To determine:.The method, which would maintain subsidiary company as the debtor.
Introduction: Consolidation is a process in which financial statements of subsidiary is merged with financial statements of the parent. In this process, effect of intercompany transactions are eliminated.
Answer to Problem 1UTI
In both of the methods subsidiary company would continue to be a debtor.
Explanation of Solution
Parent company acquired 80% interest in subsidiary company. Subsidiary company has availed loan of $1,000,000 having ten years of maturity at an interest rate of 8%. Parent company can borrow at an interest rate of 6%.
Parent company has two options to reduce the borrowing cost of the company which are discussed as follows:
- To buy outstanding bonds of subsidiary company from open market: In this case, parent company will buy bonds from outsiders that has been issed by the subsidiary. After purchase of such bonds it will be shown as debt investment of the company. Parent would be entitled to receive interest and maturity value from subsidiary company. Therefore, subsidiary compny would continue to be a debtor.
- To lend money to subsidiary company so that subsidiary company can redeem its bonds: In this case, a fresh loan would be issued to the subsidiary for redemption of old bonds. In this case as well, subsidiary company would be required to pay interest and principal amount to the parent company. Therefore, subsidiary compny would continue to be a debtor.
Conclusion:Therefore, in both the cases subsidiary would continue to be a debtor.
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Chapter 5 Solutions
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