Consolidated and other financial statements

Transcription

1 Financial reporting developments A comprehensive guide Consolidated and other financial statements Noncontrolling interests, combined financial statements, and parent company financial statements Revised October 2012

2 To our clients and other friends This Financial reporting developments ( FRD ) publication is designed to help you understand financial reporting issues related to the accounting for noncontrolling interests. This publication also includes interpretive guidance on consolidation procedure and on the presentation of combined and parent-only financial statements. The publication reflects our current understanding of the provisions in ASC 810, Consolidations, based on our experience with financial statement preparers and related discussions with the FASB and SEC staffs. The accounting for noncontrolling interests is based on the economic entity concept of consolidated financial statements. Under the economic entity concept, all residual economic interest holders in an entity have an equity interest in the consolidated entity, even if the residual interest is relative to only a portion of the entity (that is, a residual interest in a subsidiary). Therefore, a noncontrolling interest is required to be displayed in the consolidated statement of financial position as a separate component of equity. Likewise, the consolidated net income or loss and comprehensive income or loss attributable to both controlling and noncontrolling interests is separately presented on the consolidated statement of comprehensive income. Consistent with the economic entity concept, after control is obtained, increases or decreases in ownership interests that do not result in a loss of control should be accounted for as equity transactions. However, changes in ownership interests that result in a loss of control of a subsidiary or group of assets generally result in corresponding gain or loss recognition upon deconsolidation. The decrease in ownership guidance generally does not apply to transactions involving non-businesses, in-substance real estate or oil and gas mineral rights conveyances. The primary revisions made to this publication include the reorganization of certain content and the removal of the discussion of the transition guidance in FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (primarily codified in ASC 810). We also enhanced the interpretive guidance in Chapter 2 related to the presentation of noncontrolling interests when derivatives are issued with or as part of those interests. We also added certain other interpretive guidance (for example, to reflect the issuance of new guidance for deconsolidating insubstance real estate). These important changes are summarized in Appendix C. Practice and authoritative guidance interpreting the provisions of ASC 810 continue to evolve and therefore readers should monitor developments in this area closely. October 2012 Financial reporting developments Consolidated and other financial statements

3 Contents 1 Consolidated financial statements Objectives and scope Consolidation procedure time of acquisition Acquisition through single step Acquisition through multiple steps Proportionate consolidation Differing fiscal year-ends between parent and subsidiary Nature and classification of the noncontrolling interest Noncontrolling interests Equity derivatives issued on the stock of a subsidiary Is the equity derivative embedded in the noncontrolling interest or freestanding? Equity derivatives considered embedded Equity derivatives considered freestanding Equity derivatives deemed to be financing arrangements Application of the redeemable equity guidance Measurement and reporting issues related to redeemable equity securities Earnings per share considerations Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Redeemable or convertible equity securities and UPREIT structures Redeemable noncontrolling interest denominated in a foreign currency Attribution of net income or loss and comprehensive income or loss Attribution procedure Substantive profit sharing arrangements Attribution of losses Distributions in excess of the noncontrolling interest s carrying amount Attribution to noncontrolling interests held by preferred shareholders Attribution of goodwill impairment Attributions related to business combinations effected before Statement 160 and Statement 141(R) were adopted Effect on effective income tax rate Changes in a parent s ownership interest in a subsidiary while control is retained Increases and decreases in a parent s ownership of a subsidiary Increases in a parent s ownership interest in a subsidiary Increases in a parent s ownership interest in a consolidated VIE Decreases in a parent s ownership interest in a subsidiary without loss of control Accounting for a stock option of subsidiary stock Scope exception for in-substance real estate transactions Scope exception for oil and gas conveyances Decreases in ownership of a subsidiary that is not a business or nonprofit activity Financial reporting developments Consolidated and other financial statements i

4 Contents Issuance of preferred stock by a subsidiary Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Accumulated other comprehensive income considerations Accounting for foreign currency translation adjustments upon a change in parent s ownership interest without loss of control Allocating goodwill upon change in parent s ownership interest Accounting for transaction costs incurred in connection with changes in ownership Chart summarizing accounting for changes in ownership Comprehensive example Consolidation at the acquisition date Consolidation in year of combination Consolidation after purchasing an additional interest Consolidation in year Consolidation after selling an interest without loss of control Consolidation in year Intercompany eliminations Procedures for eliminating intercompany balances and transactions Effect of noncontrolling interest on elimination of intercompany amounts Loss of control over a subsidiary or a group of assets Deconsolidation of a subsidiary or derecognition of certain groups of assets Loss of control Nonreciprocal transfers to owners Gain/loss recognition Measuring the fair value of consideration received and any retained noncontrolling investment Accounting for contingent consideration in deconsolidation Accounting for a retained creditor interest in deconsolidation Accounting for accumulated other comprehensive income in deconsolidation Deconsolidation through multiple arrangements Deconsolidation through a bankruptcy proceeding Gain/loss classification and presentation Subsequent accounting for retained noncontrolling investment Comprehensive example Deconsolidation by selling entire interest Deconsolidation by selling a partial interest Combined financial statements Purpose of and procedures for combined financial statements Common management Procedures applied in combining entities for financial reporting Parent-company financial statements Purpose of and procedures for parent-company financial statements Investments in subsidiaries Investments in non-controlled entities Disclosure requirements Financial reporting developments Consolidated and other financial statements ii

5 Contents 9 Presentation and disclosures Certain presentation and disclosure requirements related to consolidation Consolidated statement of comprehensive income presentation Reconciliation of equity presentation Presentation of redeemable noncontrolling interests in equity reconciliation Interim reporting period requirements Consolidated statement of financial position presentation Consolidated statement of cash flows presentation Presentation of transaction costs in statement of cash flow Disclosure Comprehensive example A Comprehensive example... A-1 B Comparison of ASC 810 to IAS 27(R)... B-1 C Summary of important changes... C-1 D Abbreviations used in this publication... D-1 E Index of ASC references in this publication... E-1 Financial reporting developments Consolidated and other financial statements iii

