park’s bonds at the beginning of the year. The bonds
have interest payment dates of January 1 and July 1.
Jacky Park
Winter
Investment in Park Bonds, $200,000 par 196,000
10% Bonds payable, $400,000 400,000
Bond premium 16,000
Interest expense 36,000
Interest receivable 10,000
Interest income 21,000
Interest payable 20,000
Required:
Prepare the necessary consolidation working paper entries on December

31, 2006 with respect to the intercompany bonds.
LO2
Exercise 3
Pheasant Corporation owns 80% of Rural Corporation’s outstanding

common stock that was purchased at book value and fair value on
January 1, 1999.
Additional information:
1. Pheasant sold inventory items that cost $3,000 to Rural during

2006 for $6,000. One-half of this merchandise was inventoried by
Rural at year-end. At December 31, 2006, Rural owed Pheasant
$2,000 on account from the inventory sales. No other
intercompany sales of inventory have occurred since Pheasant
acquired its interest in Rural.
2. Pheasant sold a plant asset with a book value of $5,000 and a 5-

year useful life to Rural for $10,000 on December 31, 2004. This
plant asset remains in use by Rural and is depreciated by the
straight-line method.
7-8
3. On January 2, 2006, Rural paid $10,800 for $10,000 par value of

Pheasant’s 10-year, 10% bonds. These bonds have interest payment
dates of January 1 and July 1, and mature on January 1, 2010.
Straight-line amortization has been applied by Rural to the
Pheasant bond investment.
4. Pheasant uses the equity method in accounting for its investment

in Rural.
Required:
Complete the working papers to consolidate the financial statements

of Pheasant Corporation and Rural for the year ended December 31,
2006.

7-9
Pheasant Corporation and Subsidiary

Consolidation Working Papers
at December 31, 2006
Eliminations Balance
Pheasant Rural Debit Credit Sheet
INCOME STATEMENT
Sales $ 50,000 $ 24,000
Income from 6,900
Gain or loss on
bonds
Interest Income 800
Cost of sales ( 14,000) ( 9,000)
Depreciation ( 3,900) ( 5,800)
Interest expense ( 2,000)
Net income 37,000 10,000
Retained
Earnings 1/1 12,000 8,000
Add: Net income 37,000 10,000
Dividends ( 6,000) ( 2,000)
Retained
Earnings 12/31 $ 43,000 $ 16,000
BALANCE SHEET
Cash 8,000 1,400
Interest Rec 500
Receivables 11,000 3,500
Inventories 5,000 3,000
Equipment-net 43,000 31,000
Investment in
Rural stock 30,100
Investment in
Pheasant bonds 10,600
TOTAL ASSETS $ 97,100 $ 50,000
LIAB. & EQUITY
Accounts payable 3,100 6,000
Interest payable 1,000
Bonds payable 20,000
Capital stock 30,000 28,000
Retained
Earnings 43,000 16,000
1/1 Noncontrl.
Interest
12/31 Noncontrl.
Interest
Expense
TOTAL LIAB. & $
EQUITY 97,100 $ 50,000

7-10
LO2
Exercise 4
December 31, 2006 balance sheets for Wren Corporation, and Schrub
Corporation, its 90%-owned subsidiary, are presented in the first two
columns of partially completed balance sheet working papers. Wren
paid $160,000 for its 90% interest in Schrub on January 1, 2003 when
Schrub had $150,000 of total stockholders’ equity. The $25,000 cost-
book differential was assigned to plant assets with a 10-year
remaining life.
On January 1, 2006, Wren purchased $50,000 of Schrub Corporation’s

10% bonds for $48,000, at which time the unamortized premium on the
bonds was $2,000. The bonds pay interest on June 30 and December 31
and mature on December 31, 2010. Both Wren and Schrub use straight-
line amortization. Wren uses the equity method of accounting for its
investment in Schrub.
Required:
Complete the consolidated balance sheet working papers.

