Intercompany Transactions Bonds Leases

Chapter 05—Intercompany Transactions: Bonds and Leases
Multiple Choice
1. The usual impetus for transactions that create a long-term debtor-creditor relationship between members of a
consolidated group is due to the:
a. subsidiary's ability to borrow larger amounts of capital at more favorable terms than would be available to the
parent.
b. parent's ability to borrow larger amounts of capital at more favorable terms than would be available to the
subsidiary.
c. parent's desire to decentralize asset management and credit control.
d. parent's desire to eliminate long-term debt.
ANSWER: b
RATIONALE: The usual impetus for transactions that create a long-term debtor-creditor relationship
between members of a consolidated group is due to the parent s ability to borrow larger
amounts of capital at more favorable terms than would be available to the subsidiary. The
parent may also desire to manage the capital needs of the subsidiary for better control of
capital sources.
DIFFICULTY: E
LEARNING OBJECTIVES: Introduction
2. The motivation of a parent company to purchase the outstanding bonds of a subsidiary could be to:
a. replace the existing debt with new debt at a lower interest rate.
b. reduce the parent company's acquisition price for the subsidiary.
c. increase the parent company's ownership percentage in the subsidiary.
d. create interest revenue to offset interest expense in future income statements.
ANSWER: a
RATIONALE: Although not explicitly stated in the chapter, to replace existing debt with new debt at lower
interest rates would be one reason a parent might purchase the outstanding bonds of a
subsidiary.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.5-1
3. Intercompany debt that must be eliminated from consolidated financial statements may result from:
a. one member of a consolidated group selling its bonds directly to another member of the group.
b. one member of a consolidated group advancing funds to another member of the group so that the member may
retire bonds it had issued to outside parties.
c. one member of a consolidated group purchasing bonds from outside parties as an investment that had been
issued to outside parities by another member of the group.
d. all of the above.
ANSWER: d
RATIONALE: All of these situations will result in intercompany debt that must be eliminated from
consolidated financial statements.
DIFFICULTY: E
4. Elimination procedures for intercompany bonds purchased from outside parties by another member of the consolidated
group are:
a. not needed except in the period of acquisition if purchased at par.
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b. not needed except in the period of acquisition if purchased at a premium or discount.

c. not needed except in the period of acquisition if only a portion of the outstanding bonds are purchased.
d. needed each period as long as the intercompany investment in bonds exists.
ANSWER: d
RATIONALE: As long as intercompany debt exists, this debt must be eliminated from consolidated financial
statements.
DIFFICULTY: E
5. In years subsequent to the year one member of a consolidated group purchases another member s outstanding bonds
from outside parties, Consolidated Income Statements:
a. recognize a prorated share of any gain or loss from intercompany bonds.
b. recognize a prorated share of any gain but would not show a share of a loss from intercompany bonds.
c. recognize a prorated share of any loss but would not show a share of a gain from intercompany bonds.
d. would not recognize any gain or loss from intercompany bonds.
ANSWER: d
RATIONALE: In years subsequent to the year one member of a consolidated group purchases bonds of
another member from outside parties, the bonds are effectively retired on a consolidated basis
and a gain or loss is recognized in that year. Although the bonds will continue to exist and
each entity will have balances pertaining to those bonds in subsequent years, those balances
will be eliminated, so there will be no impact on the consolidated financial statements in
subsequent years.
DIFFICULTY: E
6. A subsidiary has outstanding $100,000 of 8% bonds that were issued at face value. The parent purchased all the bonds
for $96,000 with 5 years remaining to maturity. How will the parent's use of the effective interest amortization rather than
straight-line amortization of the discount affect the consolidated financial statements?
a. The consolidated financial statements report the same information whether the parent uses straight-line or
effective interest amortization on its investment in s b s bonds.
b. Will result in a different gain on retirement
c. Will result in more interest expense in the first year after the intercompany purchase.
d. Will result in less interest expense in the first year after the intercompany purchase.
ANSWER: a
RATIONALE: The consolidated financial statements will report the same information regardless of the
amortization method used by the parent because all intercompany interest will be eliminated.
DIFFICULTY: E
7. In the year when one member of a consolidated group purchases from outside parties the bonds of another affiliate, the
consolidated income statement includes:
a. a gain if purchased above book value.
b. a gain if purchased below book value.
c. a loss if purchased below book value.
d. a deferred gain if purchased above book value.
ANSWER: b