6 Contents Notice to readers: This publication includes excerpts from and references to the FASB Accounting Standards Codification (the Codification or ASC). The Codification uses a hierarchy that includes Topics, Subtopics, Sections and Paragraphs. Each Topic includes an Overall Subtopic that generally includes pervasive guidance for the topic and additional Subtopics, as needed, with incremental or unique guidance. Each Subtopic includes Sections that in turn include numbered Paragraphs. Thus, a Codification reference includes the Topic (XXX), Subtopic (YY), Section (ZZ) and Paragraph (PP). Throughout this publication references to guidance in the codification are shown using these reference numbers. References are also made to certain pre-codification standards (and specific sections or paragraphs of pre-codification standards) in situations in which the content being discussed is excluded from the Codification. This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decisions. Portions of FASB publications reprinted with permission. Copyright Financial Accounting Standards Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT , U.S.A. Portions of AICPA Statements of Position, Technical Practice Aids, and other AICPA publications reprinted with permission. Copyright American Institute of Certified Public Accountants, 1211 Avenue of the Americas, New York, NY , USA. Copies of complete documents are available from the FASB and the AICPA. Financial reporting developments Consolidated and other financial statements iv

7 1 Consolidated financial statements 1.1 Objectives and scope Excerpt from Accounting Standards Codification Consolidation Overall Objectives General The purpose of consolidated financial statements is to present, primarily for the benefit of the owners and creditors of the parent, the results of operations and the financial position of a parent and all its subsidiaries as if the consolidated group were a single economic entity. There is a presumption that consolidated financial statements are more meaningful than separate financial statements and that they are usually necessary for a fair presentation when one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities. Scope and Scope Exceptions Entities The usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree A reporting entity shall apply consolidation guidance for entities that are not in the scope of the Variable Interest Entities Subsections (see the Variable Interest Entities Subsection of this Section) as follows: a. All majority-owned subsidiaries all entities in which a parent has a controlling financial interest shall be consolidated. However, there are exceptions to this general rule. 1. A majority-owned subsidiary shall not be consolidated if control does not rest with the majority owner for instance, if any of the following are present: i. The subsidiary is in legal reorganization ii. iii. iv. The subsidiary is in bankruptcy The subsidiary operates under foreign exchange restrictions, controls, or other governmentally imposed uncertainties so severe that they cast significant doubt on the parent's ability to control the subsidiary. In some instances, the powers of a shareholder with a majority voting interest to control the operations or assets of the investee are restricted in certain respects by approval or veto rights granted to noncontrolling shareholder (hereafter referred to as noncontrolling rights). In paragraphs through 25-14, the term noncontrolling shareholder refers to one or more noncontrolling shareholders. Those noncontrolling rights may have little or no impact on the ability of a shareholder with a Financial reporting developments Consolidated and other financial statements 1

8 1 Consolidated financial statements majority voting interest to control the investee's operations or assets, or, alternatively, those rights may be so restrictive as to call into question whether control rests with the majority owner. v. Control exists through means other than through ownership of a majority voting interest, for example as described in (b) through (e). 2. A majority-owned subsidiary in which a parent has a controlling financial interest shall not be consolidated if the parent is a broker-dealer within the scope of Topic 940 and control is likely to be temporary. 3. Except as discussed in paragraph , consolidation by an investment company within the scope of Topic 946 of a non-investment-company investee is not appropriate. b. Subtopic shall be applied to determine whether the rights of the limited partners in a limited partnership overcome the presumption that the general partner controls, and therefore should consolidate, the partnership. c. Subtopic shall be applied to determine the consolidation status of a research and development arrangement. d. The Consolidation of Entities Controlled by Contract Subsections of this Subtopic shall be applied to determine whether a contractual management relationship represents a controlling financial interest. e. Paragraph addresses the circumstances in which the accounts of a rabbi trust that is not a VIE (see the Variable Interest Entities Subsections for guidance on VIEs) shall be consolidated with the accounts of the employer in the financial statements of the employer. ASC 810 defines a subsidiary as an entity in which a parent has a controlling financial interest, whether that controlling interest comes through voting interests or other means (for example, variable interests). While consolidation policy is not the subject of this publication, in general, the first step in determining whether an entity has a controlling financial interest in a subsidiary is to establish the basis on which the investee is to be evaluated for control (that is, whether the consolidation determination should be based on ownership of the investee s outstanding voting interests or its variable interests). Accordingly, the provisions of ASC s variable interest model 1 should first be applied to determine whether the investee is a variable interest entity (VIE). Only if the entity is determined not to be a VIE should the consolidation guidance for voting interest entities within ASC be applied. Once it is determined a parent has a controlling financial interest in an entity, the assets, liabilities and any noncontrolling interests of that entity are accounted for in the parent s consolidated financial statements in accordance with the consolidation principles in ASC These principles are generally the same for entities consolidated under the voting interest and variable interest models. Illustration 1-1 summarizes how ASC 810 s control framework should generally be applied to interests in an entity. 1 Generally ASC includes guidance with respect to the consolidation considerations for voting interest entities and variable interest entities for each of ASC s sections. In each of ASC s sections there is a General subsection with respect to the consolidation model. This guidance applies to voting interest entities and also may apply to variable interest entities in certain circumstances. The Variable Interest Entities subsection within each of ASC s sections contains considerations with respect to variable interest entities. In referring to the Variable Interest Model in ASC , we are referring to the guidance applicable to variable interest entities in each of ASC s sections. Financial reporting developments Consolidated and other financial statements 2

9 1 Consolidated financial statements Illustration 1-1: ASC 810, Consolidation Decision Tree Variable Interest Model Is the entity being evaluated for consolidation a legal entity? No Yes Does a scope exception to consolidation guidance (ASC 810) apply? Employee benefit plans Governmental organizations Certain investment companies Yes Apply other GAAP No Consider whether fees paid to a decision maker or a service provider represent a variable interest Does a scope exception to the Variable Interest Model apply? Not-for-profit organizations Separate accounts of life insurance companies Lack of information Certain businesses No Yes Does the enterprise have a variable interest in a legal entity? No Apply other GAAP Consider whether silos exist or whether the interests or other contractual arrangements of the entity (excluding interests in silos) qualify as variable interests in the entity as a whole 1 Yes Is the legal entity a variable interest entity? Does the entity have sufficient equity to finance its activities without additional subordinated financial support? Do the equity holders, as a group, lack the characteristics of a controlling financial interest? Is the legal entity structured with non-substantive voting rights (i.e., anti-abuse clause)? Yes No Variable Interest Model (cont.) Voting model Is the enterprise the primary beneficiary (i.e., Does the enterprise individually have both power and benefits)? Consolidation of partnerships and similar entities Consolidation of corporations and other legal entities No No No Does the enterprise, including its related parties and de facto agents, collectively have power and benefits? Do not consolidate Does a related party or de facto agent individually have power and benefits? Yes Party most closely associated with VIE consolidates Yes Related party or de facto agent consolidates entity Yes Consolidate entity The general partner (GP) is presumed to have control unless that presumption can be overcome by one the following conditions: No Can a simple majority vote of limited partners remove a general partner without cause and there are no barriers to the exercise that removal right? Do limited partners have substantive participating rights? GP consolidates entity Yes No GP does not consolidate the entity. In limited circumstances a limited partner may consolidate (e.g., a single limited partner that has the ability to liquidate the limited partnership or kick out the general partner without cause). Does a majority shareholder, directly or indirectly, have greater than 50% of the outstanding voting shares? Do not consolidate No Consolidate entity Yes Do the minority shareholders hold substantive participating rights or do certain other conditions exist (e.g., legal subsidiary is in bankruptcy)? Yes Do not consolidate 1 See our Financial reporting developments publication, Consolidation of variable interest entities, for guidance on silos and specified assets. Financial reporting developments Consolidated and other financial statements 3

