C H A P T E R

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C H A P T E R. 6. Intercompany Debt and Other Consolidation Issues. Intercompany Debt Transactions. Direct loans between affiliated parties create no special consolidation problems. Eliminate the corresponding receivable and payable from the consolidated financial statements.

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C H A P T E R

6

Intercompany Debt and Other Consolidation Issues

Intercompany 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.
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)
• If material, the loss is treated as an extraordinary item.

Continue

Acquisition of Affiliate’s Debt from an Outside Party

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.

Continue

Acquisition of Affiliate’s Debt from an Outside Party

On 1/2/00, the market rate is 5%, and Big pays \$2,101,514 for the bonds. Since 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

Entry B

This 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.

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.

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.

Subsidiary Preferred Stock

The treatment of subsidiary preferred stock in the consolidated financial statements depends on whether the shares are viewed as:

Debt or Equity

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

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 second entry recognizes the noncontrolling interests share of the preferred stock and is based on the call price.

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.

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

Consolidated Statement of Cash Flows

The consolidated statement of cash flows is based on the consolidated balance sheet and the consolidated income statement.

Consolidated Statement of Cash Flows

Noncontrolling Interest

• Add back the noncontrolling interest’s share of the sub’s net income.
• Deduct dividends paid to the outside owners as a cash outflow.
Consolidated Statement of Cash Flows

Amortization

Add amortization of goodwill and FMV allocations to Consolidated Net Income.

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.
Consolidated 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.

Consolidated 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.

?

End of Chapter 6

Uh, Chester?

I wonder if we could discuss a little “intercompany” loan?