Chapter 8, Problem 8.9Q

To determine

Bonds of affiliate purchased from non-affiliate: When an affiliate of issuer later acquires bonds from unrelated party, the bonds are retired at the time of purchase. The bonds are not held outside the consolidated entity. Once another company within the consolidated entity purchases them, it must be treated as repurchase by debtor. Acquisition of an affiliate’s bonds by another company with in affiliated entities is referred as constructive retirement. Although bonds are not actually retired.

When constructive retirement occurs, the consolidated income statement reports gain or loss based on difference between carrying value and purchase price paid by affiliate to acquire it. And it is not reported in consolidated balance sheet either as bond payable or as investment because the bonds are no longer outstanding.

To explain : The manner in which gain or loss on constructive retirement is computed using two companies trial balance when affiliate bonds are purchased form nonaffiliated in the beginning of the current year.