10 1 Consolidated financial statements Note: The FASB currently has a consolidation project on its agenda to amend ASC 810. The FASB s tentative decisions would modify the provisions for evaluating an enterprise as a principal or an agent and the provisions for evaluating the substance of kick-out rights and participating rights, among other things. Additionally, the tentative decisions would modify the literature in ASC used to reach consolidation conclusions for limited partnerships and similar entities. Readers should monitor developments in this area closely. 1.2 Consolidation procedure time of acquisition An entity may acquire a controlling financial interest in a subsidiary through a single step or through multiple steps over time Acquisition through single step ASC 805 provides guidance when an acquirer obtains control of an acquiree through a single investment, often referred to as a single-step acquisition. Single step acquisitions are perhaps the most recognizable form of business combination. ASC 805 requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, generally measured at their fair values as of the acquisition date. These concepts are discussed further in our FRD, Business combinations. The comprehensive example in Chapter 4 includes an example of the accounting for a single-step acquisition. See Section 4.2, Illustration 4-9; Section 4.2.1, Illustration 4-10; and Section 4.2.2, Illustration Acquisition through multiple steps An acquirer may obtain control of an acquiree through a series of two or more investments, which is commonly referred to as a step acquisition. or, in ASC 805, as a business combination achieved in stages. Under ASC 805, if the acquirer holds a noncontrolling equity investment in the acquiree immediately before obtaining control, the acquirer should first remeasure that investment to fair value as of the acquisition date and recognize any remeasurement gain or loss in earnings. If, before obtaining control, an acquirer recognized changes in the value of its noncontrolling investment in the target in other comprehensive income (that is, the investment was classified as available-for-sale in accordance with ASC 320), the amount recognized in other comprehensive income as of the acquisition date should be reclassified from other comprehensive income and included in the recognized remeasurement gain or loss as of the acquisition date. The acquirer then should apply ASC 805 s business combination guidance, as discussed in our FRD, Business combinations. After taking control of a target company, further acquisitions of ownership interests (i.e., acquisitions of noncontrolling ownership interests with no changes in control) are accounted for as transactions among shareholders within equity pursuant to the guidance in ASC 810 (refer to Chapter 4). Illustration 1-2 summarizes these concepts. Financial reporting developments Consolidated and other financial statements 4

11 1 Consolidated financial statements Illustration 1-2: Summary of guidance applied for acquisitions of an interest in an entity Acquisition of an interest prior to obtaining control Apply other GAAP (ASC 320, ASC 323 and ASC 815, among others). Acquisition of an additional interest, which provides control Acquisition of an additional interest, after control has already been obtained* First, remeasure the previously held interest (i.e., the interest held before obtaining control, if any) at fair value, recognizing any gain or loss in earnings. Next, measure and consolidate (generally at fair value) the net assets acquired and any noncontrolling interests, in accordance with ASC 805. (Refer to our FRD, Business combinations, for further interpretive guidance). Reduce the carrying amount of the noncontrolling interest. Recognize any difference between the consideration paid and the reduction to the noncontrolling interest in equity attributable to the controlling interest. (See Chapter 4 for further interpretive guidance). * See Section for further discussion of this accounting. 1.3 Proportionate consolidation Excerpt from Accounting Standards Codification Consolidation Overall Other Presentation Matters If the investor-venturer owns an undivided interest in each asset and is proportionately liable for its share of each liability, the provisions of paragraph may not apply in some industries. For example, in certain industries the investor-venturer may account in its financial statements for its pro rata share of the assets, liabilities, revenues, and expenses of the venture. Specifically, a proportionate gross financial statement presentation is not appropriate for an investment in an unincorporated legal entity accounted for by the equity method of accounting unless the investee is in either the construction industry (see paragraph ) or an extractive industry (see paragraphs and ). An entity is in an extractive industry only if its activities are limited to the extraction of mineral resources (such as oil and gas exploration and production) and not if its activities involve related activities such as refining, marketing, or transporting extracted mineral resources. Real Estate General Investments Equity Method and Joint Ventures Recognition If real property owned by undivided interests is subject to joint control by the owners, the investorventurers shall not present their investments by accounting for their pro rata share of the assets, liabilities, revenues, and expenses of the ventures. Most real estate ventures with ownership in the form of undivided interests are subject to some level of joint control. Accordingly, such investments shall be presented in the same manner as investments in noncontrolled partnerships. Financial reporting developments Consolidated and other financial statements 5