RATIONALE: If one affiliate purchases the outstanding bonds of another affiliate for less than book value,
the bonds are effectively retired which would result in a gain on the consolidated income
statement. If the bonds are purchased for more than book value, a loss would result.
DIFFICULTY: E
8. On an income distribution schedule, any gain or loss resulting from intercompany bonds is charged to
a. the issuer of the bonds.
b. the purchaser of the bonds.
c. allocation between the issuer and the purchaser.
d. none of the above
ANSWER: a
RATIONALE: When one affiliate purchases another affiliate s bonds from outside parties, the purchaser is
viewed as an agent of the issuing affiliate, so the issuing affiliate bears the gain or loss.
DIFFICULTY: E
9. Company S is a 100%-owned subsidiary of Company P. Company S has outstanding 8%, 10-year bonds sold to yield
7%. On January 1 of the current year, Company P purchased all of the Company S outstanding bonds at a price that
reflected the current 9% effective interest rate. How should this event be reflected in the current year's consolidated
statements?
a. The bonds remain in the balance sheet and are accounted for at a 7% effective rate.
b. The bonds remain in the balance sheet and are accounted for at a 9% effective rate.
c. Retirement of the bonds at a gain as of the purchase date.
d. Retirement of the bonds at a loss as of the purchase date.
ANSWER: c
RATIONALE: Bonds having a stated rate of 8% that were sold to yield 7% would be recorded at a premium
on Company S books.
If Company P purchased the debt at a price that reflected a current effective interest rate of
9%, it is likely that Company P would be paying less than face value for those bonds.
If Company P is paying less than face value for bonds that have been recorded at a premium,
on a consolidated basis, the entity will retire the bonds and recognize a gain.
DIFFICULTY: M
statements?
ANSWER: c
RATIONALE: Bonds having a stated rate of 6% that were sold to yield 7% would be recorded at a discount
on Company S books.
9%, it is likely that Company P would be paying much less than face value for those bonds,
and less than the recorded value, net of the discount.
If Company P is paying less than the carrying value of the bonds net of the existing discount,
on a consolidated basis, the entity will retire the bonds and recognize a gain.
DIFFICULTY: M
statements?
ANSWER: d
RATIONALE: Bonds having a stated rate of 6% that were sold to yield 7% would be recorded at a discount
on Company S books.
6%, it is likely that Company P would be paying more than book value for those bonds.
If Company P is paying more than book value for bonds that have been recorded at a
discount, on a consolidated basis, the entity will retire the bonds and recognize a loss.
DIFFICULTY: M
12. Company S is a 100%-owned subsidiary of Company P. On January 1, 2019, Company S has $200,000 of 8% face
rate bonds outstanding, which were issued at face value. The bonds had 5 years to maturity on January 1, 2019. Premiums
or discounts would be amortized on a straight-line basis. On that date, Company P purchased the bonds for $198,000. The
amount on the consolidated balance sheet relative to the debt is:
a. bonds payable $200,000.
b. bonds payable $200,000, discount $2,000.
c. bonds payable $200,000, discount $1,600.
d. The bonds do not appear on the consolidated balance sheet.
ANSWER: d
RATIONALE: When Company P purchased its s bsidiar s bonds, it effectively retired those bonds on a
consolidated basis; therefore, they will not appear on the consolidated balance sheet.
DIFFICULTY: M
13. Company S is a 100%-owned subsidiary of Company P. On January 1, 2016, Company S has $100,000 of 8% face
rate bonds outstanding. The bonds had 5 years to maturity on January 1, 2016, and had an unamortized discount of
$5,000. On that date, Company P purchased the bonds for $99,000. The net adjustment needed to consolidate retained
earnings on December 31, 2016 is ____.
a. $(4,000)
b. $(3,200)
c. $(800)
d. $0
ANSWER: d
RATIONALE: No adjustment to retained earnings is necessary in the year intercompany bonds have been
purchased.
DIFFICULTY: M
14. Sun Company is a 100%-owned subsidiary of Peter Company. On January 1, 2016, Sun Company has $500,000 of 8%
face rate bonds outstanding, with an unamortized discount of $5,000 that is being amortized over a 5 year remaining life
to maturity. On that date, Peter Company purchased the bonds for $497,000. The adjustment to the consolidated income
of the two companies needed in the consolidation process for 2017 (the following year) is ____.
a. $2,800 increase
b. $400 decrease
c. $400 increase
d. $2,800 decrease
ANSWER: c
RATIONALE: Cash paid by Peter Company for bonds $497,000
Net value of bonds:
Face value of bonds outstanding $500,000
Less discount (5,000) 495,000
Loss on retirement of bonds $ 2,000
Increase to consolidated income for next 5 years
($2,000 / 5) resulting from elimination of intercompany
$ 400
interest income and expense.
DIFFICULTY: M
15. Company S is a 100%-owned subsidiary of Company P. Company P purchased, at a premium, Company S bonds that
are outstanding and have a remaining discount. Consolidation theory takes the position that:
a. interest expense should be adjusted to reflect the market value of the bonds on the date of Company P's
purchase.
b. the debt has been retired at a loss.
c. the debt is outstanding but should be shown at face value.
d. the gain or loss on retirement should be allocated over the remaining life of the bonds.
ANSWER: b
RATIONALE: Whenever one company purchases the outstanding debt of an affiliate, it is treated as a
retirement of debt for consolidated purposes. In this case, the retirement would be at a loss.
Assume the following:
Cash paid by Company P for bonds $105,000
Net value of bonds:
Loss on retirement of bonds $ 10,000
DIFFICULTY: M
16. Powell Company owns an 80% interest in Sauter, Inc. On January 1, 2016, Sauter issued $400,000 of 10-year, 12%
bonds at a premium of $50,000. On December 31, 2021, 5 years after original issuance, Powell purchased all of the
outstanding bonds for $390,000. Both firms use the straight-line method of amortization.
What is the gain on retirement on the 2021 consolidated income statement?
a. $12,500
b. $22,500
c. $10,000
d. $35,000
ANSWER: b
RATIONALE: Cash paid by Company P for bonds $390,000
Net value of bonds:
Add premium 25,000 425,000
Gain on retirement of bonds $ 22,500
DIFFICULTY: M
17. Company P owns 80% of Company S. On January 1, 2016 Company S has outstanding 6% bonds with a face value of
$200,000 and an unamortized discount of $3,000, which is being amortized on a straight-line basis over a remaining term
of 10 years. On January 1, 2016, Company P purchased all the bonds for $205,000. The premium also is amortized on a
straight-line basis. The net impact of the purchase on the non-controlling interest as of December 31, 2016, is ____.
a. $(8,000)
b. $(1,600)
c. $(1,440)
d. $(1,200)
ANSWER: c
Net value of bonds:
Loss on retirement of bonds - January 1, 2016 8,000
Interest adjustment needed for 2016 ($8,000 / 10 years) (800)
$ 7,200
The impact on the NCI would be 20% of this amount of $1,440.
DIFFICULTY: M
18. Company S is a 100%-owned subsidiary of Company P. Company P purchased all the outstanding bonds of Company
S at a discount. The bonds had a remaining issuance premium at the time of Company P's purchase. The bonds have 5
years to maturity. At the end of 5 years, consolidated retained earnings:
a. is greater as a result of the purchase.
b. is less as a result of the purchase.
c. is not affected by the purchase.
d. cannot be determined from the information provided.
ANSWER: c
RATIONALE: At the end of five years, the bonds would have matured. The interest adjustments would be
complete.
DIFFICULTY: M
19. Powell Company owns an 80% interest in Sauter, Inc. On January 1, 2016, Sauter issued $400,000 of 10-year, 12%
bonds at a premium of $50,000. On December 31, 2021, 5 years after original issuance, Powell purchased all of the
outstanding bonds for $390,000. Both firms use the straight-line method of amortization.
The interest adjustment in the 2021 subsidiary income distribution schedule is ____.
a. $2,000
b. $5,000
c. $4,500
d. $0
ANSWER: c
Net value of bonds:
Add premium 25,000 425,000
Interest adjustment for remaining life of bonds would
be
$4,500 ($22,500 / 5)
DIFFICULTY: M
20. When one member of a consolidated group purchases only part of the outstanding bonds of another member of the
group (for example, 80% of the bonds),
a. all bonds, and all the interest expense and interest revenue applicable to the bonds should be eliminated.
b. 20% of the bonds, and 20% the interest expense and interest revenue applicable to the bonds should be
eliminated.
c. 80% of the bonds, and 80% the interest expense and interest revenue applicable to the bonds should be
eliminated.
d. none of the bonds, and none of the interest expense and interest revenue applicable to the bonds should be
eliminated.
ANSWER: c
RATIONALE: When one member of a consolidated group purchases a portion of the outstanding bonds of
another member from outside parties, that portion of the bonds is effectively retired on a
consolidated basis and a gain or loss is recognized in that year. All of the balances related to
the bonds and interest revenue and expense relating to the portion of bonds purchased will be
eliminated.
DIFFICULTY: E
21. Soap Company issued $200,000 of 8%, 5-year bonds on January 1, 2016. The discount on issuance was $12,000.
Bond interest is paid annually on December 31. On December 31, 2018, Pumice Company purchased one-half of the
outstanding bonds for $96,000. Both companies use the straight-line method of amortization.
How much bond interest expense will appear on the December 31, 2018, consolidated income statement?
a. $18,400
b. $16,000
c. $9,200
d. $8,000
ANSWER: a
RATIONALE: Amount of bonds outstanding with outside parties during year $200,000
@ stated interest rate x 8%
16,000
Accretion of applicable discount ($12,000 /5) 2,400
$ 18,400
DIFFICULTY: M
How much interest expense will appear on the December 31, 2019, consolidated income statement?
a. $18,400
b. $16,000
c. $9,200
d. $8,000
ANSWER: c
RATIONALE: Amount of bonds still outstanding with outside parties
($200,000 x 1/2) $100,000
@ stated interest rate x 8%
8,000
Accretion of applicable discount [($12,000 x 1/2)/5] 1,200
$ 9,200
DIFFICULTY: M
What amount of gain or loss from retirement of debt will be reported on the 2018 consolidated financial statements?
a. $1,600 gain
b. $1,600 loss
c. $1,200 gain
d. $1,200 loss
ANSWER: a
RATIONALE: Cash paid by Pumice for bonds $96,000
Net value of bonds:
Face value of bonds outstanding ($200,000 x 1/2) $100,000
Less discount ($12,000 x 1/2 x 2/5*) (2,400) 97,600

* 2 years of 5 have passed
DIFFICULTY: M
24. The purchase of outstanding subsidiary bonds by the parent company has the same impact on consolidated statements
as:
a. the subsidiary retiring its own debt with the proceeds of new debt issued to outside parties.
b. the subsidiary retiring the debt with the proceeds of a loan from the parent.
c. the subsidiary retiring the debt with the proceeds of a new stock issue.
d. allowing the bonds to continue to be held by outside interests.
ANSWER: b
RATIONALE: The purchase of outstanding subsidiary bonds by the parent company has the same impact on
consolidated statements as the subsidiary retiring the debt with proceeds of a loan from the
parent as intercompany debt would be eliminated in both cases. This is not true of the other
options.
DIFFICULTY: M
25. Leasing subsidiaries are formed to achieve centralized asset management through leasing to affiliated firms, and when
they are consolidated with the parent, they are consolidated
a. only if the parent controls at least 20% of the leasing subsidiary.
b. only if the parent controls at least 50% of the leasing subsidiary.
c. only if the parent controls at least 90% of the leasing subsidiary.
d. regardless of the ownership percentage of the parent.
ANSWER: d
RATIONALE: When leasing subsidiaries exist to lease assets to affiliated companies, they are automatically
consolidated with the parent regardless of the ownership percentage of the parent.
DIFFICULTY: M
26. The effect of an operating lease on the income distribution schedule:

a. is non-existent.
b. affects only the lessee's income.
c. affects only the lessor's income.
d. affects the amount of income or distribution of income between the non-controlling and controlling interests.
ANSWER: a
RATIONALE: An operating lease will not have an impact on the amount of income or the income
distribution schedule since the amount of rental income and expense eliminated would be the
same.
DIFFICULTY: E
27. Lease terms can be considered to be "significantly affected":

