Ch05 - CHAPTER 5 UNDERSTANDING THE ISSUES 1. The first...

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Unformatted text preview: CHAPTER 5 UNDERSTANDING THE ISSUES 1. The first approach that could be used to reduce 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 ori- ginates. The intercompany interest expense would be eliminated during the consolidation process. An- other approach would have the parent purchasing the subsidiary bonds from outside parties and hold- ing them as an investment. From a consolidated viewpoint, the debt is retired. Therefore, interest ex- pense would be eliminated during the consolidation process. 2. At the 10% annual interest rate, an extraordin- ary loss on retirement of bonds will occur in the cur- rent year since the parent paid a premium to retire the subsidiarys 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% annual interest rate, an extraordinary gain on retirement of bonds will occur in the current year since the parent paid a discount to retire the subsidiarys bonds. In the current and future years, consolidated net in- come will be reduced by the difference between in- terest 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 extraordinary loss that res- ults 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 fu- ture years, the subsidiarys income will be increased by the difference between interest expense and in- terest revenue. The noncontrolling interest will re- ceive its share of this amount. 4. In the current year, consolidated net income will include an extraordinary 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 represents amortization of the discount paid by the parent. In the current year, the NCI will receive $1,000 ($5,000 20%) of the extraordinary gain on the retirement of bonds. In the current and each of the next 4 years, NCI share of income will be re- duced by $200 ($1,000 20%). 5. It is true that intercompany operating leases eliminated during the consolidation process will not have an effect on consolidated income. However, the excessive rent expense amounts will still appear on the subsidiarys separately stated income state- ment and will reduce the NCI share of consolidated income. The high lease rates will shift income from the NCI to the controlling interest 6. Either type of lease can shift income to the con- trolling interest by incorporating a higher than market...
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Ch05 - CHAPTER 5 UNDERSTANDING THE ISSUES 1. The first...

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