12 1 Consolidated financial statements The use of the proportionate gross financial statement presentation method (that is, proportionate consolidation, as described in ASC ) is permitted only in the following circumstances: a) investments in certain unincorporated legal entities in the extractive or construction industry that otherwise would be accounted for under the equity method of accounting (i.e., a controlling interest does not exist), and b) ownership of an undivided interest in real property when each owner is entitled only to its pro rata share of income and expenses and is proportionately (i.e., severally) liable for its share of each liability, and the real property owned is not subject to joint control by the owners. 1.4 Differing fiscal year-ends between parent and subsidiary Excerpt from Accounting Standards Codification Consolidation Overall Objectives General Differing Fiscal Year-Ends Between Parent and Subsidiary A difference in fiscal periods of a parent and a subsidiary does not justify the exclusion of the subsidiary from consolidation. Other Presentation Matters Differing Fiscal Year-Ends Between Parent and Subsidiary It ordinarily is feasible for the subsidiary to prepare, for consolidation purposes, financial statements for a period that corresponds with or closely approaches the fiscal period of the parent. However, if the difference is not more than about three months, it usually is acceptable to use, for consolidation purposes, the subsidiary's financial statements for its fiscal period; if this is done, recognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the financial position or results of operations A parent or an investor should report a change to (or the elimination of) a previously existing difference between the parent's reporting period and the reporting period of a consolidated entity or between the reporting period of an investor and the reporting period of an equity method investee in the parent's or investor's consolidated financial statements as a change in accounting principle in accordance with the provisions of Topic 250. While that Topic generally requires voluntary changes in accounting principles to be reported retrospectively, retrospective application is not required if it is impracticable to apply the effects of the change pursuant to paragraphs through The change or elimination of a lag period represents a change in accounting principle as defined in Topic 250. The scope of this paragraph applies to all entities that change (or eliminate) a previously existing difference between the reporting periods of a parent and a consolidated entity or an investor and an equity method investee. That change may include a change in or the elimination of the previously existing difference (lag period) due to the parent's or investor's ability to obtain financial results from a reporting period that is more consistent with, or the same as, that of the parent or investor. This paragraph does not apply in situations in which a parent entity or an investor changes its fiscal year-end. Financial reporting developments Consolidated and other financial statements 6

13 1 Consolidated financial statements Disclosure An entity should make the disclosures required pursuant to Topic 250. This paragraph applies to all entities that change (or eliminate) a previously existing difference between the reporting periods of a parent and a consolidated entity or an investor and an equity method investee. This paragraph does not apply in situations in which a parent entity or an investor changes its fiscal year-end. If there is a difference between a parent s fiscal year end and a subsidiary s fiscal year end, the parent may use the subsidiary s financial statements for consolidation purposes, provided the difference is not more than about three months (i.e., 93 days per Rule 3A-02(b) of Regulation S-X). When the fiscal year ends do differ, a parent should disclose the effect of intervening events that, if recognized, would materially affect the consolidated financial position or results of operations. If a parent elects to change or eliminate an existing difference in fiscal periods, the parent would report this as a change in accounting principle in accordance with the provisions of ASC 250. This guidance does not apply, however, in situations in which a parent entity changes its fiscal year-end. Financial reporting developments Consolidated and other financial statements 7

14 2 Nature and classification of the noncontrolling interest 2.1 Noncontrolling interests Excerpt from Accounting Standards Codification Consolidation Overall Glossary Noncontrolling Interest The portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. A noncontrolling interest is sometimes called a minority interest. Other Presentation Matters Nature and Classification of the Noncontrolling Interest in the Consolidated Statement of Financial Position The ownership interests in the subsidiary that are held by owners other than the parent is a noncontrolling interest. The noncontrolling interest in a subsidiary is part of the equity of the consolidated group The noncontrolling interest shall be reported in the consolidated statement of financial position within equity, separately from the parent s equity. That amount shall be clearly identified and labeled, for example, as noncontrolling interest in subsidiaries (see paragraph ). An entity with noncontrolling interests in more than one subsidiary may present those interests in aggregate in the consolidated financial statements A Only either of the following can be a noncontrolling interest in the consolidated financial statements: a. A financial instrument (or an embedded feature) issued by a subsidiary that is classified as equity in the subsidiary s financial statements b. A financial instrument (or an embedded feature) issued by a parent or a subsidiary for which the payoff to the counterparty is based, in whole or in part, on the stock of a consolidated subsidiary, that is considered indexed to the entity s own stock in the consolidated financial statements of the parent and that is classified as equity A financial instrument issued by a subsidiary that is classified as a liability in the subsidiary s financial statements based on the guidance in other Subtopics is not a noncontrolling interest because it is not an ownership interest. For example, Topic 480 provides guidance for classifying certain financial instruments issued by a subsidiary. Financial reporting developments Consolidated and other financial statements 8

15 2 Nature and classification of the noncontrolling interest A An equity-classified instrument (including an embedded feature that is separately recorded in equity under applicable GAAP) within the scope of the guidance in paragraph C shall be presented as a component of noncontrolling interest in the consolidated financial statements whether the instrument was entered into by the parent or the subsidiary. However, if such an equity-classified instrument was entered into by the parent and expires unexercised, the carrying amount of the instrument shall be reclassified from the noncontrolling interest to the controlling interest. Note: This chapter introduces certain concepts related to the accounting for financial instruments that may have embedded features. Given the complexity of the relevant authoritative literature and the significant judgment required to apply that literature, it may be important to consult additional guidance when accounting for these instruments and their related features. ASC indicates that a noncontrolling interest in an entity is any equity interest in a consolidated entity that is not attributable to the parent. ASC requires that the noncontrolling interest be classified as a separate component of consolidated equity. In ASC , the FASB concluded that a noncontrolling interest in an entity meets the definition of equity in Concepts Statement 6, which defines equity (or net assets) as, the residual interest in the assets of an entity that remains after deducting its liabilities. A noncontrolling interest represents a residual interest in the assets of a subsidiary within a consolidated group and is, therefore, consistent with the definition of equity in Concepts Statement 6. The noncontrolling interest is presented separately from the equity of the parent so that users of the consolidated financial statements can distinguish the parent s equity from the equity attributable to the noncontrolling interest (that is, equity of the subsidiary held by owners other than the parent). To be classified as equity in the consolidated financial statements, the instrument issued by the subsidiary should be classified as equity by the subsidiary based on other authoritative literature. If the instrument is classified as a liability in the subsidiary s financial statements (e.g., under any of the guidance in ASC 480), it cannot be presented as noncontrolling interest in the consolidated entity s financial statements because that instrument does not represent an ownership interest in the consolidated entity under US GAAP. For example, mandatorily redeemable preferred shares issued by a subsidiary would be classified as a liability in the subsidiary s financial statements pursuant to ASC 480. The preferred shares would not be classified as noncontrolling interest in the consolidated financial statements. 2.2 Equity derivatives issued on the stock of a subsidiary It is common for a parent and the noncontrolling interest holders of a subsidiary to enter into arrangements whereby they may do one or more of the following: Grant the noncontrolling interest holders an option to sell their equity interests in the subsidiary to the parent Grant the parent an option to acquire the equity interests in the subsidiary held by the noncontrolling holders Obligate the parent to acquire and the noncontrolling holders to sell their equity interests in the subsidiary Financial reporting developments Consolidated and other financial statements 9

