05_Fischer10e_SM_Ch05_final

05_Fischer10e_SM_Ch05_final - <?xml...

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CHAPTER 5 UNDERSTANDING THE ISSUES 1. The first approach that could be used to re- duce the overall consolidated interest cost but maintain the subsidiary as the debtor would have the parent advancing $1,000,000 to the subsidiary so that the subsidiary may retire the bonds. The former debt is retired, and a new long-term intercompany debt originates. The inter- company interest expense would be elimin- ated during the consolidation process. An- other approach would have the parent pur- chasing the subsidiary bonds from outside parties and holding them as an investment. From a consolidated viewpoint, the debt is retired. Therefore, interest expense would be eliminated during the consolidation pro- cess. 2. At the 10% annual interest rate, a loss on retirement of bonds will occur in the current year since the parent paid a premium to re- tire the subsidiary’s bonds. In the current and future years, consolidated net income will be increased by the difference between interest expense and interest revenue. This amount represents the amortization of the premium paid by the parent. At the 13% an- nual interest rate, a gain on retirement of bonds will occur in the current year since the parent paid a discount to retire the sub- sidiary’s bonds. In the current and future years, consolidated net income will be re- duced by the difference between interest revenue and interest expense. This amount represents the amortization of the discount paid by the parent to retire the bonds. 3. Since Company S was the original issuer of the bonds, it will absorb the loss that results in the current year from the parent retiring the bonds at a premium. The noncontrolling interest will receive its share of this loss. In the current and future years, the subsidi- ary’s income will be increased by the differ- ence between interest expense and interest revenue. The noncontrolling interest will re- ceive its share of this amount. 247
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4. In the current year, consolidated net in- come will include a gain on retirement of bonds of $5,000 ($100,000 – $95,000). In the current and each of the next 4 years, consolidated net income will be reduced by $1,000 ($5,000 ÷ 5 years), which repres- ents amortization of the discount paid by the parent. In the current year, the NCI will receive $1,000 ($5,000 × 20%) of the gain on the retirement of bonds. In the current and each of the next 4 years, NCI share of income will be reduced by $200 ($1,000 × 20%). 5. It is true that intercompany operating leases eliminated during the consolidation process will not have an effect on consolid- ated income. However, the excessive rent expense amounts will still appear on the subsidiary’s separately stated income statement and will reduce the NCI share of consolidated income. The high lease rates will shift income from the NCI to the con- trolling interest.
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05_Fischer10e_SM_Ch05_final - <?xml...

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