Jeter_AA_4e_SolutionsManual_Ch09 - CHAPTER 9 ANSWERS TO...

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ANSWERS TO QUESTIONS 1. Constructive retirement refers to the purchase of an affiliate's outstanding bonds from outsiders. From a consolidated entity viewpoint, the consolidated entity has retired its outstanding debt, and is thus treated as an early extinguishment of debt. The difference between the carrying value of the bonds and the purchase price to the purchasing affiliate is the constructive gain or loss on bond retirement. 2. The gain or loss is composed of two elements: (1) the discount or premium on the books of the issuer, and (2) the discount or premium paid by the purchaser. Discounts and/or premiums on the books of the two affiliates will be subsequently amortized to income. The cumulative effect on income of the amortization of the discount or premium by the two affiliates is equal to the constructive gain or loss. 3. The allocation of a gain or loss would be made to each affiliate based on whether the affiliate paid or issued the bonds for more or less than book value or par value. A discount (premium) to the issuer would be allocated to the issuing company as a loss (gain), whereas a discount (premium) to the purchasing affiliate would be a gain (loss). The sum of the two is the total constructive gain or loss. 4. Support for allocating the total gain or loss to the issuing company is based on the contention that the purchasing affiliate is acting as an agent for the issuing company. Since both companies are under the control of the management of the parent company, the bonds could be transferred to the issuing company. Thus, the purchase is in substance a retirement by the issuing company. 5. The noncontrolling interest is affected by the portion of the constructive gain or loss allocated to the subsidiary. Because the loss is recognized in the consolidated income statement in the year the bonds are purchased, a discount or premium amortization related to bonds that is made subsequent to the purchase is added back or is subtracted from the subsidiary's reported income. Such adjustments will increase or decrease the noncontrolling interest in the income of the subsidiary. 6. a. Investor Company b. Investee Company Purchase price $338,000 Carrying value $360,000 Par value 350,000 Par value 350,000 Constructive gain $ 12,000 Constructive gain $ 10,000 7. The outside party (the maker of the note) is primarily liable; and Affiliate Y, who discounted the note with an outside party, is contingently liable for it. 8. Stock dividends are viewed as a distribution of the earliest earnings accumulated in the retained earnings account. 9. The retained earnings balance at the date of acquisition is reduced since the issuance of a stock dividend is viewed as a distribution of the earliest earnings accumulated. 10. A memorandum entry is required to recognize the number of shares received since a dividend in
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This note was uploaded on 10/31/2010 for the course AA AC 3200 taught by Professor Arnie during the Spring '10 term at Brown Mackie College.

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Jeter_AA_4e_SolutionsManual_Ch09 - CHAPTER 9 ANSWERS TO...

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