In: Accounting
What are some alternatives a parent company has if it wishes to acquire outsanding subsidiary bonds from outside owners?
ANSWER:
A subsidiary may have outstanding bonds, and the parent may loan the subsidiary the funds needed to retire the bonds. The bonds would be retired on the subsidiary's books. There would however be intercompany debt between the parent and the subsidiary that would have to be eliminated on future consolidated statements.
There are also situations where one affiliate (usually the subsidiary) has outstanding bonds that have been purchased by parties that are not members of the affiliated group, and a decision is made by another affiliate (usually the parent) to purchase these bonds. The parent purchases the subsidiary bonds from the outside parties and holds them as an investment. This creates an intercompany investment in bonds, where each affiliate continues to accrue and record interest on the bonds. The intercompany bonds are treated as a liability on the subsidiary's books and as an investment on the parent company's books. However, from a consolidated viewpoint, the bonds have been retired and the debt to outside parties has been liquidated. The purchase of intercompany bonds has the following ramifications when consolidating:
1. Consolidated statements prepared for the period in which the bonds are purchased must portray the intercompany bond purchase as a retirement of the bonds. It is possible, but unlikely, that the bonds will be purchased at book value. The price paid for the bonds may exceed their book value, creating a loss on retirement. If the price paid for the bonds is less than their book value, there will be a gain on retirement. The resulting gain or loss on retirement will be recognized on the consolidated income statement.
2. For all periods during which the intcrcompany investment exists, the intercompany bonds, interest accruals, and interest expense/revenue must be eliminated since the bonds no longer exist from a consolidated viewpoint.
The complexity of the elimination procedures depends on whether the bonds originally were issued at face value or at a premium or discount. Additionally, one must exercise extra care in the application of elimination procedures when only a portion of the outstanding bonds is purchased intercompany.