7-11
Wren Corporation and Subsidiary

Consolidated Balance Sheet Working Papers
Eliminations Non- Consol-
Wren Schrub Debit Credit Cntl. idated
BALANCE SHEET
Cash $ 39,100 $ 30,000
Receivables 80,000 75,000
Interest
Receivable 2,500
Inventories 70,000 40,000
Land 50,000 45,000
Plant assets-net 160,000 120,000
Investment in
Schrub bonds 48,400
Investment in
Schrub stock 179,160
TOTAL ASSETS $ 629,160 $310,000
LIAB. & EQUITY
Accounts payable 47,000 23,400
Bond interest
payable 10,000 5,000
10% Bonds
Payable 200,000 100,000
Premium on bonds
payable 1,600
Capital stock 280,000 120,000
Retained
Earnings 92,160 60,000
Minority
Interest
TOTAL LIAB. &
EQUITY $ 629,160 $310,000

7-12
LO2
Exercise 5
Sunbird Corporation owns a 70% interest in Veranda Corporation. At

December 31, 2005, Veranda had $3,000,000 of par value 12% bonds
outstanding with an unamortized premium of $60,000. The bonds have
interest payment dates of January 1 and July 1 and mature on January
1, 2010.
On January 2, 2006, Sunbird purchased $1,200,000 par value of

Veranda’s outstanding bonds for $1,209,600. Assume straight-line
amortization.
Required:
Prepare the necessary consolidation working paper entries on December

31, 2006 with respect to the intercompany bonds.
LO2
Exercise 6
Rock is an 80%-owned subsidiary of Gibberbird. On January 1, 2005,

Rock issued $450,000 of $1,000 face amount 6% bonds at par. The bonds
have interest payments on January 1 and July 1 of each year and
mature on January 1, 2009. On July 1, 2006, Gibberbird purchased all
450 bonds on the open market for $1,030 per bond.
Required: With respect to the bonds, use General Journal format to:
1. Record the 2006 journal entries from July 1 to December 31 on

Rock’s books.

Gibberbird’s books.
3. Record the elimination entries for the consolidation working

papers at December 31, 2006.

7-13
LO2 & 3
Exercise 7
Caterpillar Inc. is an 80%-owned subsidiary of Bellbird Corp. On

January 1, 2005, Caterpillar issued $600,000 of $1,000 face amount 6%
bonds at $964 per bond. Interest is paid on January 1 and July 1 of
each year and covers the preceding six months. On July 1, 2006,
Bellbird purchased all 600 bonds on the open market for $1,030 per
bond. The following table shows selected amounts of amortization on
the bonds:
Amortization Table for the Bond Discount
Date Remaining Balance

01-01-05 $21,600
12-31-05 14,400
07-01-06 10,800
12-31-06 7,200
12-31-07 0
Required: With respect to the bonds, use General Journal format to:

Caterpillar’s books.

Bellbird’s books.
3. Record the elimination entries for the consolidation working

papers at December 31, 2006.

7-14
LO2&3
Exercise 8
Thornbill Corporation owns 90% of the outstanding voting common stock

of Hangout Corporation. On January 1, 1998, Hangout issued $1,000,000
face amount of 12%, $1,000 bonds payable at 119.20. The bonds pay
interest on January 1 and July 1 of each year and mature on for on
January 1, 2009. On July 1, 2006, Thornbill purchased all of the
outstanding bonds at a price of 107.50.
Required:
1. Explain the relationship between the balances in the Investment

in Hangout Bonds account on Thornbill’s books and the bond-
related accounts, i.e., Bonds Payable and Discount/Premium on
Bonds Payable, on Hangout’s books.
2. Using your written rationale from Requirement 1, determine the

balance in the Investment in Hangout Bonds account on December
31, 2006, October 31, 2007, May 31, 2008 and November 30, 2008,
assuming that amortization is recorded monthly.
LO3&4
Exercise 9
Honeyeater Corporation owns a 60% interest in Waterhole Corporation

