Advanced Fin. Acc. - Intercompany Profit Trans. - Bonds

Bonds issued by a company remain on their books as a liability, but are considered constructively retired when:

• the company borrows money from unaffiliated entities to re-purchase its own bonds at a gain.

• the company borrows money from affiliate to re-purchase its own bonds at a gain.

• the company’s parent or subsidiary purchases the bonds from outside entities.

• the company borrows money from an affiliate to re-purchase its own bonds at a gain or at a loss.

There are several theories for allocating constructive gains or losses between purchasing and issuing affiliates. The Agency Theory:

• does so based on the par value of the bonds purchased.

• assigns the entire constructive gain or loss to the parent based on their control of the decision to purchase the bonds.

• assigns the entire constructive gain or loss to the subsidiary based on the need to have the noncontrolling interest share in the retirement of the debt.

• assigns the entire constructive gain or loss to whichever company issued the bonds.

The motivation of a parent company to purchase the outstanding bonds of a subsidiary could be to:

• replace the existing debt with new debt at a lower interest rate.

• reduce the parent company’s acquisition price for the subsidiary.

• increase the parent company’s ownership percentage in the subsidiary.

• create interest revenue in offset interest expense in future income statements.

The (a)   at constructive retirement is recognized over the life of the bonds.

If the price paid by a parent company to acquire the debt of a subsidiary is greater than the book value of the liability, a (a)   on the retirement of debt from the viewpoint of the consolidated entity occurs.