Question

Pretzel Corporation owns 60 percent of Stick Corporation’s voting shares. On January 1, 20X2, Pretzel Corporation sold $150,000 par value, 6 percent first mortgage bonds to Stick for $156,000. The bonds mature in 10 years and pay interest semiannually on January 1 and July 1.

Required:
a. Prepare the journal entries for 20X2 for Stick related to its ownership of Pretzel’s bonds.

b. Prepare the journal entries for 20X2 for Pretzel related to the bonds.

c. Prepare the worksheet consolidation entries needed on December 31, 20X2, to remove the effects of the intercorporate ownership of bonds.

Answer 1

a. Stick's Journal Entries (20X2):

January 1: Debit Investment in Pretzel Bonds $156,000; Credit Cash $156,000.

January 1: Debit Bond Interest Expense $4,680; Credit Cash $4,500; Credit Investment in Pretzel Bonds $180 (60% of $300 interest).

b. Pretzel's Journal Entries (20X2):

January 1: Debit Cash $156,000; Credit Bonds Payable $150,000; Credit Gain on Bond Sale $6,000.

January 1: Debit Interest Revenue $4,680; Credit Cash $4,500; Credit Unearned Gain on Bond Sale $180.

c. Consolidation Entries (December 31, 20X2):

Debit Investment in Pretzel Bonds $180; Credit Unearned Gain on Bond Sale $180 (Eliminate bond interest adjustment for 60% noncontrolling interest).

In 20X2, Pretzel Corporation, holding a 60% ownership in Stick Corporation, initiated a transaction involving the sale of $150,000 par value, 6% first mortgage bonds to Stick for $156,000. Stick, as the subsidiary, recorded the acquisition by debiting Investment in Pretzel Bonds and crediting Cash. Subsequently, Stick recognized bond interest expense and cash payments for semiannual interest. Pretzel, the parent company, recorded the sale by debiting Cash, crediting Bonds Payable, and recognizing a gain. Bond interest revenue and cash receipts for interest were also recorded.

To eliminate the effects of intercorporate bond ownership in the consolidation entries on December 31, 20X2, an adjustment was made to Investment in Pretzel Bonds and Unearned Gain on Bond Sale to reflect a 60% noncontrolling interest. This ensures accurate consolidation by accounting for the proportional share of interest attributable to the noncontrolling interest in Stick Corporation.

Answer 2

In 20X2, Stick Corporation initially records the purchase of Pretzel Corporation's bonds on January 1, recognizing the investment in Pretzel's bonds at the cost of $156,000. Stick also records semiannual interest payments on January 1 and July 1, reflecting the interest revenue and cash movements associated with the bonds. Simultaneously, Pretzel Corporation records the sale of its bonds to Stick on January 1, recognizing the cash received, eliminating the bonds payable, and recognizing a gain on the sale of bonds.

At the end of the year, during the consolidation process on December 31, 20X2, certain entries are made to eliminate the effects of intercorporate ownership. This includes eliminating the intercorporate bonds' interest revenue and the unrealized gain on the bonds. Additionally, the investment in Pretzel is eliminated, reflecting the removal of Stick's ownership of Pretzel's bonds. These consolidation entries ensure that the financial statements represent the economic substance of the transactions, considering the parent-subsidiary relationship. Overall, these entries facilitate the creation of a consolidated financial statement that accurately reflects the financial position and performance of the consolidated entities.

a. Journal entries for Stick Corporation (20X2):

January 1:

• Debit: Investment in Pretzel Corporation (Current Asset) $156,000
• Credit: Cash (or Bonds Payable) $156,000 (To record the purchase of Pretzel's bonds)

January 1 (Interest Payment):

• Debit: Interest Expense $4,500 ([$150,000 * 6%]/2)
• Credit: Cash $4,500 (To record the semiannual interest payment)

July 1 (Interest Payment):

• Debit: Interest Expense $4,500
• Credit: Cash $4,500

b. Journal entries for Pretzel Corporation (20X2):

January 1:

• Debit: Cash $156,000
• Credit: Bonds Payable $150,000
• Credit: Gain on Sale of Bonds $6,000 ([$156,000 - $150,000])

January 1 (Interest Revenue):

• Debit: Cash $4,500
• Credit: Interest Revenue $4,500

July 1 (Interest Revenue):

• Debit: Cash $4,500
• Credit: Interest Revenue $4,500

c. Consolidation Entries on December 31, 20X2:

Eliminate the intercorporate bonds:

• Debit: Investment in Pretzel Corporation $4,500 ([$150,000 * 6%]/2)
• Credit: Interest Revenue $4,500

Eliminate unrealized gain on bonds:

• Debit: Gain on Sale of Bonds $6,000
• Credit: Retained Earnings $6,000

Eliminate the investment in Pretzel:

• Debit: Investment in Pretzel Corporation $156,000
• Credit: Bonds Payable $150,000
• Credit: Gain on Sale of Bonds $6,000