acquired several years ago at a price equal to book value and fair
value. On December 31, 2005, Waterhole had $900,000 par of 12% bonds
outstanding with an unamortized premium of $30,000. The bonds mature
in five years and pay interest on January 1 and July 1. On January 1,
2006, Honeyeater acquired one-third of Waterhole’s bonds for
$317,000. Honeyeater and Waterhole use straight-line amortization.
Waterhole reports net income of $300,000 for 2006.
Required:
1. Calculate Honeyeater’s income from Waterhole for 2006.
2. Calculate the minority interest income for 2006.

7-15
LO4
Exercise 10
Willy Wagtail Company has $4,000,000 of 12% bonds outstanding on

December 31, 2004 with unamortized premium of $120,000. These bonds
pay interest semiannually on January 1 and July 1 and mature on
January 1, 2010. Straight-line amortization is used.
Garden Inc., 80%-owned subsidiary of Willy Wagtail, buys $1,000,000
par value of Willy Wagtail’s outstanding bonds in the market for
$980,000. There is only one issue of outstanding bonds of the
affiliated companies and they have consolidated financial statements.
For the year 2005, Willy Wagtail has income from its separate
operations (excluding investment income) of $4,500,000 and Garden
reports net income of $600,000.
Required: Determine the following:
1. Noncontrolling interest expense for 2005.
2. Consolidated net income for Willy Wagtail Company and subsidiary

for 2005.

7-16
SOLUTIONS
Multiple Choice Questions
1 c
2 b
3 c
4 d Book value of Australian Owl’s

bonds acquired by Glider equals
1/3 times ($600,000 + $9,000) $ 203,000
Less: Cost of acquiring
Australian Owl bonds 198,000
Constructive gain on Australian $ 5,000
Owl bonds
5 a Consolidated interest expense =

$46,200 x 2/3 $ 30,800
6 d
7 b
8 b
9 c
4 b Australian Owl’s separate $ 350,000

income:
Income from Glider ($120,000 x
80%) = 96,000
Less: Loss on constructive
retirement of Australian Owl’s ( 3,000 )
bonds
Plus: Piecemeal recognition of
the constructive loss ($3,000/3
years) = 1,000
Consolidated net income $ 444,000
5 c Because Australian Owl is the

issuing entity the gain or loss
is not allocated to the
noncontrolling interest. The
noncontrolling interest expense $ 24,000
is ($120,000 x 20%) or

7-17
8 c Full interest for 12 months

Equals $920,000 x 10% $ 92,000
Less: interest on $230,000 for 9
months = $230,000 x 10% x 75% 17,250
Consolidated interest expense $ 74,750
9 d $ 4,024,000
Book value of Polecat’s bonds
x % purchased by Seadog 40%
Equals: Book value purchased $ 1,609,600
Purchase price ($970 x 1,600)= 1,552,000
Gain on retirement $ 57,600
10 b Total book value acquired =

$5,000,000 x 60% $ 3,000,000
Purchase price 3,000 bonds x 3,045,000
$1,015
Loss on constructive retirement $ 45,000
11 c Book value at January 1, 2007

equals $5,300,000 minus $ 5,120,000
$180,000=
Percentage of bonds acquired 80%
Equals book value acquired 4,096,000
$980=
Gain on constructive retirement= $ 176,000
12 a Book value at January 1, 2008 $ 5,030,000

equals $5,150,000 minus $120,000
Percentage of bonds acquired 70%
Equals book value acquired 3,521,000
$1,040
13 b ($5,000,000 - $3,000,000) x 12% $ 240,000

=
14 a Bonds payable $5,000,000 minus

bonds held by Branch of $ 2,000,000
$3,000,000

7-18
Interest accrued on December 31,

2007 will be the interest on
bonds held by non-affiliates or
$2,000,000 x 12% x ½ year = $ 120,000
15 b
16 b
17 c
18 d
19 b Mistletoebird’s separate income: $ 350,000