a. when the terms are the same for affiliated firms as for independent firms.
b. when the terms could not reasonably be expected to occur between independent firms.
c. only if the lease is an operating lease to the lessee and lessor.
d. only if the lease is a direct-financing lease to the lessee and lessor.
ANSWER: b
RATIONALE: Lease terms would be considered significantly affected when they could not be reasonably
expected to occur between independent parties. Examples include rental rates well below
market or unusual lease terms. These instances are usually viewed as borrowing transactions.
DIFFICULTY: E
28. The parent company leased a machine to its subsidiary using a direct-financing lease that included a bargain purchase
option. As a result of the intercompany lease, the following items should be eliminated in the consolidation process:
Depreciation
Machine Debt Interest Expense
a. Yes Yes Yes Yes
b. Yes Yes Yes No
c. Yes No No No
d. No Yes Yes No
ANSWER: d
RATIONALE: The impact of a direct-financing lease transaction between a parent and its subsidiary on the
consolidated financial statements is that the consolidated entity has an asset that is being
depreciated over its useful life. All intercompany debt and interest balances and transactions
are eliminated.
DIFFICULTY: M
29. Park owns an 80% interest in the common stock of Stable Company. Park leased a machine to Stable under a 5-year,
direct financing lease with a bargain purchase option. The lease term began January 1, 2019. The impact of the lease on
the Non-controlling share of income for 2019:
a. is an increase.
b. is a decrease.
c. is zero.
d. cannot be determined from the information given.
ANSWER: c
RATIONALE: Because a direct-financing lease has no impact on consolidated net income, there is no
impact on the NCI.
DIFFICULTY: M
30. Phil Company leased a machine to its 100%-owned subsidiary, Scout Company. The direct financing lease required
annual lease payments in advance of $2,319 for 5 years. The present value of the minimum lease payments at 8% interest
is $10,000. The adjustment needed to arrive at consolidated net income for the first year after the lease is ____.
a. $0
b. $800
c. $2,319
d. $10,000
ANSWER: a
RATIONALE: The parent s interest income of $2,319 would be eliminated against the s bsidiar s interest
expense of $2,319, so there would be no impact on consolidated net income.
DIFFICULTY: E
31. Phil Company leased a machine to its 100%-owned subsidiary, Scout Company. The direct financing lease required
annual lease payments in advance of $2,319 for 5 years. The present value of the minimum lease payments at 8% interest
is $10,000. The adjustment of assets and liabilities needed to prepare a consolidated balance sheet is to eliminate the:
a. asset leased.
b. asset leased and the obligation under the capital lease.
c. obligation under the capital lease and the present value of the minimum lease payments.
d. obligation under the capital lease.
ANSWER: c
RATIONALE: On a consolidated basis, the asset being leased is treated as property, plant and equipment
and is depreciated over its useful life. All balances relating to the financing part of the lease
including the obligation under the capital lease, interest payable, the minimum lease
payments receivable and the unearned interest income are eliminated.
DIFFICULTY: M
32. Under a sales-type lease between affiliated companies, how does the lessor treat the intercompany profit at the
inception of the lease?
a. It is recognized at the inception of the lease.
b. It is deferred and amortized over the lessee s period of usage.
c. It is deferred and recognized at the end of the lease term.
d. There is no profit at the inception of the lease.
ANSWER: b
RATIONALE: Under a sales-type lease between affiliated companies, the lessor defers any intercompany
profit and recognizes it over the lessee s period of usage as a depreciation adjustment.
DIFFICULTY: M
33. Consolidation procedures for sales-type leases:

a. allow for the recognition of the profit or loss from the lease by the lessee at the inception of the lease.
b. allow for the recognition of the profit or loss from the lease by the lessor at the inception of the lease.
c. defer the profit or loss and then amortize it over the lessee's period of usage.
d. defer the profit or loss and then amortize it over the lessor's period of usage.
ANSWER: c
RATIONALE: Consolidation procedures for sales-type leases defer the profit or loss and then amortize it
over the lessee s period of usage.
DIFFICULTY: E
34. Which of the following statements is true?

a. No adjustments are made in the income distribution schedule as a result of operating, direct-financing, and
sales-type leases.
b. No adjustments are made in the income distribution schedule as a result of operating and direct-financing
leases.
c. No adjustments are made in the income distribution schedule as a result of operating and sales-type leases.
d. No adjustments are made in the income distribution schedule as a result of direct-financing and sales-type
leases.
ANSWER: b
RATIONALE: No adjustments are made in the income distribution schedule as a result of operating and
direct- financing leases as the elimination of these transactions have no impact on
consolidated net income. However, the profit or loss resulting from a sales-type lease will be
deferred on a consolidated basis in the period of sale and recognized in subsequent periods
through a depreciation adjustment. These will impact the income distribution schedule.
DIFFICULTY: M
ADAC.FISC.5-5
ADAC.FISC.5-6
35. Which of the following statements is true?

a. No elimination entries are required on a worksheet as a result of operating, direct-financing, and sales-type
leases.
b. No elimination entries are required on a worksheet as a result of direct-financing and sales-type leases.
c. No elimination entries are required on a worksheet as a result of operating leases.
d. All the preceding are false.
ANSWER: d
RATIONALE: All intercompany balances relating to intercompany lease transactions will be eliminated in
consolidation, regardless of the type of lease.
DIFFICULTY: E
ADAC.FISC.5-5
ADAC.FISC.5-6
36. When there is an unguaranteed residual value for the lessor in a direct-financing lease, this means:
a. the total payments to be received by the lessor will come from the lessee.
b. the total payments to be received by the lessee will come from the lessor.
c. a portion of the total payments to be received by the lessor will come from parties outside the consolidated
group.
d. a portion of the total payments to be received by the lessee will come from parties outside the consolidated
group.
ANSWER: c
RATIONALE: When there is an unguaranteed residual value for the lessor in a direct-financing lease, this
means that a portion of the total payments to be received by the lessor will come from parties
outside the consolidated group through ultimate sale of the asset or another lease after the
first has expired.
DIFFICULTY: E
37. What is recorded by the lessee and the lessor when an intercompany lease contains an unguaranteed residual value?

Lessee Lessor
a. Present value of minimum lease Present value of minimum lease payments
payments and the unguaranteed residual value
b. Minimum lease payments payable Minimum lease payments receivable and
the unguaranteed residual value
c. Minimum lease payments payable Present value of minimum lease payments
d. Present value of minimum lease Minimum lease payments receivable and
payments the unguaranteed residual value
ANSWER: d
RATIONALE: When an intercompany lease contains an unguaranteed residual value, the lessee records the
present value of the minimum lease payments as its obligation. The lessor will record the sum
of its minimum lease payments receivable and the unguaranteed residual value, as well as a
contra account, unearned interest income that reduces the gross investment to the market
value of the asset at the inception of the lease.
DIFFICULTY: M
38. To eliminate intercompany bonds and interest expense of consolidated companies, Company P (Parent) and Company
S (Subsidiary) which of the following is correct?
a. Debit Interest Expense and credit Interest Income and credit Bonds Payable and debit Investment in
Company S
b. Credit Interest Expense and debit Interest Income and credit Bonds Payable and debit Investment in
Company S
c. Debit Interest Income and credit Interest Expense and debit any related Loss on Bond Retirement, if any, and
debit Bonds Payable and credit Investment in Company S Bonds
d. Debit Subsidiary Income and credit Investment in Company S Stock
ANSWER: c
DIFFICULTY: MED
39. When a parent buys subsidiary bonds:

a. The bonds become new investments/assets from a consolidated viewpoint and no elimination is necessary.
b. The bonds become new investments/assets but the parent company may not retire subsidiary bonds by
lending money.
c. Intercompany interest expense/revenue and accrued interest receivable/payable are not eliminated as the
new investments to the parent company and the new debt to the subsidiary company needs to be separately
shown when consolidation occurs.
d. The bonds are retired when consolidation occurs by elimination and in periods after the purchase need to be
eliminated and retained earnings adjustment for any retirement gain or loss that has not been amortized.
ANSWER: d
DIFFICULTY: EA
Subjective Short Answer
40. On January 1, 2016, Pope Company acquired 100% of the common stock of Siegel Company for $300,000. On this
date Siegel had total owners' equity of $250,000. Any excess of cost over book value is attributable to goodwill. Pope
accounts for its investment in Siegel using the simple equity method.
On July 1, 2016, Siegel Company sold to outside investors $300,000 par value of 10-year, 10% bonds. The price received
was equal to par. The bonds pay interest semi-annually on July 1 and January 1.
During early 2019, market interest rates on bonds similar to those issued by Siegel decreased to 8%. As a result, the
market value of the bonds increased. On July 1, 2019, Pope purchased $150,000 par value of Siegel's bonds, paying
$163,000. Pope still holds the bonds on December 31, 2019 and has amortized the premium, using the straight-line
method.
Required:
Complete the Figure 5-1 worksheet for consolidated financial statements for the year ended December 31, 2019. Round
all computations to the nearest dollar.
Figure 5-1
Trial Balance Eliminations and
Pope Siegel Adjustments
Account Titles Company Company Debit Credit
Interest Receivable 7,500
Other Current Assets 157,212 371,000
Investment in Sub. Company 410,000
Investment in Sub. Bonds 162,278
Land 50,000 30,000

Buildings and Equipment 350,000 380,000
Rent Receivable (100,000) (50,000)
Goodwill
Interest Payable (15,000)

Other Current Liabilities (120,000) (56,000)
Bonds Payable, 10% (300,000)
Other Long-Term Liabilities (200,000)

Common Stock P Co. (200,000)
Other Paid-in Capital P Co. (100,000)
Retained Earnings P Co. (280,212)
Common Stock S Co. (50,000)

Other Paid-in Capital S Co. (70,000)
Retained Earnings S Co. (180,000)
Net Sales (500,000) (400,000)

Cost of Goods Sold 300,000 240,000
Operating Expenses 100,000 50,000
Interest Expense 30,000
Interest Income (6,778)
Subsidiary Income (80,000)
Dividends Declared P Co. 50,000
Dividends Declared S Co. 20,000
Loss on Retirement of Bonds
Consolidated Net Income

To NCI
To Controlling Interest
Total NCI
Ret. Earn. Contr. Int. 12-31
0 0
Consol. Control. Consol.

