Question

A subsidiary has a debt outstanding that was originally issued at a discount. At the beginning of the current year, the parent company acquired the debt at a slight premium from outside parties. Which of the following statements is true?

a. Whether the balances agree or not, both the subsequent interest income and interest expense should be reported in a consolidated income statement.
b. The interest income and interest expense will agree in amount and should be offset for consolidation purposes.
c. In computing any noncontrolling interest allocation, the interest income should be included but not the interest expense.
d. Although subsequent interest income and interest expense will not agree in amount, both balances should be eliminated for consolidation purposes.

Answer 1

When consolidating financial statements, subsequent interest income and expense resulted from intercompany transactions should be eliminated, even if the amounts do not agree due to acquisition at different values.

Step-by-step explanation:

The statement that is true when the parent company acquires subsidiary debt that was issued at a discount and is now bought at a premium is: d. Although subsequent interest income and interest expense will not agree in amount, both balances should be eliminated for consolidation purposes.

When preparing consolidated financial statements, the intercompany transactions, including interest income earned by the parent from the subsidiary for the debt the parent holds, and the corresponding interest expense recognized by the subsidiary, must be eliminated. This is because consolidated financial statements present the financial position and results of operations as if the parent and subsidiary are a single economic entity.

This elimination is essential to avoid overstatement of both interest income and expense, ensuring that the consolidated financial results only reflect transactions with external parties. The acquisition of debt at a premium means that any subsequent accounting will involve adjustments that likely result in the interest income and expense not being exactly equal, but for consolidation purposes, these differences are not recognized and both balances are eliminated.