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6-1
CHAPTER
6
Intercompany Debt
and Other
Consolidation Issues
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6-2
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.
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6-3



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)
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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.
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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
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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. 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
Continue
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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.
Consolidation Journal - Entry B
Date
Description
31-Dec Bonds Payable (Little)
Interest Income (Big)
Loss on Retirement of Bonds
Investment in Bonds (Big)
Interest Expense (Little)
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Page
Debit
##
Credit
1,865,797
103,081
262,557
2,084,595
146,840
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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.
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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.
Consolidation Journal - Entry *B
Page
##
Date
Credit
Note that, Description
over the remaining life of Debit
the bonds,
31-Dec Bonds Payable (Little)
1,892,637
the
book Income
values(Big)
will eventually converge
to the
Interest
103,081
point where
the adjustment to R/E218,798
will be
Retained
Earnings
Investment
in Bonds
(Big) completely.
2,067,676
amortized
away
Interest Expense (Little)
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146,840
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6-10
Acquisition of Affiliate’s Debt from
an Outside Party
Example:
Problem 22 (page 314)
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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.
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Subsidiary Preferred Stock
Viewed 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.
Consolidated Journal
Date
Description
Parent's Acquisition
Preferred Stock (at par)
Add'l Paid-in Capital
Investment in Subsidiary
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Page
Debit
##
Credit
$$$
$$$
$$$
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Subsidiary Preferred Stock
Viewed as Debt
The Preferred Stock is treated as debt when it has no
rights other than a cumulative dividend.
Two entries are required to eliminate the preferred stock:
The second entry recognizes the noncontrolling
interest’s share of the preferred stock and is based on
the call price.
Consolidated Journal
Date
Description
Noncontrolling Interest
Preferred Stock (at par)
Add'l Paid-in Capital
Noncontrolling Interest
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
$$$
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Slide
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So, what do
we do when
the Preferred
Stock is
viewed as
Equity?
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Subsidiary Preferred Stock
Viewed 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 Journal
Date
Description
Preferred Stock (at par)
R/E (if participating)
Investment in Subsidiary
Noncontrolling Interest
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
$$$
$$$
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Subsidiary Preferred Stock
Viewed as Equity
Example:
Problem 27 (page 315)
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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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Consolidated Statement of Cash
Flows
Amortization
Add amortization of
FMV allocations to
Consolidated Net
Income.
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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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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
financing cash outflow.
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Consolidated Statement of Cash
Flows
Example:
Problem 31 (page 316-17)
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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.
EPS =
McGraw-Hill/Irwin
Net
Income
Weighted Average
÷
Common Shares
Outstanding
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6-23
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.

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?
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Consolidated Earnings Per Share
Example:
Problem 35 (page 317)
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Subsidiary 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 Transactions
Measure ownership
percentage before
and after the
transaction, and
adjust investment
account and APIC by
any alteration.
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Subsidiary 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 Transactions
Example:
Problem 36 (page 318)
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End of Chapter 6
Uh, Chester?
I wonder if we
could discuss a
little
“intercompany”
loan?
McGraw-Hill/Irwin
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