Income from Berries ($120,000 x
80%) = 96,000
Less: Loss on constructive
retirement of Mistletoebird ( 3,000 )
bonds
Plus: Piecemeal recognition of
the constructive loss ($3,000/3
years) = 1,000
Consolidated net income $ 444,000
20 c Since Mistletoebird is the

issuing entity the gain or loss
is not allocated to the
noncontrolling interest. The
noncontrolling interest income $ 24,000
is ($120,000 x 20%).

7-19
Exercise 1
1. Pitta is the issuing affiliate.
2. Effect on consolidated net income:

Gain on constructive retirement of bonds $ 3,000
Less: Piecemeal recognition of gain ($6,000
interest income - $5,400 interest expense) ( 600 )
Increase in consolidated net income $ 2,400
3. Percent of bonds outstanding on December 31, 2006 is 40%,

computed as $3,600 consolidated interest expense divided by
$9,000 interest expense of Pitta.
4. New Guinea is partially owned as evidenced by the minority

interest income. The ownership percentage is 70% ($7,500
minority interest income divided by $25,000 income of New
Guinea = 30% minority interest.
5. Straight-line amortization
$100,000 par x 60% purchased $ 60,000

Purchase price 5 years before maturity 57,000
Gain 3,000
Nominal interest ($60,000 x 9%) $ 5,400

Discount amortization ($3,000/5 years) 600
Bond interest income $ 6,000
6. Pitta’s income from New Guinea
Share of New Guinea’s reported income

($25,000 x 70%) = $ 17,500
Add: Constructive gain 3,000
Less: Piecemeal recognition of constructive
gain ( 600 )
Income from New Guinea $ 19,900

7-20
Exercise 2
2006 Debit Credit

12/31 Bond Interest Payable 10,000
Bond Interest Receivable 10,000
12/31 Bonds Payable 200,000

Interest Revenue 21,000
Bond premium 8,000
Interest Expense (50% owned) 18,000
Investment in Park’s Bonds 196,000
Gain on bonds 15,000
Supporting Computations:
Cost of bonds to Jacky Winter $ 195,000
196,000-1,000 amortization
Book value acquired 1/1/2005 where
4,000 per year is amortized 210,000
($400,000 + $20,000) x 50% =
Gain on constructive bond retirement $ 15,000
Exercise 3
Pheasant Corporation and Subsidiary

Consolidation Working Papers
Pheasant Rural Debit Credit contl. idated
INCOME STATEMENT
Sales $ 50,000 $24,000 a $ 6,000 $68,000
Income from 6,900 e 6,900
Loss on bonds d 800 ( 800)
Interest Income 800 d 800
Cost of sales ( 14,000) ( 9,000) b 1,500 a $ 6,000 ( 18,500)
Depreciation ( 3,900) ( 5,800) c 1,000 ( 8,700)
Interest expense ( 2,000) d 1,000 ( 1,000)
Minority income $2,000 ( 2,000)
Net income 37,000 10,000 37,000
Retained
Earnings 1/1 12,000 8,000 f 8,000 12,000
Add: Net income 37,000 10,000 37,000
Dividends ( 6,000) ( 2,000) e 1,600 ( 400) ( 6,000)
Retained
Earnings 12/31 $ 43,000 $16,000 $43,000

