Slide

6-1

Chapter Six

InterCompany
Debt
Transactions
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-2

Chapter 6
Inter-Company Debt Transactions

Direct loans between

affiliated parties create no
special consolidation
problems.
Eliminate the corresponding

receivable and payable from

the consolidated financial
statements.

McGraw-Hill/Irwin

Also eliminate the effects of

any related interest.

The McGraw-Hill Companies, Inc.

Slide
6-3

Acquisition of Affiliates Debt from

an Outside Party
In
Ineffect,
effect,the
theSub
Sub
has
hasissued
issuedthe
the
debt
debt indirectly
indirectlyto
to
the
theParent.
Parent. How
How
should
shouldthis
thisbe
be
accounted
accountedfor?
for?

Parent
(3) Investors
sell the
bonds to the
parent
company.

(1) 80%
Ownership

(2) Assume the

Sub issued
bonds to outside
investors.
McGraw-Hill/Irwin

Sub

The McGraw-Hill Companies, Inc.

Slide
6-4

Acquisition of Affiliates Debt from

an Outside Party

The
Theacquired
acquireddebt
debtmust
mustbe
be

treated
treatedas
asifif itithas
hasbeen
been
extinguished.
extinguished.

Any
Anyrelated
related loss
loss related
relatedto
tothis
this
early
earlyextinguishment
extinguishment of
of debt
debtis
is
recorded
recorded in
in the
theconsolidated
consolidated
financial
financialstatements
statementsin
inthe
theyear
yearof
of
acquisition.
acquisition.(see
(seeAPB
APBOpinion
Opinion26)
26)

IfIf material,
material,the
the loss
lossis
is treated
treatedas
as
an
anextraordinary
extraordinaryitem.
item.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-5

Acquisition of Affiliates Debt from

an Outside Party

Big
Big owns
owns 90%
90% of
of Little.
Little. On
On 1/1/00,
1/1/00, Little
Little issued
issued $2
$2
million
million of
of 6%,
6%, 10-year
10-year bonds.
bonds. The
The current
current
carrying
carrying amount
amount on
on Littles
Littles books
books at
at 1/1/04
1/1/04 is:
is:
Bonds
BondsPayable
Payable==$2,000,000
$2,000,000
Bond
Bond Discount
Discount== $161,043
$161,043
Carrying
CarryingAmount
Amount== $1,838,957
$1,838,957

On
On 1/2/04,
1/2/04, Big
Big decides
decides to
to re-purchase
re-purchase Littles
Littles
bonds
bonds from
from the
the market,
market, effectively
effectively extinguishing
extinguishing
the
the debt.
debt.
Note
Note The
The Straight-line
Straight-line Method
Method is
is used
used to
to
amortize
amortize any
any premiums/discounts
premiums/discounts
Continue
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-6

Acquisition of Affiliates Debt from

an Outside Party
On
On 1/2/04,
1/2/04, the
the market
market rate
rate is
is 5%,
5%, and
and Big
Big
pays
pays $2,101,514
$2,101,514 for
for the
the bonds.
bonds. Since
Since
Littles
Littles carrying
carrying value
value is
is $1,838,957,
$1,838,957,
there
there is
is an
an effective
effective loss
loss of
of $262,557
$262,557 to
to
be
be recorded
recorded by
by the
the consolidated
consolidated entity.
entity.
At
At 12/31/04,
12/31/04, the
the consolidated
consolidated entity
entity must:
must:

Record
Record the
theloss
lossof
of$262,557
$262,557

Eliminate
Eliminatethe
therelated
relatedintercompany
intercompanydebt
debt at
at

BV
BV

Eliminate
Eliminatethe
theintercompany
intercompanyinterest
interest

Continue
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-7

Acquisition of Affiliates Debt from

an Outside Party
Entry
Entry B
B

This
Thisentry
entryis
ismade
madeat
at the
theend
endof
ofthe
the year
yearthat
thatthe
thedebt
debt is
is
extinguished
extinguished
We
Wewill
willassume
assumethat
thatany
anygains/losses
gains/losses from
from this
this
transaction
transaction belong
belongto
tothe
theparent.
parent. Thus,
Thus, there
there will
will be
be
no
noeffect
effect on
onNoncontrolling
NoncontrollingInterest.
Interest.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-8

Acquisition of Affiliates Debt from

an Outside Party
Entry
Entry*B
*B(Subsequent
(SubsequentYears)
Years)
Adjust
Adjust the
theBVs
BVsof
ofthe
theBonds
BondsPayable
Payableand
andthe
the
Investment
Investmentin
inBonds
Bonds to
to reflect
reflectamortization.
amortization.
Also,
Also,the
theloss
lossis
isnow
now reflected
reflectedin
inR/E,
R/E,which
whichmust
mustalso
also
be
beadjusted
adjustedfor
for the
thedifference
differencein
ininterest
interest amounts.
amounts.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-9

Acquisition of Affiliates Debt from

an Outside Party
Entry
Entry*B
*B(Subsequent
(SubsequentYears)
Years)
Adjust
Adjust the
theBVs
BVsof
ofthe
theBonds
BondsPayable
Payableand
andthe
the
Investment
Investmentin
inBonds
Bonds to
to reflect
reflectamortization.
amortization.
Also,
Also,the
theloss
lossis
isnow
now reflected
reflectedin
inR/E,
R/E,which
whichmust
mustalso
also
be
beadjusted
adjustedfor
for the
thedifference
differencein
ininterest
interest amounts.
amounts.

Note
Notethat,
that,over
over the
theremaining
remaininglife
life of
of the
thebonds,
bonds,
the
thebook
bookvalues
valueswill
will eventually
eventuallyconverge
convergeto
tothe
the
point
pointwhere
wherethe
theadjustment
adjustment to
toR/E
R/Ewill
will be
be
amortized
amortized away
awaycompletely.
completely.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-10

Consolidated Statement of Cash

Flows
The consolidated
statement of cash flows
is based on the
consolidated balance
sheet and the
consolidated income
statement.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-11

Consolidated Statement of Cash

Flows
Noncontrolling
Noncontrolling Interest
Interest

Add
Add back
back the
the
noncontrolling
noncontrolling
interests
interests share
share of
of the
the
subs
subs net
net income.
income.

Deduct
Deduct dividends
dividends paid
paid
to
to the
the outside
outside owners
owners
as
as aa cash
cash outflow.
outflow.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-12

Consolidated Statement of Cash

Flows

Amortization
Amortization
Add
Add amortization
amortization of
of
goodwill
goodwill and
and FMV
FMV
allocations
allocations to
to
Consolidated
Consolidated Net
Net
Income.
Income.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
6-13

Consolidated Statement of Cash

Flows
Intercompany Transactions

McGraw-Hill/Irwin

Intercompany cash flows

should not be included on the
statement of cash flows.
The intercompany cash flows
are already eliminated from
the balance sheet, so no
additional effects appear on
the statement of cash flows.

The McGraw-Hill Companies, Inc.