Question

A subsidiary issues bonds. The parent can then acquire the bonds either directly from the subsidiary or from a nonaffiliate that had originally acquired the subsidiary's bonds.

a) Discuss the parent's accounting as it relates to the preparation of consolidated financial statements, for their acquisition of the bonds:

1. from the nonaffiliate.
2. directly from the subsidiary.

b) Why does it matter who the bonds are acquired from?

Answer 1

a) 1. When the parent acquires the bonds from a nonaffiliate, the bonds were originally held outside the consolidated entity and the bonds must be treated as if they were reacquired by the original issuer. In this case the bond acquisition is handled as a constructive retirement, which means the bonds are treated as if the subsidiary had retired the bonds when the consolidated financial statements are prepared. Any gain or loss on constructive retirement should be reported in the consolidated income statement but not in separate financial statements of the parent and subsidiary.2. When the parent purchases the bonds directly from the subsidiary the transaction is viewed as an inter-company debt and must be eliminated in the preparation of the consolidated financial statements.

b) When a parent acquires a subsidiary's debt it is important to know if the acquisition is direct or indirect. In case of direct intercompany debt transfer, there is no impact on consolidated financial statements. However, if the parent has to go outside the consolidated entity i.e. in case of indirect intercompany debt transfer, the impact of the transaction on the consolidated entity must be reported.