Intercompany Bonds, Cash Flow, EPS, and Unconsolidated Investments

Fundamentals of Advanced Accounting

by Fischer/Taylor/Cheng

Learning Objectives and Reflections

CHAPTER 5

Intercompany Bonds, Cash Flow, EPS, and Unconsolidated Investments

Learning Objectives

When you have completed this chapter, you should be able to

1.  Explain the alternatives a parent company has if it wishes to acquire outstanding subsidiary bonds from outside owners.

2.  Follow the procedures used to retire intercompany bonds on a consolidated worksheet.

3.  Demonstrate an understanding of the effect of a business combination on cash flow in and after the period of the purchase.

4.  Compute earnings per share for a consolidated firm.

5.  Apply consolidation-type procedures to influential investments.

6.  (Appendix) Be able to apply consolidation procedures to a worksheet that is arranged in a vertical format.

·  When the parent buys subsidiary bonds, the bonds cease to exist, from a consolidated viewpoint. They are retired on the consolidated worksheet by elimination.

·  When the intercompany bonds are eliminated, there will be a difference between the amortized cost and the price paid; this creates a gain or loss on retirement.

·  In periods subsequent to the intercompany purchase, the bonds must continue to be eliminated, and retained earnings is adjusted for the remaining retirement gain or loss that has not already been amortized.

·  Intercompany interest expense/revenue and accrued interest receivable/payable are also eliminated.

·  Subsequent to the period of purchase, the only impact of consolidations on cash flow is the added amortization and depreciation caused by the purchase.

·  A purchase of a subsidiary for cash is in the ‘‘investing’’ section of the cash flow statement. The cash outflow is net of the cash received.

·  A purchase of a subsidiary by issuing securities is a noncash investing/financing activity that must be disclosed in the notes to the cash flow statement. Any subsidiary cash received in the purchase is a positive cash flow under ‘‘investing.’’

·  The parent purchase of subsidiary bonds is treated as a retirement and is a financing activity.

·  The parent purchase of additional shares of subsidiary stock is viewed as a treasury stock transaction and is considered a financing activity.

·  Prior to calculating consolidated EPS, the subsidiary’s EPS (including dilution adjustments that add more subsidiary shares) is calculated.

·  The parent’s numerator for EPS includes its own internally generated net income plus its share of subsidiary EPS.

·  The parent also adjusts its numerator and denominator for dilative parent company securities and subsidiary securities that are satisfied by issuing parent company shares.

·  The sophisticated equity method is used for ‘‘influential’’ investments.

·  The sophisticated equity income is based on the investee’s adjusted (for intercompany profits) income less amortizations of excess from the D&D. Note that this process includes adjustment for only investee-generated intercompany transactions.

·  The investor must make a separate adjustment for its share of unrealized profits on sales to the investee.

·  The investor cannot adjust its investment below a zero balance by recording its share of investee losses. If the investee becomes profitable, income equal to the unrecorded losses must be excluded from income.

·  An initial ownership interest may not be ‘‘influential.’’ If a second block is purchased, so as to make the total interest ‘‘influential,’’ the prior block is retroactively converted to the sophisticated equity method.

·  If an interest is sold down to a level that is no longer influential, the remaining interest stays at its equity-adjusted cost. The use of the equity method is discontinued in future periods.

·  On vertical worksheets for consolidations subsequent to acquisition, the income statement accounts appear at the top, followed by the retained earnings statement accounts, and then the balance sheet accounts.

·  Net income is carried down to the retained earnings section.

·  Ending retained earnings is then carried down to the balance sheet section.

·  On a vertical worksheet, the eliminating and adjusting entries are the same as those on a trial balance worksheet.