7-21
BALANCE SHEET
Cash 8,000 1,400 $ 9,400
Interest Rec 500 h 500
Receivables 11,000 3,500 g 2,000 12,500
Inventories 5,000 3,000 b 1,500 6,500
Equipment-net 43,000 31,000 c 3,000 71,000
Investment in c 4,000 e 5,300
Rural stock 30,100 f 28,800
Investment in
Pheasant bonds 10,600 d 10,600
TOTAL ASSETS $ 97,100 $50,000 $99,400
LIAB. & EQUITY
Accounts payable 3,100 6,000 g 2,000 7,100
Interest payable 1,000 h 500 500
Bonds payable 20,000 d 10,000 10,000
Capital stock 30,000 28,000 f 28,000 30,000
Retained
Earnings 43,000 16,000 43,000
1/1 Noncontl.
Interest f 7,200 7,200
12/31 Noncontl.
Interest Expense 8,800 8,800
TOTAL LIAB. & $ $99,400
EQUITY 97,100 $50,000

7-22
Exercise 4
Wren Corporation and Subsidiary

Consolidated Balance Sheet Working Papers
Wren Schrub Debit Credit cntl idated
BALANCE SHEET
Cash $ 39,100 $30,000 $69,100
Receivables 80,000 75,000 155,000
Interest
Receivable 2,500 c $ 2,500
Inventories 70,000 40,000 110,000
Land 50,000 45,000 95,000
Plant assets-net 160,000 120,000 b $ 15,000 295,000
Investment in
Schrub bonds 48,400 a 48,400
Investment in a 2,160
Schrub stock 179,160 b 177,000
TOTAL ASSETS $ 629,160 $310,000 $724,100
LIAB. & EQUITY
Accounts payable 47,000 23,400 70,400
Bond interest
payable 10,000 5,000 c 2,500 12,500
10% Bonds
Payable 200,000 100,000 a 50,000 250,000
Premium on bonds
payable 1,600 a 800 800
Capital stock 280,000 120,000 b 120,000 280,000
Retained
Earnings 92,160 60,000 b 60,000 92,160
Noncontroling a 240
Interest b 18,000 18,240
TOTAL LIAB. & $ 248,300 248,300 $724,100
EQUITIES 629,160 $310,000

7-23
Supporting computations
Book value of bonds

($102,000 x 50%) $ 51,000
Cost of acquiring $50,000 par ( 48,000 )
Constructive gain 3,000
Piecemeal recognition of gain ( 600 )
Unrecognized at December 31,
2006 $ 2,400
Majority share ($2,400 x 90%) $ 2,160

Minority share ($2,400 x 10%) $ 240
Excess allocated to plant

assets $ 25,000
Depreciation for 4 years
($2,500 x 4 years) ( 10,000 )
Remaining excess $ 15,000
Exercise 5
2006 Debit Credit

12/31 Bond Interest Payable 72,000
12/31 Premium on Bonds Payable 18,000

Bonds Payable 1,200,000
Interest Revenue 141,600
Interest Expense 138,000
Investment in Veranda Bonds 1,207,200
Gain on Retirement of Bonds 14,400
Supporting Computations:
Cost of bonds to Sunbird $ 1,209,600
Book value acquired
($3,000,000 + $60,000) x 40% = 1,224,000
Gain on constructive bond retirement $ 14,400

7-24
4 years remaining
Premium on Bond Payable
$60,000 x 3/4 x 40% = $18,000
Interest Expense
$1,200,000 x 12% = $144,000
Less: $60,000 x 1/4 x 40% = $ 6,000
$138,000
Interest Revenue
$144,000 - ($9,600 x 1/4) = $141,600
Exercise 6
Date
2006 Account Name Debit Credit
Gibberbird’s books
Jul 01 Investment in Rock Bonds 463,500
Cash 463,500
Dec 31 Bond Interest Receivable 13,500

Bond Interest Revenue 10,800
Investment in Rock Bonds 2,700
Rock’s books
Dec 31 Bond Interest Expense 13,500
Bond Interest Payable 13,500
Consolidated Working Papers

Dec 31 Bond Interest Payable 13,500
Dec 31 Bonds Payable 450,000

Loss on Bonds 13,500
Bond Interest Expense 13,500
Investment in Rock Bonds 460,800
Interest Revenue:
($450,000 x 6% x 1/2) - ($13,500 premium/5 periods) =
$13,500 - $2,700 = $10,800

