In: Accounting
when the consolidated entity is viewed as a single company, all amounts associated with the interoperate indebtedness must be eliminated, including the investment in bonds, the bonds payable, any unamortized discount or premium on the bonds, the interest income and expense on the bonds, and any accrued interest receivable and payable.
A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party.
Examples include a trade receivable/payable arising from an intercompany sale of inventory on credit, and the issuance of a note payable by one affiliate to another in exchange for operating funds.
An indirect intercompany debt transfer involves the issuance of debt to an unrelated party and the subsequent purchase of the debt instrument by an affiliate of the issuer.
For example, Special Foods borrows funds by issuing a debt instrument, such as a note or a bond, to Nonaffiliated Corporation. The debt instrument subsequently is purchased from Nonaffiliated Corporation by Special Foods’ parent, Peerless Products. Thus, Peerless Products acquires the debt of Special Foods indirectly through Nonaffiliated Corporation.
All account balances arising from interoperate financing arrangements must be eliminated when consolidated statements are prepared.
Although the discussion focuses on bonds, the same concepts and procedures also apply to notes and other types of interoperate indebtedness.
Intercompany Indebtedness
One advantage of having control over other companies is that management has the ability to transfer resources from one legal entity to another as needed by the individual companies. Companies often find it beneficial to lend excess funds to affiliates and to borrow from affiliates when cash shortages arise.
The borrower often benefits from lower borrowing rates, less restrictive credit terms, and the informality and lower debt issue costs of intercompany borrowing relative to public debt offerings. The lending affiliate may benefit by being able to invest excess funds in a company about which it has considerable knowledge, perhaps allowing it to earn a given return on the funds invested while incurring less risk than if it invested in unrelated companies.
The combined entity may find it advantageous for the parent company or another affiliate to borrow funds for the entire enterprise rather than having each affiliate going directly to the capital markets. This chapter discusses the procedures used to prepare consolidated financial statements when interoperate indebtedness arises from either direct or indirect debt transfer.
Bond Sale Directly to an Affiliate
When one company sells bonds directly to an affiliate, all effects of the intercompany indebtedness must be eliminated in preparing consolidated financial statements. A company cannot report an investment in its own bonds or a bond liability to itself.
Thus, when the consolidated entity is viewed as a single company, all amounts associated with the interoperate indebtedness must be eliminated, including the investment in bonds, the bonds payable, any unamortized discount or premium on the bonds, the interest income and expense on the bonds, and any accrued interest receivable and payable.