16 2 Nature and classification of the noncontrolling interest Those arrangements can take the form of options (written or purchased, puts or calls), forwards (datecertain or contingent) or even swap-like contracts. In some cases, the arrangements may be papered between the parent and the noncontrolling interest holders, and in other cases between the subsidiary and the noncontrolling interest holders. The various options and forwards described above are contracts on the shares (common or preferred) of a subsidiary. If the underlying share is classified in equity (as noncontrolling interest), the equity derivatives 2 on the noncontrolling interest should be separately evaluated to determine their classification. The accounting in this area can be complex because of the variety of authoritative guidance that should be considered and the terms of the transaction. For example, (1) the equity derivative may be entered into contemporaneously with the creation of the noncontrolling interest or subsequent to its creation, (2) the form of the equity derivative (that is, whether it is embedded or freestanding) can be determinative and (3) the strike price of the equity derivative may be set at either a fixed or variable (formulaic) price or at fair value. Each of those variations can affect the accounting. The following summarizes, at a high level, the relevant accounting considerations applicable to equity derivatives associated with noncontrolling interest Is the equity derivative embedded in the noncontrolling interest or freestanding? The first step in accounting for an equity derivative associated with a noncontrolling interest is to determine whether the equity derivative is an embedded feature in the noncontrolling interest or a freestanding financial instrument, because the accounting can be significantly different. For example, the accounting for a freestanding written put on a subsidiary s shares is different than that for puttable shares issued by the subsidiary. While ASC 480 provides little interpretive guidance on the definition of a freestanding financial instrument, we believe that the substance of a transaction should be considered in making this determination. The determination of whether an instrument is embedded or freestanding involves understanding both the form and substance of the transaction, and may involve substantial judgment. In this regard, documenting an instrument in a separate contract is not necessarily determinative that it is freestanding, particularly when a contract is entered into in conjunction with another transaction. If the transactions are between the same parties and involve the same underlying (in this context, the issuer s shares), it is important to assess whether the instruments are (1) legally detachable and (2) separately exercisable. Those concepts can be further described as follows: Legally detachable Generally, whether two instruments can be legally separated and transferred such that the two components may be held by different parties. Separately exercisable Generally, whether one instrument can be exercised without terminating the other instrument (e.g., through redemption, simultaneous exercise, or expiration). If the exercise of one instrument must result in the termination of the other, the instruments would generally not be considered freestanding pursuant to ASC 480. On the other hand, if one instrument can be exercised while the other instrument continues to be outstanding, the instruments would be considered freestanding under ASC This chapter refers to derivatives in the common use of the word, not just instruments that meet the definition of a derivative in ASC Financial reporting developments Consolidated and other financial statements 10

17 2 Nature and classification of the noncontrolling interest For example, if a parent enters into a contract with the only minority shareholder of its privately held subsidiary that permits the shareholder to put its shares in the subsidiary to the parent at a fixed price, that put option generally would be considered to be embedded in the related shares. In contrast, if the same parent enters into a put option on publicly traded common stock of a different subsidiary, and that put option permits the counterparty to put any common shares of the subsidiary to the parent at a fixed price (e.g., the counterparty could put shares of the subsidiary already owned or buy shares in the market), that written put option would be considered freestanding, provided that it is also legally detachable from the shares Equity derivatives considered embedded If the equity derivative is considered a feature embedded in the subsidiary s shares, that embedded feature should be analyzed to determine whether the shares should be a mandatorily redeemable financial instrument subject to ASC 480 or, if the shares are not a liability, whether the feature should be bifurcated. To determine whether the embedded feature should be bifurcated, the hybrid instrument (the subsidiary s shares and embedded feature) should be evaluated under ASC In many cases, unless the subsidiary itself is a publicly traded entity, the feature will not meet the definition of a derivative pursuant to ASC because those features usually require gross physical settlement or the transfer of the full amount of consideration payable in exchange for the full number of underlying nonpublic subsidiary shares. As the underlying nonpublic shares are not readily convertible to cash, this gross physical settlement does not meet any of the forms of net settlement pursuant to ASC However, if the instrument meets the definition of a derivative, it should be evaluated under ASC (a) to determine if an exception from bifurcation is available. 3 The exception in ASC (a) is applicable if the feature is considered indexed to the issuer s own stock and would be classified in equity. ASC includes guidance that should be considered in making this determination. There are special considerations as to whether the feature is considered indexed to the issuer s own stock when subsidiary shares are involved, as discussed in ASC C. If an equity derivative is (1) deemed to be embedded and (2) the entire instrument is not a liability, the redeemable equity guidance should be considered (see Section below) Equity derivatives considered freestanding An equity derivative that is considered a freestanding financial instrument should be evaluated pursuant to ASC 480 to determine whether liability classification is required as, for the purposes of ASC 480, an issuer s equity share includes the equity shares of any entity whose financial statements are included in the consolidated financial statements. Instruments that may require the issuer to transfer cash or other assets in exchange for its own shares are among those classified as liabilities pursuant to ASC 480. For example, a physically settled forward contract that requires the parent to pay cash in exchange for the subsidiary s shares is within the scope of ASC 480. Further, a freestanding written put option on the subsidiary s shares is also a liability under ASC 480 regardless of whether it settled gross or net. If the equity derivative is not a liability pursuant to ASC 480, the instrument should be evaluated to determine whether it is a derivative pursuant to ASC 815. Similar to the analysis of an embedded feature in the subsidiary s shares, frequently, it will not meet the definition of a derivative because it lacks net settlement. Even if the contract meets the definition of a derivative, it may still qualify for a scope exception from derivative accounting pursuant to ASC (a), which considers the guidance in ASC If the equity derivative does not meet the definition of a derivative, that same guidance in ASC is applied to determine the contract s classification. 3 The embedded feature would be considered a derivative if the underlying shares were publicly traded. If the feature meets the net settlement criterion by way of a required or alternative settlement in net cash or net shares, the conclusion that the feature was embedded should be revisited. Financial reporting developments Consolidated and other financial statements 11