7-25
Exercise 7
Date
2006 Account Name Debit Credit
Bellbird’s books
Jul 01 Investment in Caterpillar Bonds 618,000
Cash 618,000
Dec 31 Bond Interest Receivable 18,000

Investment in Caterpillar Bonds 3,600
Caterpillar’s books
Dec 31 Bond Interest Expense 21,600
Bond Interest Payable 18,000
Discount on Bonds Payable 3,600
Consolidated Working Papers

Dec 31 Bond Interest Payable 18,000
Dec 31 Bonds Payable 600,000

Loss on Bonds 28,800
Bond Interest Expense 20,600
Discount on Bonds Payable 7,200
Investment in Caterpilllar Bonds 614,400
(Book value of bonds $589,200 - purchase cost $618,000 = $28,800 loss)

7-26
Exercise 8
Requirement 1
The purpose of the Investment in Hangout Bonds account on the

acquirer’s books and the Bonds Payable, Discount on Bonds
Payable/Premium on Bonds Payable accounts on the issuer’s books is
similar in that each set of accounts is tracking the net book value
of the bonds. Since we know that at the maturity date the net book
value of the books must be equal to the face amount of the bonds
being redeemed, then no matter what amounts are initially placed into
these accounts, the balance on the maturity date is equal to the
maturity value of the bonds. Therefore, both sets of accounts are
moving toward the same final number. In this problem, the original
premium on the bonds is a total of $192,000 which is $192 per bond.
Since the bonds have an eight-year or 96-month term, the rate of
amortization is $2 per month per bond or $2,000 per month in total.
When Thornbill acquires the bonds it pays a premium of $75,000 which,
when amortized over the 30-month remaining life of the bond will
produce an amortization rate of $2.50 per month per bond or $2,500
per month in total. When these different rates of amortization are
applied to the Premium on Bonds Payable on Hangout’s books and the
Investment in Hangout Bonds account on Thornbill’s books, the account
balances converge toward the face amount of the bonds.
Requirement 2
Amortization date Months since acquisition Cumulative amortization
Dec 31, 2006 6 months $15,000

Oct 31, 2007 16 months $40,000
May 31, 2008 23 months $57,500
Nov 30, 2008 29 months $72,500
The $75,000 premium on the bonds as acquired by Thornbill will be

amortized at a rate of $2,500 per month ($75,000 premium/30 months to
maturity). The balance in the Investment in Hangout Bonds account
will be the original balance of $1,075,000 minus the cumulative
amortization amounts shown above or:
Dec 31, 2006 $1,060,000

Oct 31, 2007 $1,035,000
May 31, 2008 $1,017,500
Nov 30, 2008 $1,002,500

7-27
Exercise 9
Preliminary computations:
Book value of bonds $930,000 x 1/3 = $ 310,000
Cost of bonds 317,000
Requirement 1:
Income from Waterhole:
Share of Waterhole’s income ($300,000 x $ 180,000
60%)
Less: Constructive loss ($7,000 x 60%) ( 4,200 )
Plus: Piecemeal recognition of loss
($7,000/5 years) x 60% 840
Income from Waterhole $ 176,640
Requirement 2:
Minority interest income:
Waterhole’s reported income $ 300,000
Less: Constructive loss on bonds ( 7,000 )
Plus: Piecemeal recognition of loss 1,400
Equals: Adjusted reported income $ 294,400
Minority percentage 40%
Minority interest income $ 117,760

7-28
Exercise 10
Requirement 1
Minority interest income $600,000 x 20% $ 120,000
Requirement 2
Consolidated net income:
Income from Willy Wagtail’s operations $ 4,500,000
Income from Garden:
Willy Wagtail’s share of Garden income
= 80% x $600,000 $ 480,000
Add: Constructive gain on bond
retirement ($4,000,000 + $120,000)*25%- 50,000
980,000
Less: Piecemeal recognition of gain =
$50,000/8 years ( 12,500 )
517,500
Less: Noncontrolling interest expense
20% x $600,000 = ( 120,000 )
Consolidated net income $ 4,897,500

