Question

This week, we discussed the accounting for the investment of bonds in a subsidiary. Why are bonds treated as retired during the consolidation process? What theoretical justification is used to support this accounting treatment?

Please justify your answer, from a practical and also theoretical standpoint.

Answer 1

When bonds issued by subsidiary are purchased by the holding company, that portion of bonds acquired by the holding company needs to be treated as retired bonds for the purpose of consolidation only though they do not retire actually. The reason behind consolidation is to see the performance and position of the company as a single large entity. While consolidating the books of subsidiary and holding companies, the liabilities and assets of the subsidiary and liabilities and assets of the holding companies are shown in consolidated balance sheet with few intercorporate adjustments. If the bonds are not eliminated, the bonds will appear as liabilities as bonds payable and the same bonds will appear as Investments in bonds in Assets in the consolidated balance sheet. This hampers the true and fair view as once bonds payable are acquired by issuing entity they no longer remain payable and ceases to be a liability.

Thus, the bonds need to be written off against the investments in bonds and the resulting profit or loss on retirement needs to be recognised in the income statement.