18 2 Nature and classification of the noncontrolling interest Equity derivatives deemed to be financing arrangements In limited situations, a parent may enter into an equity derivative to acquire a subsidiary s shares that should be accounted for as a financing of the parent s purchase of the minority interest. In those situations, equity derivatives are entered into between the parent and minority interest holder at the inception of noncontrolling interest that require physical settlement. The contracts may be either (1) a fixed-priced forward to buy the remaining interest in the subsidiary at a stated future date and the forward is considered freestanding or (2) combination of a purchased call option and written put option with same (or not significantly different) fixed strike price and same fixed exercise date that are embedded in the shares. 4 Essentially, the parent consolidates 100% of the subsidiary and does not recognize the noncontrolling interest at the consolidated entity level, but rather a liability for the financing (i.e., the future purchase of the noncontrolling interest). In those circumstances, the risks and rewards of owning the noncontrolling interest have been obtained by the parent during the period of the equity derivative, even though the legal ownership of the noncontrolling interest is still retained by the noncontrolling interest holders. Essentially, combining the equity derivative and the noncontrolling interest reflects the substance of the transaction; that is, the noncontrolling interest holder is financing the noncontrolling interest. ASC states that the forward contract should be recognized as a liability, initially measured at the present value of the fixed forward price. Subsequently, the liability is accreted to the fixed forward price over the term of the forward contract with the resulting expense recognized as interest cost. Similar accounting and measurement would be applied to the combined noncontrolling interest and embedded options. The initial measurement guidance in ASC is not consistent with the general initial measurement requirement of ASC 480 for physically settled forward purchase contracts. The general measurement guidance in ASC states that a freestanding physically settled forward contract should be measured initially at the fair value of the underlying shares at inception, adjusted for any consideration or unstated rights or privileges. While the methods are different, we generally believe that they should result in approximately the same initial measurement. Any significant differences would require additional analysis to determine if there are additional rights or privileges in the transaction Application of the redeemable equity guidance Generally, an embedded feature, whether or not bifurcated, that permits or requires the noncontrolling interest holder to deliver the subsidiary s interests in exchange for cash or other assets from the controlling entity (or the subsidiary itself) will result in the noncontrolling interest being considered redeemable equity. Public entities should consider the SEC staff s guidance (included in codification at ASC S99-3A) on redeemable equity securities when classifying redeemable noncontrolling interest. Those interests should first follow the accounting and measurement guidance in ASC (including allocation of earnings, adjustments for dividends, etc.). The SEC s guidance should then be considered, which could affect the classification (presented in the mezzanine rather than in equity), and if so, may also adjust the measurement of any noncontrolling interest and the related earnings per share calculations. 4 ASC through describe three different derivative instruments indexed to the stock of a consolidated subsidiary. One instrument includes a written put and purchased call. ASC provides for three different ways to account for the written put and purchased call, based on how the instruments were issued relative to the noncontrolling interest (i.e., freestanding from or embedded in the noncontrolling interest). ASC suggests that when the written put/purchased call are freestanding, they should be combined with the noncontrolling interest and accounted for as a financing. This accounting is not one of the three ways described in ASC We believe the guidance in ASC is inconsistent with the guidance formerly in EITF 00-4, Majority Owner's Accounting for a Transaction in the Shares of a Consolidated Subsidiary and a Derivative Indexed to the Minority Interest in That Subsidiary. As the Codification was not intended to change GAAP, we believe ASC should be followed unless ASC 815 requires the options to be combined with the noncontrolling interest, in which case the accounting described in ASC through should be followed. Financial reporting developments Consolidated and other financial statements 12

19 2 Nature and classification of the noncontrolling interest In certain instances, the issuer may be required, or may have a choice, to exchange the subsidiary s interests by delivery of its own shares, rather than cash or other assets. In those instances, the SEC staff s guidance requires the issuer to consider the guidance in ASC through to determine whether it can deliver the shares that could be required under the settlement of the exchange. If the issuer does not completely control settlement by delivery of its own shares (i.e., it cannot satisfy the settlement in shares), cash settlement would be presumed and temporary classification may be required for the noncontrolling interest Measurement and reporting issues related to redeemable equity securities Redeemable noncontrolling interest is required to be initially measured at the initial carrying amount of the noncontrolling interest pursuant to the guidance in ASC While that will generally be fair value, the guidance in ASC should be considered. For all companies, both public and nonpublic, noncontrolling interest is first accounted for pursuant to ASC 810. If the noncontrolling interest is considered redeemable pursuant to ASC S99-3A, the redeemable noncontrolling interest is presented in temporary equity. The measurement guidance is not applied in lieu of the accounting for noncontrolling interest under ASC 810. Rather, it is an incremental measurement that starts with the carrying amount pursuant to ASC 810 and adjusts for any increase (but not decrease) to the carrying amount of temporary equity. As a result, a parent should first attribute net income or loss of the subsidiary and related dividends to the noncontrolling interest pursuant to ASC 810. After that attribution, the issuer should consider the provisions of ASC S99-3A to determine whether any further adjustments are necessary to increase the carrying value of redeemable noncontrolling interest. The amount presented in temporary equity should be the greater of the noncontrolling interest balance determined pursuant to ASC 810 or the amount determined pursuant to ASC S99-3A. Pursuant to ASC S99-3A, a security (including noncontrolling interest) that is currently redeemable is measured at the current redemption amount. For a security that is not redeemable currently, but will become redeemable in the future, the SEC guidance permits the following two methods of adjusting the carrying amount of the redeemable security: Method 1 Adjust the carrying amount of the redeemable security to what would be the redemption amount assuming the security was redeemable at the balance sheet date. Method 2 Accrete the carrying amount of the redeemable security to the redemption amount over time, to the date it is probable 5 it will become redeemable, using an appropriate method (e.g., the interest method). The SEC guidance does not specify which method is required. We generally believe issuers should evaluate the specific facts and circumstances of the applicable redemption feature and the level of subjectivity and assumptions necessary and apply the method that best presents the economics of the redeemable noncontrolling interest. Once the method is selected, it should be consistently applied. Paragraph 16e of ASC S99-3A states that the amount in temporary equity should not be less than the redeemable instrument s initial amount reported in temporary equity. It further states that reductions in the carrying amount of a temporary equity instrument are appropriate only to the extent of increases in the redeemable instrument s carrying amount from the application of the SEC guidance. We generally believe only the incremental measurement pursuant to the SEC staff s guidance is subject to this requirement. An issuer could potentially adjust a redeemable noncontrolling interest s balance below its initial carrying amount when applying ASC The ASC master glossary defines probable as: the future event or events are likely to occur. Financial reporting developments Consolidated and other financial statements 13

