Slide

6-1

Chapter Six

Inter-
Company
Debt
Transactions

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Slide
6-2
Chapter 6
Inter-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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.

Slide
6-3
Acquisition of Affiliate’s Debt from
an Outside Party
In
Ineffect,
effect,the
theSub
Sub
has
hasissued
issuedthe
the
debt
debt indirectly
indirectlyto
to Parent
the (1) 80%
theParent.
Parent. How
How Ownership
should (3) Investors
shouldthis
thisbebe sell the
accounted
accountedfor?for? bonds to the
parent
company.

Sub
(2) Assume the
Sub issued
bonds to outside
investors.
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Slide
6-4
Acquisition of Affiliate’s Debt from
an Outside Party
 The

Theacquired
acquireddebt
debtmust
mustbe
be
treated
treatedas asifif itithas
hasbeen
been
extinguished.
extinguished.
 Any

Anyrelated
related loss
loss related
relatedto tothis
this
“early
“earlyextinguishment
extinguishment of of debt”
debt”isis
recorded
recorded in in the
theconsolidated
consolidated
financial
financialstatements
statementsin inthetheyear
yearofof
acquisition.
acquisition.(see (seeAPB
APBOpinion
Opinion26)26)
 IfIf material,

material,the
the loss
lossis
is treated
treatedasas
an
anextraordinary
extraordinaryitem. item.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.

Slide
6-5
Acquisition of Affiliate’s Debt from
an Outside Party
Big
Big owns
owns 90%
90% of
of Little.
Little. On
On 1/1/00,
1/1/00, Little
Little issued
issued $2
$2
million
million of
of 6%,
6%, 10-year
10-year bonds.
bonds. The
The current
current
carrying
carrying amount
amount on on Little’s
Little’s books
books atat 1/1/04
1/1/04 is:
is:
Bonds
BondsPayable
Payable==$2,000,000
$2,000,000
Bond
Bond Discount
Discount== $161,043
$161,043
Carrying
CarryingAmount
Amount== $1,838,957
$1,838,957
On
On 1/2/04,
1/2/04, Big
Big decides
decides to
to re-purchase
re-purchase Little’s
Little’s
bonds
bonds from
from the
the market,
market, effectively
effectively extinguishing
extinguishing
the
the debt.
debt.
Note
Note –– The
The Straight-line
Straight-line Method
Method isis used
used to
to
amortize
amortize any
any premiums/discounts
premiums/discounts
Continue
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Slide
6-6
Acquisition of Affiliate’s Debt from
an Outside Party
On
On 1/2/04,
1/2/04, the
the market
market rate
rate is
is 5%,
5%, and
and Big
Big
pays
pays $2,101,514
$2,101,514 for
for the
the bonds.
bonds. Since
Since
Little’s
Little’s carrying
carrying value
value is
is $1,838,957,
$1,838,957,
there
there isis an
an effective
effective loss
loss of
of $262,557
$262,557 toto
be
be recorded
recorded by by the
the consolidated
consolidated entity.
entity.
At
At 12/31/04,
12/31/04, the
the consolidated
consolidated entity
entity must:
must:
Record
 Record the
theloss
lossof
of$262,557
$262,557
Eliminate
 Eliminatethe
therelated
relatedintercompany
intercompanydebt
debt at
at
BV
BV
Eliminate
 Eliminatethe
theintercompany
intercompanyinterest
interest
Continue
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Slide
6-7
Acquisition of Affiliate’s Debt from
an Outside Party

Entry
Entry B
B
This
Thisentry
entryis
ismade
madeatat the
theend
endof
ofthe
the year
yearthat
thatthe
thedebt
debt is
is
“extinguished”
“extinguished”
We
Wewill
willassume
assumethatthatany
anygains/losses
gains/losses from
from this
this
transaction
transaction belong
belongto tothe
theparent.
parent. Thus,
Thus, there
there will
will be
be
no
noeffect
effect on
onNoncontrolling
NoncontrollingInterest.
Interest.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.

Slide
6-8
Acquisition of Affiliate’s Debt from
an Outside Party

Entry
Entry*B *B(Subsequent
(SubsequentYears)
Years)
Adjust
Adjust the
theBV’s
BV’sof ofthe
theBonds
BondsPayable
Payableand
andthe
the
Investment
Investmentin inBonds
Bonds toto reflect
reflectamortization.
amortization.
Also,
Also,the
theloss
lossis
isnow
now reflected
reflectedininR/E,
R/E,which
whichmust
mustalso
also
be
beadjusted
adjustedfor
for the
thedifference
differencein ininterest
interest amounts.
amounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.

Slide
6-9
Acquisition of Affiliate’s Debt from
an Outside Party

Entry
Entry*B *B(Subsequent
(SubsequentYears)
Years)
Adjust
Adjust the
theBV’s
BV’sof ofthe
theBonds
BondsPayable
Payableand
andthe
the
Investment
Investmentin inBonds
Bonds toto reflect
reflectamortization.
amortization.
Also,
Also,the
theloss
lossis
isnow
now reflected
reflectedininR/E,
R/E,which
whichmust
mustalso
also
be
beadjusted
adjustedfor
for the
thedifference
differencein ininterest
interest amounts.
amounts.

Note
Notethat,
that,over
over the
theremaining
remaininglife
life of
of the
thebonds,
bonds,
the
thebook
bookvalues
valueswill
will eventually
eventuallyconverge
convergeto tothe
the
point
pointwhere
wherethe theadjustment
adjustment to toR/E
R/Ewill
will be
be
amortized
amortized away
awaycompletely.
completely.
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Slide
6-10
Consolidated Statement of Cash
Flows

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

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Slide
6-11
Consolidated Statement of Cash
Flows
Noncontrolling
Noncontrolling Interest
Interest
Add
 Add back
back thethe
noncontrolling
noncontrolling
interest’s
interest’s share
share ofof the
the
sub’s
sub’s net
net income.
income.
Deduct
 Deduct dividends
dividends paidpaid
to
to the
the outside
outside owners
owners
as
as aa cash
cash outflow.
outflow.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.

Slide
6-12
Consolidated Statement of Cash
Flows

Amortization
Amortization
Add
Add amortization
amortization of
of
goodwill
goodwill and
and FMV
FMV
allocations
allocations to
to
Consolidated
Consolidated Net
Net
Income.
Income.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc.
Slide
6-13
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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