Income Retained Balance
Account Titles Statement NCI Earnings Sheet
Interest Receivable
Other Current Assets
Investment in Sub. Company
Investment in Sub. Bonds
Land
Buildings and Equipment
Rent Receivable
Goodwill
Interest Payable
Other Current Liabilities
Bonds Payable, 10%
Other Long-Term Liabilities

Common Stock P Co.
Other Paid-in Capital P Co.
Retained Earnings P Co.
Common Stock S Co.

Other Paid-in Capital S Co.
Retained Earnings S Co.
Net Sales
Cost of Goods Sold
Operating Expenses
Interest Expense
Interest Income
Subsidiary Income
Dividends Declared P Co.
Dividends Declared S Co.
Loss on Retirement of Bonds

To NCI
Total NCI
ANSWER: For the worksheet solution, please refer to Answer 5-1.

Answer 5-1
Pope Siegel Adjustments
Interest Receivable 7,500 (B1) 7,500
Investment in Sub.
Company 410,000 (CY) 60,000
(EL) 300,000
(D) 50,000
Investment in Sub. Bonds 162,278 (B2) 162,278
Land 50,000 30,000

Accumulated depreciation (100,000) (50,000)
Goodwill (D) 50,000
Interest Payable (15,000) (B1) 7,500

Bonds Payable, 10% (300,000) (B2) 150,000
Other Long-Term
Liabilities (200,000)
Other Paid-in Capital P
Co. (100,000)
Common Stock S Co. (50,000) (EL) 50,000

Other Paid-in Capital S
Co. (70,000) (EL) 70,000
Retained Earnings S Co. (180,000) (EL) 180,000
Net Sales (500,000) (400,000)

Interest Expense 30,000 (B2) 7,500
Interest Income (6,778) (B2) 6,778
Subsidiary Income (80,000) (CY) 80,000
Dividends declared P Co. 50,000
Dividends declared S Co. 20,000 (CY) 20,000
Loss on Retirement of
Bonds (B2) 13,000

To NCI
To Controlling
Interest
Total NCI
Ret. Earn. Contr. Int. 12-
31
0 0 607,278 607,278
(continued)

Interest Receivable 0
Other Current Assets 528,212
Investment in Sub. Company 0
Investment in Sub. Bonds 0
Land 80,000
Buildings and Equipment 730,000
Accumulated depreciation (150,000)
Goodwill 50,000

Other Current Liabilities (176,000)

Common Stock S Co.

Net Sales (900,000)

Cost of Goods Sold 540,000
Operating Expenses 150,000
Interest Income 0
Subsidiary Income 0
Dividends declared P Co. 50,000
Dividends declared S Co.
Loss on Retirement of Bonds 13,000
Consolidated Net Income (174,500)

To NCI 0
To Controlling Interest 174,500 (174,500)
Total NCI 0
Ret. Earn. Contr. Int. 12-31 (404,712) (404,712)
0

Eliminations and Adjustments:

(CY) Eliminate the current-year entries made in the investment account and in the
Siegel income account.
(EL) Eliminate the Siegel Company equity balances at the beginning of the year
against the investment account.
(D) Distribute the $50,000 excess of cost over book value to goodwill. ($300,000 -
$250,000)
(B1) Eliminate $7,500 of intercompany interest receivable and payable. ($150,000 x
10% / 2)
DIFFICULTY: M
NOTES: straight-line amortization; consolidation in year bonds are purchased
accounts for its investment in Siegel using the simple equity method.
Also on July 1, 2016, Siegel Company sold to outside investors $200,000 par value of 10-year, 10% bonds. The price
received was equal to par. The bonds pay interest semi-annually on July 1 and January 1.
During early 2019, market interest rates on bonds similar to those issued by Siegel decreased to 8%. As a result, the
market value of the bonds increased. On July 1, 2019, Pope purchased $100,000 par value of Siegel's bonds, paying
$112,695. Pope still holds the bonds on December 31, 2019 and has amortized the premium, using the effective-interest
method which has resulted in interest income of $4,508 and a balance in the Investment in Subsidiary Bonds account of
$112,203.
Required:
Prepare the eliminating entries pertaining to the intercompany purchase of the bonds for the year ended December 31,
2019.
ANSWER: (B1) Interest payable 5,000
Interest receivable 5,000
Eliminate $5,000 ($100,000 x 10% / 2)
of intercompany interest receivable and
payable. (payment date January 1)
(B2) Interest income - Parent 4,508
Interest expense - Subsidiary 5,000
Eliminate all of the intercompany
interest income and one-half of the
interest expense for the last one-half of
the year.
Bonds payable - Subsidiary 100,000
Investment in Subsidiary bonds 112,203
Eliminate the balance in investment in
bonds against one-half of the bonds
payable.
Loss on retirement of bonds 12,695
The resulting loss is $12,695 ($112,695

purchase price of bonds less $100,000
carrying value).
DIFFICULTY: M
NOTES: effective-interest amortization; consolidation in year bonds are purchased
accounts for its Investment in Siegel using the simple equity method.
On January 1, 2016, Siegel Company sold to outside investors $300,000 par value of 10-year, 10% bonds. The price
received was equal to par. The bonds pay interest semi-annually on July 1 and January 1.
During 2016, market interest rates on bonds similar to those issued by Siegel decreased to 8%. As a result, the market
value of the bonds increased. On December 31, 2016, Pope purchased $150,000 par value of Siegel's bonds, paying
$163,000. Pope still holds the bonds on December 31, 2019 and has amortized the premium, using the straight-line
method.
Required:
Prepare the eliminating entries pertaining to the intercompany purchase of bonds outstanding for the year ended
December 31, 2019.
ANSWER: Eliminations and Adjustments:
(B1) Interest payable 7,500
Eliminate $7,500 ($150,000 x 10% / 2)
of intercompany interest receivable and
payable. (payment date January 1)
interest income ($15,000 - 1,444*) and
one-half of the interest expense for the
last one-half of the year.
bonds ($163,000 - $1,444*) against one-
half of the bonds payable.
Retained earnings 13,000
The resulting loss is $13,000 ($163,000
purchase price of bonds less $150,000
carrying value). Since the loss occurred
in 2016, it is debited to retained
earnings.
*Annual adjustment to interest = $1,444 ($13,000 / 9).
DIFFICULTY: D

NOTES: straight-line amortization; consolidation in year after bonds were purchased
43. On January 1, 2019, Parent Company purchased 90% of the common stock of Subsidiary Company for $450,000. On
this date, Subsidiary had common stock, other paid in capital, and retained earnings of $20,000, $130,000, and $200,000,
respectively. Any excess of cost over book value is due to goodwill. Parent accounts for the Investment in Subsidiary
using the cost method.
On January 1, 2019, Subsidiary sold $100,000 par value of 6%, ten-year bonds for $97,000. The bonds pay interest semi-
annually on January 1 and July 1 of each year.
On January 1, 2021, Parent repurchased all of Subsidiary's bonds for $96,400. The bonds are still held on December 31,
2021.
Both companies have correctly recorded all entries relative to bonds and interest, using straight-line amortization for
premium or discount.
Required:
Complete the Figure 5-4 worksheet for consolidated financial statements for the year ended of December 31, 2021. Round
Figure 5-4
Parent Sub. Adjustments
Interest Receivable 3,000
Investment in Sub. Bonds 96,800
Land 100,000 50,000

Rent Receivable (150,000) (70,000)
Goodwill

Discount on Bonds Payable 2,400


Net Sales (630,000) (360,000)
Dividend Income (27,000)
Gain on Retirement of Bonds

To NCI
Total NCI
0 0

Interest Receivable
Investment in Sub. Bonds
Land
Rent Receivable
Goodwill
Interest Payable
Other Current Liabilities
Bonds Payable, 6%
Discount on Bonds Payable
Common Stock P Co.
Common Stock S Co.

