Chapter 08 Intercompany Indebtedness Answer Key
 

Multiple Choice Questions
 1. Cutler Company owns 80 percent of the common stock of Marina Inc. Cutler acquires some of Marina’s bonds from an unrelated party for less than the carrying value on Marina’s books and holds them as a long-term investment. For consolidated reporting purposes, how is the acquisition of Marina’s bonds treated? 
A. As a decrease in the Bonds Payable account on Marina’s books.
B. As an increase in noncurrent assets.
C. Everything related to the bonds is eliminated in the consolidation worksheet, and nothing related to the bonds appears in the consolidated financial statements.
D. As a retirement of bonds.

2. Culver owns 80 percent of the common stock of Fowler Company. Culver also purchases some of Fowler’s bonds directly from Fowler and holds the bonds as a long-term investment. How is the acquisition of the bonds treated for consolidated reporting purposes? 
A. As a retirement of bonds.
B. As an increase in the Bonds Payable account on Fowler’s books.
C. Everything related to the bonds is eliminated in the consolidation worksheet, and nothing related to the bonds appears in the consolidated financial statements.
D. As an increase in noncurrent assets.

3. At the end of the year, a parent acquires a wholly owned subsidiary’s bonds from unaffiliated parties at a cost less than the subsidiary’s carrying value. The consolidated net income for the year of acquisition should include the parent’s separate operating income plus: 
A. the subsidiary’s net income increased by the gain on constructive retirement of debt.
B. the subsidiary’s net income decreased by the gain on constructive retirement of debt.
C. the subsidiary’s net income increased by the gain on constructive retirement of debt, and decreased by the subsidiary’s bond interest expense.
D. the subsidiary’s net income decreased by the gain on constructive retirement of debt, and decreased by the subsidiary’s bond interest expense.

4. A loss on the constructive retirement of a parent’s bonds by a subsidiary is effectively recognized in the accounting records of the parent and its subsidiary:
I. at the date of constructive retirement.
II. over the remaining term of the bonds. 
A. I
B. II
C. Both I and II
D. Neither I nor II

5. When one company purchases the debt of an affiliate from an unrelated party, a gain or loss on the constructive retirement of debt is recognized by which of the following?
   
A. Option A
B. Option B
C. Option C
D. Option D

6. Which of the following statements is (are) correct?
I. The amount assigned to the noncontrolling interest may be affected by a constructive retirement of bonds.
II. A constructive retirement of bonds normally results in an extraordinary gain or loss.
III. In constructive retirement, the bonds are considered outstanding, even though they are treated as if they were retired in preparing consolidated financial statements. 
A. I
B. II
C. I and III
D. I, II, and III

 
7. On January 1, 20X6, Nichols Corporation issued 10-year bonds at par to unrelated parties. The bonds pay interest of $15,000 every June 30 and December 31. On December 31, 20X9, Harn Corporation purchased all of Nichols’ bonds in the open market at a $6,000 discount. Harn is Nichols’ 80 percent owned subsidiary. Harn uses the straight line method of amortization. The consolidated income statement for the year 20X9 should report with respect to the bonds:
I. interest expense of $30,000.
II. an extraordinary gain of $6,000. 
A. I
B. II
C. Either I or II
D. Neither I nor II

 Light Corporation owns 80 percent of Sound Company’s voting shares. On January 1, 20X7, Sound sold bonds with a par value of $300,000 at 95. Light purchased $200,000 par value of the bonds; the remainder was sold to nonaffiliates. The bonds mature in ten years and pay an annual interest rate of 6 percent. Interest is paid semiannually on January 1 and July 1.

8. Based on the information given above, what amount of interest expense should be reported in the 20X8 consolidated income statement? 
A. $6,000
B. $6,500
C. $5,000
D. $10,000

 9. Based on the information given above, what amount of interest receivable will be recorded by Light Corporation on December 31, 20X8, in its separate financial statements? 
A. $5,000
B. $6,500
C. $10,000
D. $6,000

10. Based on the information given above, what amount of interest expense will be eliminated in the preparation of the 20X8 consolidated financial statements? 
A. $13,000
B. $13,500
C. $10,000
D. $15,000

 Master Corporation owns 85 percent of Servant Corporation’s voting shares. On January 1, 20X8, Master Corporation sold $200,000 par value 8 percent bonds to Servant for $245,000. The bonds mature in 10 years and pay interest semiannually on January 1 and July 1.