20 2 Nature and classification of the noncontrolling interest Earnings per share considerations As noted in ASC S99-3A paragraph 22, adjustments to the carrying amount of redeemable noncontrolling interest from the application of the SEC guidance do not affect net income or comprehensive income in the consolidated financial statements. However, the adjustments may affect earnings per share (EPS). The effect, if any, will depend on (1) whether the noncontrolling interest is represented by the subsidiary s common shares or preferred shares and (2) if common shares, whether the redemption amount is at the then-current fair value or some other value (e.g., a formulaic value or fixed amount). Refer to Section of our FRD, Earnings per share, for further discussion of the EPS effects of redeemable equity instruments (including redeemable noncontrolling interest) Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests The following table summarizes the accounting for certain common equity derivatives used to acquire interests in a subsidiary. This table assumes the equity derivatives are issued on all of the outstanding noncontrolling interest (i.e., for the fixed number of shares not held by the parent) and are entered into by the controlling interest. This table should be applied only after determining (1) when the equity derivative was entered into relative to the creation of the noncontrolling interest 6 (2) whether its price is fixed, variable or at fair value and (3) whether the instrument is embedded or freestanding. It should be used as a starting point in applying the literature. Parenthetical references cite the relevant literature. Application of ASC S99-3A is not specifically provided in the table, but references are made where the SEC staff s guidance would be an additional consideration. This table, necessarily, does not contemplate all possible instruments and assumes subsidiaries represent substantive entities as contemplated in ASC C. Careful consideration of the individual facts and circumstances will be necessary to determine the appropriate accounting for any instrument issued on noncontrolling interest. Instrument Entered into Redemption amount Accounting Written put option permitting the noncontrolling interest holder to put its interest to the controlling interest Contemporaneous with creation of noncontrolling interest Fixed, fair value or variable If embedded If the embedded written put option does not require bifurcation pursuant to ASC , the put option is recognized as part of the noncontrolling interest. Changes in the fair value of the option over its life are not recognized. Earnings are generally attributed to the controlling interest and noncontrolling interests without considering the put option. If the embedded put option is exercised, the noncontrolling interest is reduced and APIC is adjusted for any difference between the noncontrolling interest s carrying value and the consideration paid. 7 For SEC reporting, additional consideration of ASC S99-3A is required for the noncontrolling interest. 6 This table assumes that equity derivatives issued subsequent to the creation of the noncontrolling interest are freestanding. Depending on individual facts and circumstances, certain equity derivatives issued subsequent to the creation of the noncontrolling interest could be considered embedded. If the instrument is considered to be embedded, the guidance on equity derivatives embedded in the noncontrolling interest should be applied, and the guidance in ASC S99-3A should be considered. 7 ASC requires transactions between the controlling interest and noncontrolling interest that do not result in consolidation or deconsolidation to be recognized in equity. Financial reporting developments Consolidated and other financial statements 14

21 2 Nature and classification of the noncontrolling interest Instrument Entered into Redemption amount Accounting If freestanding ASC 480 requires it to be classified as a liability and measured at fair value with the changes in value recognized in earnings. The exercise of the option results in the acquisition of noncontrolling interest and any difference between the cash paid and the combined value of the freestanding instrument and noncontrolling interest s carrying value would be recorded to APIC. If embedded and bifurcated The written put option is bifurcated and reported separately at fair value with changes in fair value recorded in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810. For SEC reporting, additional consideration of ASC S99-3A is required for the host equity derivative. Subsequent to creation of noncontrolling interest Fixed, fair value or variable The written put option is recognized as a liability that is initially and subsequently measured at fair value pursuant to ASC 480. The noncontrolling interest is recognized and measured in accordance with ASC 810. Purchased call option permitting the controlling interest to acquire the noncontrolling interest Contemporaneous with creation of noncontrolling interest Fixed, fair value or variable If embedded If the embedded purchased call option does not require bifurcation pursuant to ASC , the call option is recognized as part of the noncontrolling interest. Changes in the fair value of the option over its life are not recognized. Earnings are generally attributed to the controlling interest and noncontrolling interests without considering the call option. If the embedded call option is exercised, the noncontrolling interest is reduced and APIC is adjusted for any difference between the noncontrolling interest s carrying value and the consideration paid. If (1) freestanding and in the scope of ASC or (2) bifurcated The purchased call option is reported separately and measured at fair value with changes in value recognized in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810. If freestanding and not in the scope of ASC Follow ASC to determine the appropriate classification and subsequent measurement of the instruments as an asset or equity. (ASC through 25-43) The noncontrolling interest continues to be recognized pursuant to ASC 810. For a freestanding call option classified as equity pursuant to ASC , if the call option is not exercised and were entered into by the parent, the carrying amount of the instrument should be reclassified from the noncontrolling interest to the controlling interest. If it is not exercised and were entered into by the subsidiary, there is no reclassification to be made. The 1986 AICPA Options Paper provides potential measurement alternatives to be evaluated if it were determined that neither ASC nor ASC applied. Financial reporting developments Consolidated and other financial statements 15

22 2 Nature and classification of the noncontrolling interest Instrument Entered into Redemption amount Accounting Subsequent to creation of noncontrolling interest Fixed, fair value or variable If freestanding and in the scope of ASC The freestanding purchased call option is reported separately and measured at fair value with changes in value recognized in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810. If freestanding and not in the scope of ASC Follow ASC to determine the appropriate classification and subsequent measurement of the instruments as an asset or equity. (ASC through ) The noncontrolling interest continues to be recognized pursuant to ASC 810. For a freestanding call option classified as equity pursuant to ASC , if the call option is not exercised and were entered into by the parent, the carrying amount of the instrument should be reclassified from the noncontrolling interest to the controlling interest. If it is not exercised and were entered into by the subsidiary, there is no reclassification to be made. The 1986 AICPA Options Paper provides potential measurement alternatives to be evaluated if it were determined that neither ASC nor ASC applied. Forward contract to acquire the noncontrolling interest Contemporaneous with creation of noncontrolling interest Payment amount and settlement date are fixed If embedded The noncontrolling interest would be a mandatorily redeemable financial instrument classified as a liability pursuant to ASC and measured initially at fair value. 8 Noncontrolling interest is not recognized and no earnings are allocated to the noncontrolling interest. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary s assets and liabilities. If freestanding The forward contract is classified as a liability and initially measured at an appropriate value. 9 The liability is accreted to the settlement amount over the term of the forward contract with the resulting expense recognized as interest cost. Noncontrolling interest is not recognized and no earnings are allocated to the noncontrolling interest.. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary s assets and liabilities. (ASC and ASC through 55-54) When the forward contract is settled, the liability is derecognized. 8 Subsequently, whether the measurement requirements of ASC or ASC S99 would be required depends on the application of the transition guidance in ASC (b). If the measurement guidance under ASC is applicable, the liability is measured at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception based on the initial measurement. 9 When addressing the initial measurement of a forward contract on shares of a subsidiary, there are three conflicting measurement models. A freestanding forward contract under ASC is initially measured at the fair value of the shares to be repurchased, adjusted for any consideration or unstated rights or privileges. A freestanding forward contract under ASC is initially measured at the present value of the contract amount, which we believe should be discounted using a market-based rate reflecting the issuer s own credit risk. A mandatorily redeemable noncontrolling interest is measured at fair value under ASC We generally believe that these methods should result in approximately the same initial measurement. Any significant differences would require additional analysis to determine if there were additional rights or privileges granted in the transaction. Financial reporting developments Consolidated and other financial statements 16