Net Sales
Cost of Goods Sold
Operating Expenses
Interest Expense

Interest Income
Dividend Income
Gain on Retirement of Bonds

To NCI
Total NCI

Answer 5-4
Interest Receivable 3,000 (B1) 3,000
Investment in Sub.
Company 450,000 (CV) 45,000 (EL) 360,000
(D) 135,000
Investment in Sub.
Bonds 96,800 (B2) 96,800
Land 100,000 50,000

Buildings and
Equipment 400,000 290,000
Accumulated
Depreciation (150,000) (70,000)
Goodwill (D) 150,000
Interest Payable (3,000) (B1) 3,000

Other Current
Liabilities (114,000) (70,000)
Bonds Payable, 6% (100,000) (B2) 100,000
Discount on Bonds
Payable 2,400 (B2) 2,400
Other Long-Term
Liabilities (200,000)
Other Paid-in Capital
P Co. (250,000)
Retained Earnings P
Co. (400,000) (CV) 45,000

S Co. (130,000) (EL) 117,000
Retained Earnings S
Co. (250,000) (EL) 225,000 (D) 15,000

Net Sales (630,000) (360,000)

Interest Expense 6,300 (B2) 6,300
Interest Income (6,400) (B2) 6,400
Dividend Income (27,000) (CY) 27,000
Dividends Declared P
Co. 50,000
Dividends Declared S
Co. 30,000 (CY) 27,000
Gain on Retirement of
Bonds (B2) 900
Consolidated Net
Income
To NCI
To Controlling
Interest
Total NCI
Ret. Earn. Contr. Int.
12-31
0 0 691,400 691,400

Interest Receivable 0
Investment in Sub. Bonds 0
Land 150,000
Accumulated Depreciation (220,000)
Goodwill 150,000
Interest Payable 0
Other Current Liabilities (184,000)
Bonds Payable, 6% 0
Discount on Bonds Payable 0

Net Sales (990,000)



Interest Expense 0
Interest Income 0
Dividend Income 0
Gain on Retirement of Bonds (900)

To NCI 7,070 (7,070)
Total NCI (59,070) (59,070)
Ret. Earn. Contr. Int. 12-31 581,830 (581,830)
0
Determination and Distribution of Excess Schedule:

Company Parent Price NCI Value
Fair Value (90%) (10%)
Fair value of subsidiary $500,000 $450,000 $ 50,000
Less book value of interest acquired:
Common stock 20,000
Paid-in capital in excess of par 130,000
Retained earnings 200,000
350,000 350,000 350,000
Interest acquired 90% 10%
Book value 315,000 35,000
Excess of fair value over book value $150,000 $135,000 $ 15,000
All assigned to goodwill $150,000
(CV) Convert to simple equity method as of January 1, 2021 (90% of $50,000 increase in S b s
retained earnings from January 1, 2019 to January 1, 2021).
(CY) Eliminate Parent s dividend income against dividends declared by Subsidiary.
(EL) Eliminate 90% of the Subsidiary Company equity balances at the beginning of the year
(D) Distribute the $150,000 excess of cost over book value to goodwill; allocate to Parent and
NCI.
(B1) Eliminate $3,000 of intercompany interest receivable and payable. ($100,000 x 6% x 1/2)
(B2) Eliminate all of the intercompany interest income and expense. Eliminate the balances in
investment in bonds, bonds payable, and discount on bonds payable. The resulting gain of
$900 is the gain as of beginning of year: on January 1, 2021 $97,300* carrying value of
bonds less $96,400 purchase price.
*Bond purchase amount was $97,000 + $300 amortization of discount ($3,000 / 10).
Subsidiary Company Income Distribution Schedule
Interest adjustment 100 Internally generated net income 69,900
Gain on retirement 900
Adjusted income 70,700
NCI Share 10%
NCI 7,070

Parent Company Income Distribution Schedule

Internally generated net income 123,200
90% × Sub's adjusted income 63,630
Controlling interest 186,830
DIFFICULTY: M
NOTES: cost method; straight-line amortization; consolidation in year bonds are purchased
this date, Subsidiary had common stock, other paid in capital, and retained earnings of $20,000, $130,000, and $200,000,
using the simple equity method.
On January 1, 2019, Subsidiary sold $100,000 par value of 6%, ten-year bonds for $97,000. The bonds pay interest semi-
annually on January 1 and July 1 of each year.
On January 1, 2021, Parent repurchased all of Subsidiary's bonds for $96,400. The bonds are still held on December 31,
2021.
Both companies have correctly recorded all entries relative to bonds and interest, using straight-line amortization for
premium or discount.
Required:
Prepare the eliminating entries pertaining to the intercompany purchase of bonds for the year ended December 31, 2021.

(B1) Interest payable (1) 3,000
Eliminate intercompany interest
receivable and payable. (payment date
January 1)
(B2) Interest income - Parent (2) 6,400
Interest expense - Subsidiary (3) 6,300
interest income and expense for the year.
Discount on bonds payable (4) 2,400
Investment in Subsidiary bonds (5) 96,800
payable.
Gain on retirement of bonds (6) 900
The resulting gain is $900 ($97,300
carrying value of bonds less $96,400
purchase price).
(1) $100,000 x 6% x 1/2 = $3,000

(2) Discount on parent purchase $100,000 - $96,400 = 3,600 / 9 = $400 amortization of
discount. Interest income = $6,400 (6,000 + 400)

(3) Original bond discount = $3,000 ($100,000 - 97,000); amortization of discount is $300
per year ($3,000 / 10). Interest expense = $6,300 (6,000 + 300)
(4) $3,000 - ($300 x 2 years) = 2,400
(5) $96,400 + 400 = 96,800
(6) Gain is $900 ($97,000 + 300) carrying value of bonds less $96,400 purchase price
DIFFICULTY: M
NOTES: straight-line amortization; consolidation in year bonds were purchased
this date, Subsidiary had common stock, other paid in capital, and retained earnings of $20,000, $130,000, and $200,000
respectively. Any excess of cost over book value is due to goodwill. Parent account for the Investment in Subsidiary using
the simple equity method.
On July 1, 2019, Subsidiary sold $100,000 par value of 9%, ten-year bonds for $106,755, which resulted in an effective
interest rate of 8%. The bonds pay interest semi-annually on January 1 and July 1 of each year. Subsidiary uses the
effective-interest method of amortizing the premium.
An amortization table for 2019 and 2021 is presented below:
Date Cash Int Interest Exp Premium Amort Premium Bal Carrying Value
7/1/19 6,755 106,755
12/31/19 4,500 4,270 230 6,525 106,525
7/1/21 4,500 4,261 239 6,286 106,286
12/31/21 4,500 4,251 249 6,037 106,037
On July 1, 2021, Parent repurchased all of Par's bonds for $94,153, which resulted in an effective interest rate of 10%. The
bonds are still held at year end.
Both companies have correctly recorded all entries relative to bonds and interest. The balance in the Investment in
Subsidiary Bonds account is $94,361 at December 31, 2021, and the parent recognized interest income of $4,708 during
the period.
Required:
Prepare the eliminating entries pertaining to the intercompany purchase of bonds for the year ending December 31, 2021.

(B1) Interest payable (1) 4,500
Eliminate intercompany interest
receivable and payable. (payment date
January 1)
interest income and expense for the year.
Premium on bond payable 6,037

payable.
Gain on retirement of bonds (2) 12,133
To recognize the gain on the retirement
of the bonds
(1) $100,000 x 9% x 1/2 = $4,500
(2) $106,286 carrying value of bonds less $94,153 purchase price
DIFFICULTY: M
NOTES: effective-interest method; consolidation in year of bond purchase which occurred July 1
this date Subsidiary had total owners' equity of $440,000. Any excess of cost over book value is due to goodwill. Parent
accounts for its investment in Subsidiary using the simple equity method.
On January 1, 2016, Parent held merchandise acquired from Subsidiary for $50,000. During 2016, Subsidiary sold
merchandise to Parent for $120,000, of which Parent holds $30,000 on December 31, 2016. Subsidiary's gross profit on
sales is 40%. On December 31, 2016, Parent still owes Subsidiary $5,000 for merchandise.
On December 31, 2016, Parent sold $100,000 par value of 11%, 10-year bonds for $106,232, which resulted in an
effective interest rate of 10%. The bonds pay interest semi-annually on June 30 and December 31. Parent uses the
effective-interest method of amortization for the premium.
An amortization table for 2017 and 2016 is presented below:
Cash Interest Premium Premium Debt
Interest Expense Amortization Balance Carrying
Value
12/31/16 6,232 106,232
6/30/17 5,500 5,312 (188) 6,044 106,044
12/31/17 5,500 5,302 (198) 5,846 105,846
6/30/16 5,500 5,292 (208) 5,638 105,638
12/31/16 5,500 5,282 (218) 5,420 105,420
On December 31, 2017, Subsidiary repurchased $50,000 par value of the bonds, paying a price equal to par. The bonds
are still held on December 31, 2016.
On December 31, 2016, Parent sold equipment with a cost of $50,000 and accumulated depreciation of $30,000 to
Subsidiary for $40,000. Subsidiary will use the equipment beginning in 2019.
Required:
Figure 5-7
Inventory, December 31 120,000 60,000

Investment in Parent Bonds 50,000

Land 140,000 100,000
Accumulated Depreciation (120,000) (130,000)
Goodwill
Current Liabilities (160,000) (80,000)

Premium on Bonds Payable (5,420)
Other Long-Term Liabilities (200,000) (140,000)

Net Sales (590,000) (520,000)


Gain on Sale of Equipment (20,000)

To NCI
Total NCI
0 0
Inventory, December 31
Investment in Parent Bonds

Land
Accumulated Depreciation
Goodwill
Current Liabilities
Bonds Payable, 10%
Premium on Bonds Payable
Common Stock P Co.
Common Stock S Co.

