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Chapter 6 Hoyle Outline

Chapter 6 Hoyle Outline - Updated Sixth Edition Chapter 6...

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Updated Sixth Edition Chapter 6 Intercompany Debt and Other Consolidation Issues Chapter Outline I. Intercompany Debt Transactions 1. No real consolidation problem is created when one member of a business combination loans money to another. The resulting receivable/payable accounts as well as the interest income/expense balances are identical and can be directly offset in the consolidation process. B. The acquisition of an affiliate’s debt instrument from an outside party does require special handling so that consolidated financial statements can be produced. 1. Since the acquisition price will usually differ from the book value of the liability, a gain or loss has been created which is not recorded within the individual records of either company. 2. Because of the amortization of any associated discounts and/or premiums, the interest income being reported by the buyer will not correspond with the interest expense of the debtor. 3. In the consolidation process, all balances must be adjusted to reflect the effective retirement of the debt. C. In the year of acquisition, all intercompany accounts (the liability, the receivable, interest income, and interest expense) are eliminated during the consolidation process while the gain or loss (which produced all of the discrepancies) is recognized. 1. Although several alternatives exist, the textbook assigns all income effects resulting from the retirement to the parent company, the party ultimately responsible for the decision to reacquire the debt. 2. Any noncontrolling interest is, therefore, not affected by the adjustments utilized to consolidate intercompany debt. D. Even after the year of retirement, all intercompany accounts must be eliminated again in each subsequent consolidation; however, the beginning retained earnings of the parent company is adjusted rather than a gain or loss account. 1. The change in retained earnings is needed because a gain or loss was created in a prior year by the retirement of the debt, but only interest income and interest expense were recognized by the two parties. 2. The amount of the change made to retained earnings at any point in time is the original gain or loss adjusted for the subsequent amortization of discounts or premiums. Study Guide – Chapter 6 81
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II. Subsidiary Preferred Stock A. The specific nature of a subsidiary’s preferred stock has a significant impact on the procedures to be applied during the consolidation process. 1. Preferred stocks that have a set call value and no rights other than a cumulative dividend are viewed as being equivalent to debt instruments. 2. Preferred stocks that have voting and/or participation rights are considered ownership (or equity) interests. B. Subsidiary preferred stock may be viewed as a debt instrument.
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