[nalratoss]

I have watched the Roger videos and reading the Gleim chapters. This was one of my weakness in undergrad as I never understood this. Finally two CPA review courses have helped me understand this. They explain elimination of intercompany transactions pretty well, except for the part about bonds.

Wagner, a holder of a $1,000,000 Palmer, Inc. bond, collected the interest due on March 31, year 2, and then sold the bond to Seal, Inc. for $975,000. On that date, Palmer, a 75% owner of Seal, had a $1,075,000 carrying amount for this bond. What was the effect of Seal’s purchase of Palmer’s bond on the retained earnings and noncontrolling interest amounts reported in the March 31, year 3 consolidated balance sheet?
Retained earnings | Noncontrolling interest
A. $ 100,000 increase | $ 0
B. $ 75,000 increase | $ 25,000 increase
C. $ 0 | $ 25,000 increase
D. $ 0 | $ 100,000 increase

First of all, I assume Palmer is the acquirer and Seal is the acquiree. So Seal, the sub, is buying a bond from the parent. But then I got lost, as I don’t know where did the elimination entry come out from:

The Roger textbook tells me an elimination entry looks like this
Let’s assume that the acquiree issued an 8% bond at its 1000 face value several years ago, and the acquirer purchased the bond on the open market for $900 plus accrued interest on 12/31/x1. Also assume the bond pays interest annually on Jan 1st.

DR Bond Payable
CR Investment in Bond
CR Gain on retirement

Note that the purchase of the bond of one company by the other is treated as an early retirement.

[nalratoss]

I guess what confuses me is that I don't know the original journal entry from the transaction between acquirer and acquiree. Thus, I don't understand that elimination try 🙂

[fragchild]

It's a tough question. Is the answer A?

[Anonymous]

Yes, the answer is A. Not because I'm smart, but because I looked it up. I had to read the problem 4 times to even realize that there were 3 companies involved. Geez! Seal the sub is buying the bond from an outsider, Wagner. So now the Parent Palmer has a bond payable to Seal, its sub.

According to Becker, the rule is:

If one member of the consolidated group acquires an affiliate's debt from an outsider, the debt is considered to be retired and a gain/loss is recognized on the consolidated income statement.

Gain/loss is the difference between the price paid to acquire the debt and the book value of the debt.

The gain/loss is not reported on either company's books, but is recorded through an elimination entry. All intercompany account balances are also eliminated.

To record issue of bond in previous years on Parent's books:
Dr Cash 1,075,000
CR Bonds payable to outsider 1,000,000
CR Premium on bonds payable 75,000

To record purchase of bond on Sub's books:
DR Investment in bond 975,000
CR Cash to outsider 975,000

Elimination entry to eliminate intercompany balances and recognize gain on retired debt:
DR Bonds payable 1,000,000
DR Premium 75,000
CR Investment in bond 975,000
CR Gain on extinguishment 100,000

So, balances on consolidated books:
Bonds payable 0
Premium 0
Investment in bond 0
Gain $100,000

[Author]

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