 11. Based on the information given above, in the preparation of the 20X8 consolidated financial statements, premium on bonds payable will be: 
A. debited for $45,000 in the eliminating entries.
B. credited for $40,500 in the eliminating entries.
C. debited for $40,500 in the eliminating entries.
D. credited for $45,000 in the eliminating entries.

12. Based on the information given above, in the preparation of the 20X8 consolidated financial statements, interest income will be: 
A. debited for $11,500 in the eliminating entries.
B. credited for $11,500 in the eliminating entries.
C. debited for $16,000 in the eliminating entries.
D. credited for $16,000 in the eliminating entries.

13. Based on the information given above, what amount of investment in bonds will be eliminated in the preparation of the 20X8 consolidated financial statements? 
A. $240,500
B. $200,000
C. $245,000
D. $211,500

 Moon Corporation issued $300,000 par value 10-year bonds at 107 on January 1, 20X3, which Star Corporation purchased. On July 1, 20X7, Sun Corporation purchased $120,000 of Moon bonds from Star. The bonds pay 12 percent interest annually on December 31. The preparation of consolidated financial statements for Moon and Sun at December 31, 20X9, required the following eliminating entry:
  

14. Based on the information given above, what percentage of the subsidiary’s ownership does the parent company hold? 
A. 75 percent
B. 65 percent
C. 80 percent
D. 95 percent

15. Based on the information given above, what amount did Sun pay when it purchased the bonds on July 1, 20X7? 
A. $118,020
B. $118,920
C. $118,620
D. $117,220

16. Based on the information given above, what amount of gain or loss on bond retirement is included in the 20X7 consolidated income statement? 
A. $6,600
B. $4,800
C. $6,000
D. $5,400

17. Based on the information given above, if 20X9 consolidated net income of $50,000 would have been reported without the eliminating entry provided, what amount will actually be reported? 
A. $47,900
B. $48,200
C. $49,400
D. $48,800

 ABC, a holder of a $400,000 XYZ Inc. bond, collected the interest due on June 30, 20X8, and then sold the bond to DEF Inc. for $365,000. On that date, XYZ, a 90 percent owner of DEF, had a $450,000 carrying amount for this bond.

18. Based on the information given above, what amount of gain or loss on bond retirement was recorded? 
A. No gain or loss
B. $85,000 gain
C. $85,000 loss
D. $35,000 loss

19. Based on the information given above, what was the effect of DEF’s purchase of XYZ’s bond on the noncontrolling interest amount reported in XYZ’s June 30, 20X8, consolidated balance sheet? 
A. No effect
B. $35,000 increase
C. $8,500 decrease
D. $8,500 increase

 .
 

 Granite Company issued $200,000 of 10 percent first mortgage bonds on January 1, 20X4, at 105. The bonds mature in 10 years and pay interest semiannually on January 1 and July 1. Mortar Corporation purchased $140,000 of Granite’s bonds from the original purchaser on December 31, 20X8, for $125,000. Mortar owns 75 percent of Granite’s voting common stock.