7-29

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Chapter 7 Test Bank

INTERCOMPANY PROFIT TRANSACTIONS – BONDS

Multiple Choice Questions

a. purchase of the bonds by a non-affiliate.

a. always assigned to the parent company because it has

a. realized gains and losses from the issuing affiliate’s

©2009 Pearson Education, Inc. publishing as Prentice Hall

Use the following information in answering questions 4 and 5.

Australian Owl Company owns an 80% interest in Glider Company. On

Australian Owl’s books

©2009 Pearson Education, Inc. publishing as Prentice Hall

Use the following information in answering questions 7, 8, and 9.

©2009 Pearson Education, Inc. publishing as Prentice Hall

Use the following information for questions 10 through 15.

Dollarbird Corporation issued five thousand, $1,000 par, 12% bonds on

©2009 Pearson Education, Inc. publishing as Prentice Hall

a. $2,000,000 and $120,000.

a. debit to Bond Interest Expense for $360,000.

a. affiliate is a 100%-owned subsidiary.

©2009 Pearson Education, Inc. publishing as Prentice Hall

a. the agency theory.

a. when the subsidiary is the issuing affiliate.

Use the following information in answering questions 19 and 20.

Mistletoebird Corporation owns an 80% interest in Berries Company

19. Consolidated net income for 2006 was

©2009 Pearson Education, Inc. publishing as Prentice Hall

Cost of sales $ 280,000 $ 50,000 $ 330,000

The interest income and expense eliminations relate to a $100,000, 9%

Required: Answer the following questions.

1. Which company is the issuing affiliate?

2. What is the dollar effect of the constructive retirement on

3. What portion of the bonds remains outstanding at December 31,

4. Is New Guinea a wholly-owned subsidiary? If not, what percentage

5. Does the purchasing affiliate use straight-line or effective

6. Explain the calculation of Pitta’s $19,900 income from New

©2009 Pearson Education, Inc. publishing as Prentice Hall

Jacky Winter Corporation owns a 90% interest in Park Company. The

Prepare the necessary consolidation working paper entries on December

Pheasant Corporation owns 80% of Rural Corporation’s outstanding

1. Pheasant sold inventory items that cost $3,000 to Rural during

2. Pheasant sold a plant asset with a book value of $5,000 and a 5-

3. On January 2, 2006, Rural paid $10,800 for $10,000 par value of

4. Pheasant uses the equity method in accounting for its investment

Complete the working papers to consolidate the financial statements

©2009 Pearson Education, Inc. publishing as Prentice Hall

Pheasant Corporation and Subsidiary

©2009 Pearson Education, Inc. publishing as Prentice Hall

On January 1, 2006, Wren purchased $50,000 of Schrub Corporation’s

Complete the consolidated balance sheet working papers.

©2009 Pearson Education, Inc. publishing as Prentice Hall

Wren Corporation and Subsidiary

©2009 Pearson Education, Inc. publishing as Prentice Hall

Sunbird Corporation owns a 70% interest in Veranda Corporation. At

On January 2, 2006, Sunbird purchased $1,200,000 par value of

Prepare the necessary consolidation working paper entries on December

Rock is an 80%-owned subsidiary of Gibberbird. On January 1, 2005,

1. Record the 2006 journal entries from July 1 to December 31 on

2. Record the 2006 journal entries from July 1 to December 31 on

3. Record the elimination entries for the consolidation working

©2009 Pearson Education, Inc. publishing as Prentice Hall

Caterpillar Inc. is an 80%-owned subsidiary of Bellbird Corp. On

Amortization Table for the Bond Discount