Question

If a company sells a depreciable asset to its subsidiary at a profit on December 31, 20X3, what account balances must be eliminated or adjusted in preparing the consolidated income statement for 20X3? If the sale instead occurred on January 1, 20X3, what additional account(s) will require adjustment in preparing the consolidated income statement?

When a parent company sells land to a subsidiary at more than book value, the consolidation entries at the end of the period include a debit to the gain on the sale of land. When a parent purchases the bonds of a subsidiary from a nonaffiliate at less than book value, the consolidation entries at the end of the period contain a credit to a gain on bond retirement. Why are these two situations not handled in the same manner on the consolidation worksheet?

How would the relationship between interest income recorded by a subsidiary and interest expense recorded by the parent be expected to change when comparing a direct placement of the parent’s bonds with the subsidiary to a constructive retirement in which the subsidiary purchases the bonds of the parent from a nonaffiliate?

Please provide as much detail on these topics. I would like to obtain a better understanding of these concepts.

Answer 1

Answer-1:

If a company sells a depreciable asset to its subsidiary at a profit on December 31, 20X3, the following account balances must be eliminated or adjusted in preparing the consolidated income statement:-

(i) Depreciable assets

(ii) Income tax expense

(iii) Profit on sale of depreciable asset

(iv) Deferred tax liability

If a company sells a depreciable asset to its subsidiary at a profit on January 1, 20X3, the following account balances must be eliminated or adjusted in preparing the consolidated income statement:-

(i) Depreciable assets

(ii) Retained earnings

(iii) Deferred tax asset

Answer-2:

The difference in treatment is due to the effect of the transactions on the consolidated entity. In the case of land sold to another affiliate, a gain has been recorded that is not a gain from the viewpoint of the consolidated entity. Thus, it must be eliminated in the consolidation process. On the other hand, in a bond repurchase the buyer simply records an investment in bonds and the debtor makes no special entries because of the purchase by an affiliate. Neither company records the effect of the transaction on the economic entity. Thus, in the consolidation process an entry must be made to show the gain on bond retirement that has occurred from the viewpoint of the economic entity

Answer-3:

Interest income recorded by the subsidiary and interest expense recorded by the parent should be equal in the direct replacement case. When the subsidiary purchases parent company bonds from a nonaffiliated, interest income and interest expense will not be the same unless the bonds are purchased from the nonaffiliated at an amount equal to the liability reported by the parent.