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6

C H A P T E R

Intercompany Debt and Other

Consolidation Issues

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Intercompany Debt TransactionsIntercompany Debt Transactions

Direct loans between affiliated parties create no special consolidation problems. Eliminate the corresponding

receivable and payable from the consolidated financial statements.

Also eliminate the effects of any related interest.

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Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

The acquired debt must be treated as if it has been extinguished.

Any related loss related to this “early extinguishment of debt” is recorded in the consolidated financial statements in the year of acquisition. (see APB Opinion 26)

The loss is treated as an extraordinary item only if it meets the criteria of APB Opinion 30. (See SFAS 145)

The acquired debt must be treated as if it has been extinguished.

Any related loss related to this “early extinguishment of debt” is recorded in the consolidated financial statements in the year of acquisition. (see APB Opinion 26)

The loss is treated as an extraordinary item only if it meets the criteria of APB Opinion 30. (See SFAS 145)

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Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

In year of acquisition: Eliminate liability, receivable,

interest income, interest expense on consolidation worksheet.

Recognize any gain or loss. Income effects assigned to parent

(decided to reacquire the debt). NCI not affected by adjustments.

In year of acquisition: Eliminate liability, receivable,

interest income, interest expense on consolidation worksheet.

Recognize any gain or loss. Income effects assigned to parent

(decided to reacquire the debt). NCI not affected by adjustments.

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Big owns 90% of Little. On 1/1/96, Little issued $2 million of 6%, 10-year bonds. The current carrying amount on Little’s books at 1/1/00 is:

Bonds Payable = $2,000,000

Bond Discount = $161,043

Carrying Amount = $1,838,957

On 1/2/00, Big decides to re-purchase Little’s bonds from the market, effectively

extinguishing the debt.

Big owns 90% of Little. On 1/1/96, Little issued $2 million of 6%, 10-year bonds. The current carrying amount on Little’s books at 1/1/00 is:

Bonds Payable = $2,000,000

Bond Discount = $161,043

Carrying Amount = $1,838,957

On 1/2/00, Big decides to re-purchase Little’s bonds from the market, effectively

extinguishing the debt.

Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

Continue

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On 1/2/00, the market rate is 5%, and Big pays $2,101,514 for the bonds. Because Little’s

carrying value is $1,838,957, there is an effective loss of $262,557 to be recorded by

the consolidated entity.

At 12/31/00, the consolidated entity must: Record the loss of $262,557

Eliminate the related intercompany debt at BV Eliminate the intercompany interest

On 1/2/00, the market rate is 5%, and Big pays $2,101,514 for the bonds. Because Little’s

carrying value is $1,838,957, there is an effective loss of $262,557 to be recorded by

the consolidated entity.

At 12/31/00, the consolidated entity must: Record the loss of $262,557

Eliminate the related intercompany debt at BV Eliminate the intercompany interest

Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

Continue

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Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

Entry BThis entry is made at the end of the year that the debt is

“extinguished”

We will assume that any gains/losses from this transaction belong to the parent. Thus, there will be

no effect on Noncontrolling Interest.

Entry BThis entry is made at the end of the year that the debt is

“extinguished”

We will assume that any gains/losses from this transaction belong to the parent. Thus, there will be

no effect on Noncontrolling Interest.

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Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

After year of retirement: Eliminate liability, receivable,

interest income, interest expense on consolidation worksheet.

Adjust beginning retained earnings for gain/loss (only interest income and expense were recognized).

R/E change = original gain/loss ± discount/premium amortization.

After year of retirement: Eliminate liability, receivable,

interest income, interest expense on consolidation worksheet.

Adjust beginning retained earnings for gain/loss (only interest income and expense were recognized).

R/E change = original gain/loss ± discount/premium amortization.

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Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

Entry *B (Subsequent Years)

Adjust the BV’s of the Bonds Payable and the Investment in Bonds to reflect amortization.

Also, the loss is now reflected in R/E, which must also be adjusted for the difference in interest amounts.

Entry *B (Subsequent Years)

Adjust the BV’s of the Bonds Payable and the Investment in Bonds to reflect amortization.

Also, the loss is now reflected in R/E, which must also be adjusted for the difference in interest amounts.

Note that, over the remaining life of the bonds, the book values will eventually converge to the

point where the adjustment to R/E will be amortized away completely.

Note that, over the remaining life of the bonds, the book values will eventually converge to the

point where the adjustment to R/E will be amortized away completely.

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Acquisition of Affiliate’s Debt from an Outside Party

Acquisition of Affiliate’s Debt from an Outside Party

Example:

Problem 22 (page 314)

Example:

Problem 22 (page 314)

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The treatment of subsidiary preferred stock in the consolidated financial

statements depends on whether the shares are viewed as:

Debt or EquityThe parent’s acquisition of the preferred stock is accounted for

in a manner similar to the accounting for the parent’s

acquisition of the subsidiary’s bonds.

