Chapter 6 InterCompany Debt Transactions

1
Chapter 6Inter-Company 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.

2
Acquisition of Affiliates Debt from an Outside
Party
In effect, the Sub has issued the debt indirectly
to the Parent. How should this be accounted for?
3
Acquisition of Affiliates 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.

4
Acquisition of Affiliates Debt from an Outside
Party

• Big owns 90 of Little. On 1/1/00, Little issued
  2 million of 6, 10-year bonds. The current
  carrying amount on Littles books at 1/1/04 is
• Bonds Payable 2,000,000
• Bond Discount 161,043
• Carrying Amount 1,838,957
• On 1/2/04, Big decides to re-purchase Littles
  bonds from the market, effectively extinguishing
  the debt.
• Note The Straight-line Method is used to
  amortize any premiums/discounts

5
Acquisition of Affiliates Debt from an Outside
Party

• On 1/2/04, the market rate is 5, and Big pays
  2,101,514 for the bonds. Since Littles
  carrying value is 1,838,957, there is an
  effective loss of 262,557 to be recorded by the
  consolidated entity.
• At 12/31/04, the consolidated entity must
• Record the loss of 262,557
• Eliminate the related intercompany debt at BV
• Eliminate the intercompany interest

6
Acquisition of Affiliates 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.

7
Acquisition of Affiliates Debt from an Outside
Party

• Entry B (Subsequent Years)
• Adjust the BVs 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.

8
Acquisition of Affiliates Debt from an Outside
Party

• Entry B (Subsequent Years)
• Adjust the BVs 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.
9
Consolidated Statement of Cash Flows

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

10
Consolidated Statement of Cash Flows

• Noncontrolling Interest
• Add back the noncontrolling interests share of
  the subs net income.
• Deduct dividends paid to the outside owners as a
  cash outflow.

11
Consolidated Statement of Cash Flows
Amortization Add amortization of goodwill and FMV
allocations to Consolidated Net Income.
12
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.