Net Sales
Cost of Goods Sold
Operating Expenses
Interest Income
Interest Expense
Subsidiary Income
Gain on Sale of Equipment

To NCI
Total NCI

Answer 5-7
Inventory, December
31 120,000 60,000 (EI) 12,000
Other Current Assets 399,620 325,000 (IA) 5,000
Investment in Sub.
Company 550,000 (CY) 60,000
(EL) 440,000
(D) 50,000
Investment in Parent 50,000 (B) 50,000
Bonds
Land 140,000 100,000
Buildings and
Equipment 325,000 440,000 (F) 10,000
Accumulated
Depreciation (120,000) (130,000) (F) 30,000
Goodwill (D) 62,500
Current Liabilities (160,000) (80,000) (IA) 5,000

Bonds Payable, 10% (100,000) (B) 50,000
Premium on Bonds
Payable (5,420) (B) 2,710
Other Long-Term
Liabilities (200,000) (140,000)
P Co. (100,000)
Retained Earnings P
Co. (489,200) (BI) 16,000 (B) 2,923

S Co. (200,000) (EL) 160,000
Retained Earnings S
Co. (250,000) (EL) 200,000 (D) 12,500
(BI) 4,000
Net Sales (590,000) (520,000) (IS) 120,000

Cost of Goods Sold 355,000 310,000 (EI) 12,000 (BI) 20,000
(IS) 120,000
Interest Income (5,500) (B) 5,500
Interest Expense 10,574 (B) 5,287
Gain on Sale of
Equipment (20,000) (F) 20,000
Dividends Declared P
Co. 50,000
Dividends Declared S
Co. 25,000 (CY) 20,000
Consolidated Net
Income
To NCI
To Controlling
Interest
Total NCI
12-31
0 0 827,710 827,710


Inventory, December 31 168,000

Investment in Parent Bonds 0

Land 240,000
Goodwill 62,500
Current Liabilities (235,000)

Premium on Bonds Payable (2,710)

Net Sales (990,000)


Interest Income 0
Subsidiary Income 0
Gain on Sale of Equipment 0

To NCI 21,600 (21,600)
Total NCI (135,100) (135,100)
0
Determination and Distribution of Excess Schedule:

Company Parent Price NCI Value
Fair Value (80%) (20%)
Fair value of subsidiary $502,500 $402,000 $ 100,500
Less book value of interest acquired:
Total o ners equity 440,000 440,000 440,000
Interest acquired 80% 20%
Book value 352,000 88,000
Excess of fair value over book value $ 62,500 $ 50,000 $ 12,500
All assigned to goodwill $ 62,500

(CY) Eliminate the current-year entries made in the investment account and in the subsidiary
income account; eliminate intercompany dividends.
(EL) Eliminate 80% of the Subsidiary Company equity balances at the beginning of the year
(D) Distribute the $62,500 excess of cost over book value to goodwill; allocate to Parent and
Noncontrolling Interest.
(BI) Eliminate the $20,000 ($50,000 x 40%) of gross profit in the beginning inventory.
(IS) Eliminate the entire intercompany sales of $120,000.
(EI) Eliminate the $12,000 ($30,000 x 40%) of gross profit in the ending inventory.
(IA) Eliminate the $5,000 intercompany accounts receivable and payable.
(B) Eliminate the interest income and the investment in bonds. Eliminate one-half of the
bonds payable, premium on bonds, and interest expense. The gain to Parent of $2,923 is
credited to retained earnings since it occurred in 2017.
(F) Eliminate the gain on sale of equipment ($40,000 - $20,000 Net book value), restore the
old accumulated depreciation of $30,000, and increase the equipment by $10,000 to
restore its original historical cost of $50,000.
Subsidiary Company Income Distribution Schedule

Deferred profit in ending 12,000 Internally generated net income 100,000
inventory
Realized profit in beginning 20,000
inventory
Adjusted income 108,000
NCI Share 20%
NCI 21,600
Parent Company Income Distribution Schedule

Defer gain on sale 20,000 Internally generated net income 130,000
Amortize gain on debt retirement 213
80% × Sub's adjusted income 86,400
Controlling interest 196,187
DIFFICULTY: D
47. Smart Corporation is a 90%-owned subsidiary of Phan Inc. On January 2, 2016, Smart agreed to lease $400,000 of
construction equipment from Phan for $3,000 a month on an operating lease. The equipment has a 10-year life and is
being depreciated using the straight-line method.
Required:
Prepare the eliminations and adjustments required by the intercompany lease on the Figure 5-8 partial worksheet for
December 31, 2016. Key and explain all eliminations and adjustments.
Figure 5-8
Phan Inc. and Smart Corp.
Consolidated Partial Worksheet
For the Year Ended December 31, 2016
Eliminations and
Trial Balance Adjustments
Debit
Phan Smart Debit Credit
Equipment 987,000 40,000
Accumulated Depreciation -
Equipment (212,500) (8,000)
Equipment Under
Operating Lease 400,000
Equipment Under
Operating Lease (120,000)
Rent Receivable 3,000
Rent Payable (3,000)
Rental Income (50,000)
Rent Expense 36,000
Depreciation Expense 138,700 2,000

Answer 5-8
Phan Inc. and Smart Corp.
Eliminations and
Debit
Phan Smart Debit Credit
Equipment 987,000 40,000 (OL2) 400,000
Accumulated
Depreciation -
Equipment (212,500) (8,000) (OL2) 120,000
Equipment Under
Operating
Lease 400,000 (OL2) 400,000
Accumulated
Depreciation -
Equipment Under
Operating
Lease (120,000) (OL2) 120,000
Rent Receivable 3,000 (OL1b) 3,000
Rent Payable (3,000) (OL1b) 3,000
Rental Income (50,000) (OL1a) 36,000
Rent Expense 36,000 (OL1a) 36,000
559,000 559,000

(OL1a) Eliminate intercompany rent expense/revenue of $3,000 per month.

(OL1b) Eliminate one month's accrued rent receivable and payable.
(OL2) Reclassify asset under the intercompany operating lease and related
accumulated depreciation.
DIFFICULTY: E
NOTES: operating lease
48. Tempo Industries is an 80%-owned subsidiary of Dalie Inc. On January 1, 2017, Dalie leased an asset to Tempo and
the following journal entries were made:
Tempo
Assets Under Capital Lease 21,561
Cash 5,000
Obligations Under Capital Lease 16,561
Dalie
Minimum Lease Payments Receivable 20,000
Cash 5,000
Unearned Interest Income 3,439
Asset (cost of asset leased) 18,000
Sales Profit on Leases 3,561
The terms of the lease agreement require Tempo to make five payments of $5,000 each at the beginning of each year. The
implicit interest rate used by both Dalie and Tempo is 8%.
Required:
Prepare the eliminations and adjustments required by the intercompany lease on the Figure 5-9 partial worksheet of
Figure 5-9
Dalie and Tempo Industries
Eliminations and
Account Titles Dalie Tempo Debit Credit
Minimum Lease Payments 20,000
Receivable
Unearned Interest Income (2,114)
Assets Under Capital Lease 21,561
Assets Under Capital Lease (4,312)
Plant Assets 410,000 260,000
Plant Assets (167,000) (98,000)
Obligations Under Capital
lease (16,561)
Sales Profit on Leases (3,561)

Answer 5-9
Dalie and Tempo Industries
Eliminations and
Account Titles Dalie Tempo Debit Credit
Minimum Lease Payments 20,000 (CL2) 20,000
Receivable
Unearned Interest Income (2,114) (CL2) 2,114
Assets Under Capital Lease 21,561 (CL2) 21,561
- Assets Under Capital
Lease (4,312) (CL3) 4,312
Plant Assets 410,000 260,000 (CL2) 21,561 (CL4) 3,561
- Plant Assets (167,000) (98,000) (CL5) 712 (CL3) 4,312
Obligations Under Capital
lease (16,561) (CL2) 16,561
Interest Payable (1,325) (CL2) 1,325
Interest Income (1,325) (CL1) 1,325
Sales Profit on Leases (3,561) (CL4) 3,561
Interest Expense 1,325 (CL1) 1,325
Depreciation Expense 17,500 10,470 (CL5) 712
51,471 51,471