The treatment of subsidiary preferred stock in the consolidated financial

statements depends on whether the shares are viewed as:

Debt or EquityThe parent’s acquisition of the preferred stock is accounted for

in a manner similar to the accounting for the parent’s

acquisition of the subsidiary’s bonds.

Subsidiary Preferred StockSubsidiary Preferred Stock

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Subsidiary Preferred StockViewed as Debt

Subsidiary Preferred StockViewed as Debt

The Preferred Stock is treated as debt when it has no rights other than a cumulative dividend.

Two entries are required to eliminate the preferred stock:

The Preferred Stock is treated as debt when it has no rights other than a cumulative dividend.

Two entries are required to eliminate the preferred stock:

The first entry is based on the amount the parent paid for the acquired preferred stock.

The first entry is based on the amount the parent paid for the acquired preferred stock.

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Subsidiary Preferred StockViewed as Debt

Subsidiary Preferred StockViewed as Debt

The Preferred Stock is treated as debt when it has no rights other than a cumulative dividend.

Two entries are required to eliminate the preferred stock:

The Preferred Stock is treated as debt when it has no rights other than a cumulative dividend.

Two entries are required to eliminate the preferred stock:

The second entry recognizes the noncontrolling interest’s share of the preferred stock and is based on

the call price.

The second entry recognizes the noncontrolling interest’s share of the preferred stock and is based on

the call price.

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So, what do we do when

the Preferred Stock is

viewed as Equity?

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Subsidiary Preferred StockViewed as Equity

Subsidiary Preferred StockViewed as Equity

When the Preferred Stock is treated as equity, it has rights other than a cumulative dividend, often

including a conversion feature or participation rights.

When the Preferred Stock is treated as equity, it has rights other than a cumulative dividend, often

including a conversion feature or participation rights.

The entry allocates the preferred stock amounts to the investment and to the noncontrolling interest.

The entry allocates the preferred stock amounts to the investment and to the noncontrolling interest.

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Subsidiary Preferred StockViewed as Equity

Subsidiary Preferred StockViewed as Equity

Example:

Problem 27 (page 315)

Example:

Problem 27 (page 315)

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Consolidated Statement of Cash Flows

Consolidated Statement of Cash Flows

The consolidated statement of cash flows is based on the consolidatedconsolidated balance

sheet and the consolidatedconsolidated income

statement.

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AmortizationAdd amortization of

FMV allocations to Consolidated Net

Income.

AmortizationAdd amortization of

FMV allocations to Consolidated Net

Income.

Consolidated Statement of Cash Flows

Consolidated Statement of Cash Flows

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Consolidated Statement of Cash Flows

Consolidated Statement of Cash Flows

Intercompany Transactions Intercompany cash flows

should not be included on the statement of cash flows.

The intercompany cash flows are already eliminated from the balance sheet, so no additional effects appear on the statement of cash flows.

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Noncontrolling InterestAdd back the

noncontrolling interest’s share of the sub’s net income.

Deduct dividends paid to the outside owners as a financing cash outflow.

Noncontrolling InterestAdd back the

noncontrolling interest’s share of the sub’s net income.

Deduct dividends paid to the outside owners as a financing cash outflow.

Consolidated Statement of Cash Flows

Consolidated Statement of Cash Flows

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Consolidated Statement of Cash Flows

Consolidated Statement of Cash Flows

Example:

Problem 31 (page 316-17)

Example:

Problem 31 (page 316-17)

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Consolidated Earnings Per ShareConsolidated Earnings Per Share

If potentially dilutive items exist on the sub’s own financial statements, then the portion of

the sub’s net income included in consolidated net income may not be appropriate for the computation of consolidated earnings per

share.

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?

Consolidated Earnings Per ShareConsolidated Earnings Per Share

Compute the sub’s own diluted EPS.

The earnings used in the above computation are used in the determination of consolidated EPS.

The portion assigned to the computation is based on the % of the sub owned by the parent.

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Consolidated Earnings Per ShareConsolidated Earnings Per Share

Example:

Problem 35 (page 317)

Example:

Problem 35 (page 317)

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Subsidiary Stock TransactionsSubsidiary Stock Transactions

Book value of parent’s investment account

increased if subsidiary issues new stock and

decreased if subsidiary reacquires treasury stock.

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Subsidiary Stock TransactionsSubsidiary Stock Transactions

Measure ownership percentage before and after the transaction, and adjust investment account and APIC by any alteration.

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Subsidiary Stock TransactionsSubsidiary Stock Transactions

Treasury stock acquired by subsidiary

Similar adjustment to parent’s investment account.

Eliminate subsidiary treasury stock during consolidation process as part of Entry S.

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Subsidiary Stock TransactionsSubsidiary Stock Transactions

Example:

Problem 36 (page 318)

Example:

Problem 36 (page 318)

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Uh, Chester? Uh, Chester?

I wonder if we I wonder if we could discuss a could discuss a

little little “intercompany” “intercompany”

loan?loan?

End of Chapter 6End of Chapter 6