Question

A parent company buys bonds on the open market that had been previously issued by its subsidiary. The price paid by the parent is less than the carrying amount of the bonds on the subsid- iary's records. How should the parent report the difference between the price paid and the carrying amount of the bonds on its consolidated financial statements?

a. As a loss on retirement of the bonds.
b. As a gain on retirement of the bonds.
c. As an increase to interest expense over the remaining life of the bonds.
d. Because the bonds now represent intra-entity debt, the difference is not reported.

Answer 1

In consolidated financial statements, when a parent company purchases its subsidiary's bonds for less than their carrying amount, the difference is eliminated as an intra-entity transaction and does not affect the consolidated income. Option b. is correct answer.

Step-by-step explanation:

When a parent company buys bonds on the open market that were previously issued by its subsidiary and the purchase price is less than the bonds' carrying amount on the subsidiary's books, this presents a unique situation for reporting in consolidated financial statements.

As per accounting principles, when the parent and subsidiary consolidate, any intra-entity transactions are eliminated. In this case, since the bonds still exist between entities within the same corporate group, the difference between the purchase price and the carrying amount does not impact the consolidated income statement. Instead, the transaction results in a gain or loss that is eliminated in consolidation because it pertains to intra-entity dealings.

The accounting entry would remove the bond liability from the subsidiary’s books and the investment from the parent's books, and the difference would adjust the consolidated retained earnings or another appropriate equity account.