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Several years ago, Penston Company purchased 90 percent of the outstanding shares of Swansan Corporation. Penston made the acquisition because Swansan produced a vital component used in Penstons manufacturing process. Penston wanted to ensure an adequate supply of this item at a reasonable price. The former owner, James Swansan, retained the remaining 10 percent of Swansans stock and agreed to continue managing this organization. He was given responsibility for the subsidiarys daily manufacturing operations but not for any financial decisions. Swansans takeover has proven to be a successful undertaking for Penston. The subsidiary has managed to supply all of the parents inventory needs and distribute a variety of items to outside customers.

At a recent meeting, Penstons president and the companys chief financial officer began discussing Swansans debt position. The subsidiary had a debt-to-equity ratio that seemed unreasonably high considering the significant amount of cash flows being generated by both companies. Payment of the interest expense, especially on the subsidiarys outstanding bonds, was a major cost, one that the corporate officials hoped to reduce.

However, the bond indenture specified that Swansan could retire this debt prior to maturity only by paying 107 percent of face value. This premium was considered prohibitive. Thus, to avoid contractual problems, Penston acquired a large portion of Swansans liability on the open market for 101 percent of face value. Penstons 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 Swansans books. Company accountants currently are computing the noncontrolling interests share of consolidated net income to be reported for the current year. They are unsure about the impact of this $300,000 loss. The subsidiarys debt was retired, but officials of the parent company made the decision.

Who lost this $300,000?

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