CHAPTER 11

INTERCOMPANYBOND HOLDINGS

SECTION

FOCUS OF CHAPTER 11• The Constructive Retirement of the

Bonds• Calculating the Gain or Loss on

Extinguishment of Debt

The Consolidated Perspective

• From a consolidated viewpoint, the purchase by one member of any or all of the outstanding bonds of another member constitutes a constructive retirement of the bonds.

Paxco

Saxco

Consolidated Group

Ways to Acquire Bonds of a Group Member: Directly & Indirectly

• Intercompany bond holdings can arise in two ways:– DIRECT transactions—One member

issues bonds to another member.– INDIRECT transactions—One member

acquires in the marketplace the outstanding bonds of another member.

• The result of an indirect transaction is as if a direct transaction had occurred.

The Constructive Retirementof the Bonds: Reporting Results

• The constructive retirement of the bonds results in reporting in consolidation:– An imputed gain or loss—in the period

of the bond acquisition.– An nonextraordinary item (per FAS

145).– No future interest income or interest

expense on the intercompany bond investment or liability, respectively.

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Calculating the Imputed Gain or Loss: Done At the Acquisition Date

• Compare at the acquisition date:– The acquiring entity’s cost—excluding

any amount related to purchased interest—with

– The issuing entity’s carrying value of the intercompany portion of the bonds.

Calculating the Imputed Gain or Loss: Done At the Acquisition Date

• Compare at the acquisition date:– The acquiring entity’s cost—excluding

any amount related to purchased interest—with

– The issuing entity’s carrying value of the intercompany portion of the bonds.

Premiums and Discounts:They Result in Gains or Losses

Issuer Has

Acquirer Has

Reporting Result

Premium Discount GAIN Discount Premium LOSS Premium Premium GAIN OR LOSS* Discount Discount GAIN OR LOSS*

*It depends on which entity has the larger item.

Partial Ownerships: Determining the NCI Share of the Gain or Loss

• Three possible ways exist for assigning a portion of the imputed gain or loss to the NCI:– The Parent Company Method: Assign 100%

to the parent (an arbitrary method).– The Issuing Company Method: Assign 100%

to the issuing company (an arbitrary method).– The Face Value Method: Assign only the

subsidiary’s premium or discount to the NCI(based on legal boundary realities).

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Partial Ownerships: Determining the NCI Share of the Gain or Loss

• Three possible ways exist for assigning a portion of the imputed gain or loss to the NCI:– The Parent Company Method: Assign 100%

to the parent (an arbitrary method).– The Issuing Company Method: Assign 100%

to the issuing company (an arbitrary method).– The Face Value Method: Assign only the

subsidiary’s premium or discount to the NCI(based on legal boundary realities).

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Simplified Procedures: Eliminating Premiums and Discounts in the G/L

• Rationale for These Procedures—Substance Over Form: The parent can either– (1) Loan money to the subsidiary for it

to retire bonds held by the parent or– (2) Have the subsidiary lend money to the

parent for it to retire its own bonds held by the subsidiary.

– The results are identical to that of eliminating the premiums and discounts in the G/L.

Review Question #1On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/1/06, and (4) semiannual interest payments (on 1/1 and 7/1). What is the 2006 consolidated reportable gain or loss?A. $1,000 loss. B. $7,000 loss. C. $2,000 gainD. $11,000 gain

Review Question #1With Answer

On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/1/06, and (4) semiannual interest payments (on 1/1 and 7/1). What is the 2006 consolidated reportable gain or loss?A. $1,000 loss. B. $7,000 loss. C. $2,000 gain ([$520,000 x 60%] - [$319,000 - $9,000 for interest])D. $11,000 gain

Review Question #2On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/3/06, and (4) semiannual interest payments (on 7/1 and 1/1). What is the unrealized gain at 12/31/06?A. $ -0- B. $500 C. $1,500 D. $2,000

Review Question #2With Answer

On 10/1/06, Pondex paid $319,000 to acquire 60% of Sondex’s 12% bonds having (1) a face value of $500,000 and (2) a carrying value of $520,000, (3) a maturity date of 1/3/06, and (4) semiannual interest payments (on 7/1 and 1/1). What is the unrealized gain at 12/31/06?A. $ -0- B. $500 C. $1,500 ($2,000 x 3/4 unexpired)D. $2,000

End of Chapter 11• Time to Clear Things Up—Any

Questions?