Discussion 6.2: Who Lost this $300,000?Several years ago, Penston Companypurchased 90 percent of the outstanding shares of Swansan Corporation. Penstonmade the acquisition because Swansan produced a vital component used inPenston’s manufacturing process. Penston wanted to ensure an adequate supply ofthis item at a reasonable price. The former owner, James Swansan, retained theremaining 10 percent of Swansan’s stock and agreed to continue managing thisorganization. He was given responsibility for the subsidiary’s dailymanufacturing operations but not for any financial decisions.Swansan’s takeover has proven to be a successful undertaking for Penston. Thesubsidiary has managed to supply all of the parent’s inventory needs anddistribute a variety of items to outside customers.At a recent meeting, Penston’s president and the company’s chief financialofficer began discussing Swansan’s debt position. The subsidiary had adebt-to-equity ratio that seemed unreasonably high considering the significantamount of cash flows being generated by both companies. Payment of the interestexpense, especially on the subsidiary’s outstanding bonds, was a major cost,one that the corporate officials hoped to reduce. However, the bond indenturespecified that Swansan could retire this debt prior to maturity only by paying107 percent of face value.This premium was considered prohibitive. Thus, to avoid contractual problems,Penston acquired a large portion of Swansan’s liability on the open market for101 percent of face value. Penston’s purchase created an effective loss of$300,000 on the debt, the excess of the price over the book value of the debt,as reported on Swansan’s books.Company accountants currently are computing the noncontrolling interest’s shareof consolidated net income to be reported for the current year. They are unsureabout the impact of this $300,000 loss. The subsidiary’s debt was retired, butofficials of the parent company made the decision. Who lost this $300,000?
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