(CL1) Eliminate intercompany interest expense/revenue.
(CL2) Eliminate intercompany debt and unearned income; eliminate the asset under
capital lease and record the owned asset.
(CL3) Reclassify depreciation.
(CL4) Reduce cost of asset for gain on sales-type lease.
(CL5) Reduce depreciation 3,561 ÷ 5 = 712 per year, to recognize one year's profit.
DIFFICULTY: M
NOTES: direct financing lease; consolidation in year of inception of lease
49. On January 1, 2016 Parent Company acquired 90% of the common stock of Subsidiary Company for $360,000. On
On January 1, 2017, Parent purchased equipment for $204,110 and immediately leased the equipment to Subsidiary on a
4-year lease. The minimum lease payments of $60,000 are to be made annually on January 1, beginning immediately, for
a total of 4 payments. The implicit interest rate is 12%. The lease provides for an automatic transfer of title at the end of 4
years. The estimated useful life of the equipment is 6 years. The lease has been capitalized by both companies. The lease
amortization schedule is presented below:
Interest on
previous Gross Unearned
Date Payment Receivable Interest Carrying Value
balance
1/1/17 240,000 (35,890) 204,110
1/1/17 60,000 180,000 (35,890) 144,110
1/1/16 60,000 17,293 120,000 (18,597) 101,403
1/1/19 60,000 12,168 60,000 (6,429) 53,571
1/1/21 60,000 6,429 0 0 0
Required:
Prepare the eliminations and adjustments required by the intercompany lease on the Figure 5-10 partial worksheet as of
Figure 5-10
Min. Lease Payments Rec. 180,000
Equipment under Cap. Lease 204,110
Acc. Depr. - Eq. Cap. Lease (34,018)
Obligation under Cap. Lease (144,110)
Interest Payable on Lease (17,293)
Interest Income on Lease (17,293)
Interest Expense on Lease 17,293

Min. Lease Payments Rec.
Unearned Interest Income
Acc. Depr. - Bldg & Equip

Equipment under Cap. Lease
Acc. Depr. - Eq. Cap. Lease
Obligation under Cap. Lease
Interest Payable on Lease
Interest Income on Lease
Interest Expense on Lease
ANSWER: For the partial worksheet solution, please refer to Answer 5-10.
Answer 5-10
Min. Lease Payments
Rec. 180,000 (CL2) 180,000
Unearned Interest
Income (18,597) (CL2) 18,597
Buildings and
Equipment 350,000 300,000 (CL3) 204,110
Accumulated
Depreciation (100,000) (50,000) (CL4) 34,018
Equipment under Cap.
Lease 204,110 (CL3) 204,110
Acc. Depr. - Eq. Cap.
Lease (34,018) (CL4) 34,018
Obligation under Cap.
Lease (144,110) (CL2) 144,110
Interest Payable on
Lease (17,293) (CL2) 17,293
Interest Income on
Lease (17,293) (CL1) 17,293
Interest Expense on
Lease 17,293 (CL1) 17,293

Min. Lease Payments Rec. 0
Unearned Interest Income 0
Equipment under Cap. Lease 0
Acc. Depr. - Eq. Cap. Lease 0
Obligation under Cap. Lease 0
Interest Payable on Lease 0
Interest Income on Lease 0
Interest Expense on Lease 0
(CL1) Eliminate the intercompany interest income and expense on the lease obligation (per
table).
(CL2) Eliminate the intercompany receivable and payable on the leased asset. The receivable
balance is $161,403 ($180,000 minimum lease payment receivable less unearned
interest of $18,597). The payable is also $161,403 ($144,110 lease obligation payable
plus $17,293 interest payable).
(CL3) Reclassify the leased equipment as Building and Equipment.
(CL4) Reclassify the accumulated depreciation on the leased equipment.
Note that consolidated net income is not impacted because equal amounts of interest expense
and revenue were eliminated.
DIFFICULTY: M
NOTES: capital lease, end of first year
50. On January 1, 2016, Parent Company acquired 90% of the common stock of Subsidiary Company for $360,000. On
respectively. Any excess of cost over book value is due to goodwill. Parent uses the simple equity method to account for
its investment in subsidiary.
years. The estimated useful life of the equipment is 6 years. The lease has been capitalized by both companies. A lease
amortization schedule, applicable to either company, is presented below:
Interest on
previous Gross Unearned
Date Payment Receivable Interest Carrying Value
balance
1/1/17 240,000 (35,890) 204,110
1/1/17 60,000 180,000 (35,890) 144,110
1/1/16 60,000 17,293 120,000 (18,597) 101,403
1/1/19 60,000 12,168 60,000 (6,429) 53,571
1/1/21 60,000 6,429 0 0 0
Required:
Figure 5-11

ANSWER:
For the partial worksheet solution, please refer to Answer 5-11.
Answer 5-11
Min. Lease Payments
Rec. 120,000 (CL2) 120,000
Unearned Interest
Income (6,429) (CL2) 6,429
Buildings and
Equipment 350,000 300,000 (CL3) 204,110
Accumulated
Depreciation (120,000) (80,000) (CL4) 68,037
Lease 204,110 (CL3) 204,110
Lease (68,037) (CL4) 68,037
Lease (101,403) (CL2) 101,403
Interest Payable on
Lease (12,168) (CL2) 12,168
Interest Income on
Lease (12,168) (CL1) 12,168
Interest Expense on
Lease 12,168 (CL1) 12,168


table).
interest of $6,429).
The payable is also $113,571 ($101,403 lease obligation payable plus $12,168 interest
payable).
(CL3) Reclassify the leased equipment as ordinary Building and Equipment.
Note that consolidated net income is not impacted because equal amounts of interest
expense and revenue were eliminated.
DIFFICULTY: M
NOTES: capital lease, end of second year
years. The estimated useful life of the equipment is 6 years. The lease has been capitalized by both companies.
A lease amortization schedule, applicable to either company, is presented below:
Carrying Carrying Interest Principal
Value on Value Rate Interest Payment Reduction
1-1-17 $204,120
- 60,000
1-1-17 144,120 12% $17,294 $60,000 $42,706
- 42,706
1-1-16 101,414 12% 12,170 60,000 47,830
- 47,830
1-1-19 53,584 12% 6,416* 60,000 53,584
- 53,584
1-1-21 $ 0 *Adjusted for rounding error.
On January 1, 2016, Parent held merchandise acquired from Subsidiary for $10,000. During 2016, subsidiary sold
merchandise to Parent for $50,000, of which $15,000 is held by Parent on December 31, 2016. Subsidiary's usual gross
profit on affiliated sales is 40%.
Required:
Figure 5-12
Current Assets 234,196 280,504

Land 100,000 60,000

Goodwill

Other Long-Term Liabilities (200,000) (15,000)

Net Sales (600,000) (350,000)

Operating & Other Expenses 140,000 67,830



To NCI
Total NCI
0 0

Current Assets

Land
Goodwill
Current Liabilities
Common Stock P Co.
Common Stock S Co.

Net Sales
Cost of Goods Sold
Operating & Other Expenses

Subsidiary Income

To NCI
Total NCI

Answer 5-12
Current Assets 234,196 280,504 (EI) 6,000
Min. Lease Payments

Rec. 120,000 (CL2) 120,000
Unearned Interest
Income (6,416) (CL2) 6,416
Investment in Sub.
Company 560,000 (CY) 60,000
(EL) 460,000
(D) 40,000
Land 100,000 60,000

Buildings and
Equipment 350,000 300,000 (CL3) 204,120
Accumulated
Depreciation (120,000) (80,000) (CL4) 68,040
Lease 204,120 (CL3) 204,120
Lease (68,040) (CL4) 68,040
Goodwill (D) 40,000

Lease (101,414) (CL2) 101,414
Interest Payable on
Lease (12,170) (CL2) 12,170
Other Long-Term
Liabilities (200,000) (15,000)
Common Stock P
Co. (200,000)
P Co. (100,000)
Retained Earnings P
Co. (482,780)
(BI) 4,000
Common Stock S
Co. (50,000) (EL) 50,000
S Co. (100,000) (EL) 100,000
Retained Earnings S
Co. (310,000) (EL) 310,000
Net Sales (600,000) (350,000) (IS) 50,000

Cost of Goods Sold 372,170 200,000 (EI) 6,000 (BI) 4,000
(IS) 50,000
Operating & Other
Expenses 140,000 67,830
Interest Income on
Lease (12,170) (CL1) 12,170
Interest Expense on
Lease 12,170 (CL1) 12,170
Dividends Declared
P Co. 50,000
Dividends Declared
S Co. 10,000 (CY) 10,000
Consolidated Net
Income
To NCI
To Controlling
Interest
Total NCI
12-31
0 0 1,034,330 1,034,330

Current Assets 508,700

Land 160,000
Goodwill 40,000
Current Liabilities (183,000)


Common Stock S Co.

