Question

Assume that a Parent company owns 100% of its Subsidiary. On January 1, 2016 the Parent company had a $1,000,000 (face) bond payable outstanding with a carrying value of $1,070,000. The bond was originally issued to an unaffiliated company. On that same date, the Subsidiary acquired the bond for $996,000. During 2016, the Parent company reported $630,000 of (pre-consolidation) income from its own operations (i.e. prior to any equity method adjustments by the Parent company) and after recording interest expense. The Subsidiary reported $420,000 of (pre-consolidation) income from its own operations after recording interest income. Related to the bond during 2016, the parent reported interest expense of $110,000 while the subsidiary reported interest income of $95,000.

Determine the following amounts that will appear in the 2016 consolidated income statements.
a. Interest income from bond investment
b. Interest expense on bond payable
c. Gain (loss) on constructive retirement of bond payable
d. Consolidated net income

Answer 1

a. Interest income from bond investment

• intercompany transaction gains or losses are eliminated when preparing consolidated financial statements

b. Interest expense on bond payable

• intercompany transaction gains or losses are eliminated when preparing consolidated financial statements

c. Gain (loss) on constructive retirement of bond payable

• gain on retirement of bond = $1,070,000 - $996,000 = $74,000

d. Consolidated net income

• consolidated net income = income from parent company + income from subsidiary + net gain from retirement of bond = $630,000 + $420,000 + $74,000 = $1,124,000