BPP Question Bank Intercompany Loan Question

Hi Mike,

Please could you help with the following question?

On 1st July 20X7, Spider acquired 60% of the equity share capital of Fly and on that date made a $10,000,000 loan to Fly at a rate of 8% per annum.

What will be the effect on group retained earnings at the year end of 31 December 20X7 when this intragroup transaction is cancelled?

—

My thoughts:

We cannot “owe ourselves” money in the group accounts, so we eliminate, in full, as follows:

DR Loan Payable (SFP) in S: 10,000,000
CR Loan Receivable (SFP) in P: 10,000,000

Now in the Income Statement…

DR Group Finance Income (10m x 8% x 6/12): 400
CR Group Finance Costs (10m x 8% x 6/12): 400

—

However, BPP’s answer is as follows…

Group retained earnings will be reduced by $160,000.

Why?

Loss of investment income (10m x 8% x 6/12): (400)
Saving of interest payable (400 x 60%): 240
Net reduction in group retained earnings: (160)

Why is the interest payable by S less than P’s interest recievable? It is a post-acquisition transaction and we are supposed to eliminate these in full. Ultimately, the answer is saying that P is losing out on “400” of income (which should come from S), but S is only having to pay “240” less. So it’s not eliminated in full is it?

Confused. 🙁

Thanks for your help in advance Mike!

Andrew