20. Based on the information given above, what amount of premium on bonds payable will be eliminated in the preparation of the 20X8 consolidated financial statements? 
A. $3,500
B. $2,800
C. $5,000
D. $2,500

 21. Based on the information given above, what amount of gain or loss on bond retirement will be reported in the 20X8 consolidated financial statements? 
A. $17,000 loss
B. $12,800 loss
C. $18,500 gain
D. $22,200 gain

22. Based on the information given above, what amount of premium on bonds payable will be eliminated in the preparation of the 20X9 consolidated financial statements? 
A. $3,500
B. $2,800
C. $5,000
D. $2,500

23. Based on the information given above, what amount of interest income will be eliminated in the preparation of the 20X9 consolidated financial statements? 
A. $17,000
B. $13,300
C. $18,500
D. $22,200

 24. Based on the information given above, what amount of interest expense will be eliminated in the preparation of the 20X9 consolidated financial statements? 
A. $17,000
B. $13,300
C. $18,500
D. $22,200

AACSB: Analytic
Bloom’s: Apply
Difficulty: 3 Hard
Learning Objective: 08-03 Prepare journal entries and elimination entries related to debt purchased from a nonaffiliate at an amount less than book value.
 

25. Based on the information given above, what amount of constructive gain will be allocated to noncontrolling interest in 20X8 consolidated financial statements? 
A. $4,925
B. $5,550
C. $5,625
D. $4,625

AACSB: Analytic
Bloom’s: Understand
Difficulty: 2 Medium
Learning Objective: 08-03 Prepare journal entries and elimination entries related to debt purchased from a nonaffiliate at an amount less than book value.
 

 Granite Company issued $200,000 of 10 percent first mortgage bonds on January 1, 20X4, at 105. The bonds mature in 10 years and pay interest semiannually on January 1 and July 1. Mortar Corporation purchased $140,000 of Granite’s bonds from the original purchaser on January 1, 20X8, for $122,000. Mortar owns 75 percent of Granite’s voting common stock.

26. Based on the information given above, what amount of premium on bonds payable will be eliminated in the preparation of the 20X8 year-end consolidated financial statements? 
A. $3,500
B. $2,800
C. $5,000
D. $2,500 

27. Based on the information given above, what amount of gain or loss on bond retirement will be reported in the 20X8 consolidated financial statements? 
A. $17,000
B. $12,800
C. $18,500
D. $22,200

28. Based on the information given above, what amount of premium on bonds payable will be eliminated in the preparation of the 20X9 year-end consolidated financial statements? 
A. $3,500
B. $2,800
C. $5,000
D. $2,500

29. Based on the information given above, what amount of interest income will be eliminated in the preparation of the 20X9 consolidated financial statements? 
A. $17,000
B. $13,300
C. $18,500
D. $22,200

 Hunter Corporation holds 80 percent of the voting shares of Moss Company. On January 1, 20X8, Moss purchased $100,000 par value 12 percent first mortgage bonds of Hunter from Cruse for $115,000. Hunter originally issued the bonds to Cruse on January 1, 20X6, for $110,000. The bonds have an 8-year maturity from the date of issue. Moss reported net income of $65,000 for 20X8, and Hunter reported income (excluding income from ownership of Moss’s stock) of $90,000.

30. Based on the information given above, what amount of interest expense does Hunter record annually? 
A. $10,750
B. $9,500
C. $2,500
D. $12,000

31. Based on the information given above, what amount of interest income does Moss record for 20X8? 
A. $12,000
B. $2,500
C. $7,500
D. $9,500

32. Based on the information given above, what gain or loss on the retirement of bonds should be reported in the 20X8 consolidated income statement? 
A. $6,250 gain
B. $7,500 gain
C. $7,500 loss
D. $6,250 loss

33. Based on the information given above, what amount of consolidated net income should be reported for 20X8? 
A. $163,750
B. $161,250
C. $146,250
D. $148,750

 Senior Corporation acquired 80 percent of Junior Company’s voting shares on January 1, 20X8, at underlying book value. On that date, it also purchased $500,000 par value 8 percent Junior bonds, which had been issued on January 1, 20X5, with a 12-year maturity. During preparation of the consolidated financial statements for December 31, 20X8, the following eliminating entry was made in the worksheet:
  

34. Based on the information given above, what price did Senior pay to purchase the Junior bonds? 
A. $530,000
B. $516,875
C. $533,750
D. $550,625

35. Based on the information given above, what was the carrying amount of the bonds on Junior’s books on the date of purchase? 
A. $533,750
B. $516,875
C. $545,000
D. $550,625