Net Sales (900,000)

Operating & Other Expenses 207,830

Subsidiary Income 0

To NCI 0
Total NCI 0
0
(CY) Eliminate Parent s current-year simple equity method entries.
(EL) Eliminate the Subsidiary Company equity balances at the beginning of the year against
the investment account.
(D) Distribute the $40,000 ($390,000 - ($50,000 + $100,000 + $200,000)) excess of cost
over book value to goodwill.
table).
payable).
(BI) Eliminate the $4,000 ($10,000 x 40%) of gross profit in the beginning inventory.
(IS) Eliminate the entire intercompany sales of $50,000.
(EI) Eliminate the $6,000($15,000 x 40%) of gross profit in the ending inventory.
DIFFICULTY: D
52. On January 1, 2016, Parent Company acquired 100% of the common stock of Subsidiary Company for $365,000. On
respectively. Any excess of cost over book value is due to goodwill. Parent uses the simple equity method to account for
its investment in subsidiary.
4-year lease. The transaction was legally structured as a sales-type lease with a present value for the minimum lease
payments of $204,120. Parent recorded the following entry:
Minimum Lease Payments Receivable 240,000
Unearned Interest Income 35,880
Equipment 174,120
Sales Profit on Lease 30,000
The minimum lease payments of $60,000 are to be made annually on January 1, beginning immediately, for a total of 4
payments. The implicit interest rate is 12%. The lease provides for an automatic transfer of title at the end of 4 years. The
estimated useful life of the equipment is 6 years. The lease has been capitalized by both companies.
A lease amortization schedule, applicable to either company, is presented below:
Carrying Carrying Interest Principal
Value on Value Rate Interest Payment Reduction
1-1-17 $204,120
- 60,000
1-1-17 144,120 12% $17,294 $60,000 $42,706
- 42,706
1-1-16 101,414 12% 12,170 60,000 47,830
- 47,830
1-1-19 53,584 12% 6,416* 60,000 53,584
- 53,584
1-1-21 $ 0 *Adjusted for rounding error.
Required:
Figure 5-13
Operating & Other Expenses 120,000 42,706
Sales Profit on Lease (30,000)

Operating & Other Expenses
Sales Profit on Lease
ANSWER: For the partial worksheet solution, please refer to Answer 5-13.
Answer 5-13
Min. Lease Payments
Rec. 180,000 (CL2) 180,000
Unearned Interest
Income (18,586) (CL2) 18,586
Buildings and
Equipment 350,000 300,000 (CL3) 204,120 (CL5) 30,000
Accumulated
Depreciation (100,000) (50,000) (CL6) 5,000 (CL4) 34,020
Lease 204,120 (CL3) 204,120
Lease (34,020) (CL4) 34,020
Lease (144,120) (CL2) 144,120
Interest Payable on
Lease (17,294) (CL2) 17,294
Operating & Other
Expenses 120,000 42,706 (CL6) 5,000
Interest Income on
Lease (17,294) (CL1) 17,294
Interest Expense on
Lease 17,294 (CL1) 17,294
Sales Profit on Lease (30,000) (CL5) 30,000


Operating & Other Expenses 157,706
Sales Profit on Lease 0
table).
payable).
(CL5) Eliminate the Sales Profit on Lease and adjust the leased asset back to cost.
(CL6) Adjust depreciation on the leased asset. ($30,000 / 6 years) The credit to depreciation
expense treats part of the sales-type lease profit as realized to the Parent through use by
Subsidiary.
DIFFICULTY: M
Essay
53. The Planes Company owns 100% of the outstanding common stock of the Sands Company. Sands issued $100,000 of
face value, 9%, 10-year bonds on January 1, 2016, for $96,000. The discount is being amortized on a straight-line basis.
On January 1, 2018, Planes purchased all the bonds as an investment for $95,000.
Required:
Be specific in answering the following questions and include numerical explanations.
a. How will this bond issue be recorded and accounted for in 2018 on the separate books of
Planes and Sands?
b. How will this bond issue be accounted for on the 2018 consolidated statements?
c. How will this bond issue be recorded and accounted for in 2019 on the separate books of
Planes and Sands?
d. How will this bond issue be accounted for on the 2019 consolidated statements?
ANSWER: a. Planes will show the bonds as an investment and will amortize the purchase discount
at the rate of $1,000 per year. Planes will record interest income of $10,000 ($9,000
cash + $1,000 discount amortization). Sands will continue to treat the bonds as

outstanding and will record interest expense of $9,400 ($9,000 cash + $400 discount
amortization).
b. The bonds are considered as retired on January 1, 2018, at a gain of $3,000 ($98,000
book value less $95,000 price). No interest expense or revenue should appear in the
consolidated statements.
c. In 2019, Planes will continue to show the bonds as an investment and will record
$10,000 interest revenue. Sands will continue to treat the bonds as outstanding and
will record $9,400 interest expense.
d. The consolidated statements will not include the bonds as an investment or as a
liability. No interest expense or revenue will be applicable to these bonds.
DIFFICULTY: M
54. The Park Company owns 80% of the outstanding common stock of the Sea Company. Park is about to lease a machine
with a 5-year life to the Sea Company. The lease would begin January 1, 2016.
Required:
Explain the adjustments that will be required in the consolidation process if each of the following occurs.
a. The lease is an operating lease.
b. The lease is a direct financing lease with a bargain purchase option.
c. The lease is a sales-type lease with a bargain purchase option.
ANSWER: a. The intercompany rent expense and rent revenue are eliminated. The asset and related
accumulation should be reclassified as normal productive assets.
b. The intercompany interest expense and revenue recorded on the lease obligation are
eliminated. The liability obligation under capital lease is eliminated against the asset,
present value of minimum lease payments. The asset--machine under capital lease
should be reclassified as a normal productive asset.
c. In addition to the procedures outlined in part b, the sales profit is eliminated and the
asset is reduced to its cost to the consolidated group. Depreciation expense is reduced to
that applicable to the cost of the asset to the consolidated group.
DIFFICULTY: M
ADAC.FISC.5-5
ADAC.FISC.5-6

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Chapter 05—Intercompany Transactions: Bonds and Leases

b. not needed except in the period of acquisition if purchased at a premium or discount.

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LEARNING OBJECTIVES: ADAC.FISC.5-2

Less discount ($12,000 x 1/2 x 2/5*) (2,400) 97,600

26. The effect of an operating lease on the income distribution schedule:

27. Lease terms can be considered to be "significantly affected":

33. Consolidation procedures for sales-type leases:

34. Which of the following statements is true?

35. Which of the following statements is true?

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39. When a parent buys subsidiary bonds:

Subjective Short Answer

Investment in Sub. Bonds 162,278

Land 50,000 30,000

Interest Payable (15,000)

Other Long-Term Liabilities (200,000)

Common Stock S Co. (50,000)

Net Sales (500,000) (400,000)

Consolidated Net Income

Consol. Control. Consol.

Investment in Sub. Bonds

Other Long-Term Liabilities

Common Stock S Co.

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ANSWER: For the worksheet solution, please refer to Answer 5-1.

Land 50,000 30,000

Interest Payable (15,000) (B1) 7,500

Common Stock S Co. (50,000) (EL) 50,000

Net Sales (500,000) (400,000)

Consolidated Net Income

Consol. Control. Consol.

Investment in Sub. Bonds 0

Interest Payable (7,500)

Other Long-Term Liabilities (200,000)

Common Stock S Co.

Net Sales (900,000)

Consolidated Net Income (174,500)

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Eliminations and Adjustments:

The resulting loss is $12,695 ($112,695

LEARNING OBJECTIVES: ADAC.FISC.5-2

Investment in Sub. Bonds 96,800

Land 100,000 50,000

Interest Payable (3,000)

Common Stock S Co. (20,000)

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Consolidated Net Income

Consol. Control. Consol.

Investment in Sub. Bonds

Common Stock S Co.

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Consolidated Net Income

ANSWER: For the worksheet solution, please refer to Answer 5-4.

Land 100,000 50,000

Interest Payable (3,000) (B1) 3,000

Common Stock S Co. (20,000) (EL) 18,000

Cengage Learning Testing, Powered by Cognero Page 22

Net Sales (630,000) (360,000)

Consol. Control. Consol.

Investment in Sub. Bonds 0

Common Stock S Co. (2,000)

Net Sales (990,000)