23 2 Nature and classification of the noncontrolling interest Instrument Entered into Redemption amount Accounting Contemporaneous with creation of noncontrolling interest Payment amount or settlement date vary based on certain conditions If embedded The resulting mandatorily redeemable financial instrument is a liability pursuant to ASC 480 and measured initially at fair value. 10 Noncontrolling interest is not recognized and no earnings are allocated to the noncontrolling interest. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary s assets and liabilities. If freestanding The forward contract is not subject to ASC as the settlement price is not fixed. Pursuant to other sections of ASC 480, a liability should be recognized at the fair value of the shares at inception, adjusted for any consideration or unstated rights or privileges. The liability is subsequently measured at the amount that would be paid on the reporting date with any change in value from the previous reporting date recognized as interest cost. Noncontrolling interest is not recognized and no earnings are allocated to the noncontrolling interest. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary s assets and liabilities. Forward contract to acquire the noncontrolling interest (continued) Subsequent to creation of noncontrolling interest Payment amount and settlement date are fixed Pursuant to ASC 480, the freestanding forward contract is recognized as a liability at the date on which the forward contract was entered into. The liability is initially measured at the fair value of the shares at inception adjusted for any consideration or unstated rights or privileges. Subsequent measurement is at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception based on the initial measurement. The previously recognized noncontrolling interest is derecognized and any difference between the amount of the liability and the noncontrolling interest s carrying amount is recognized in APIC. No further attribution of earnings is necessary because there is no noncontrolling interest. Either payment amount or settlement date varies based on certain conditions Same as the accounting if the settlement date is fixed except that the liability is subsequently measured at the amount that would be paid on the reporting date with any change in value from the previous reporting date recognized as interest cost. No further attribution of earnings is necessary because there is no noncontrolling interest. 10 Whether the subsequent measurement requirements of ASC or ASC S99 would be required depends on the application of the transition guidance in ASC (b). If the measurement guidance under ASC is applicable, the liability is subsequently measured at the settlement amount as if settlement occurred at the reporting date. Facts and circumstances should be considered in determining the measurement amount that best represents economics of the mandatorily redeemable noncontrolling interest. Financial reporting developments Consolidated and other financial statements 17

24 2 Nature and classification of the noncontrolling interest Instrument Entered into Redemption amount Accounting Written put option and purchased call option with same (or not significantly different) strike price and same exercise date Contemporaneous with creation of noncontrolling interest Fixed Price If embedded 11 Pursuant to ASC through 55-62, the options are viewed on a combined basis with the noncontrolling interest. The combined instrument is classified as a liability, initially measured at the present value of the settlement amount. 12 Subsequently, the liability is accreted to the strike price with the accretion recognized as interest expense. Noncontrolling interest is not recognized and earnings are not attributed. The parent accounts for this transaction as a financing and consolidates 100% of the subsidiary. (ASC , and 55-62) If embedded and bifurcated The combined option is reported separately at fair value with changes in fair value recorded in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810. For SEC reporting, additional consideration of ASC S99-3A is required for the host equity derivative. If freestanding The written put and purchased call should be evaluated to determine if they are a single instrument or two instruments. If viewed as a single instrument, the combined instrument containing a written put is recognized as a liability (or assets in certain instances) and measured at fair value. If viewed as two freestanding instruments, the written put option is recognized as a liability pursuant to ASC 480 and the purchased call option is evaluated pursuant to ASC and ASC and may be recognized as an asset or equity (refer to discussion in the table above for separate written puts and purchased calls). 11 ASC establishes three scenarios for the written put/purchased call scenario, including one single instrument (combined written put/purchased call), two instruments (written put and purchased call), and embedded (both options embedded in the noncontrolling interest). However, ASC suggests that the options should be considered embedded. As the Codification was not intended to change current practice, we believe that this contradiction should be resolved in favor of ASC after considering the legacy guidance in paragraphs 16 through 18 of pre-codification EITF This instrument is not considered mandatorily redeemable, as there is the possibility, while highly unlikely, that on the exercise date the noncontrolling interest has a fair value equal to the strike price in the options and neither party is economically motivated to exercise (as opposed to an embedded forward contract that requires settlement and renders the shares mandatorily redeemable). Therefore, the guidance in ASC is not applicable. However, see footnote 9, which discusses why that the various initial measurement methods in ASC should be approximately the same. Financial reporting developments Consolidated and other financial statements 18

25 2 Nature and classification of the noncontrolling interest Instrument Entered into Redemption amount Accounting Written put option and purchased call option with same (or not significantly different) strike price and same exercise date (continued) Contemporaneous with creation of noncontrolling interest (continued) Issued subsequent to creation of noncontrolling interest and issued as freestanding instruments Other than fixed price Fixed price or other than fixed price If embedded The noncontrolling interest with the embedded options is not subject ASC through Noncontrolling interest is not mandatorily redeemable and no liability should be recognized at inception. The options are recognized as part of the noncontrolling interest. Changes in the fair value of options are not recognized. Earnings are generally attributed to the controlling interest and noncontrolling interest without considering the put option. For SEC reporting, additional consideration of ASC S99-3A is required. If embedded and bifurcated The combined option is reported separately at fair value with changes in fair value recorded in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810. For SEC reporting, additional consideration of ASC S99-3A is required for the host equity derivative. If freestanding The written put and purchased call should be evaluated to determine if they are a single instrument or two instruments. If viewed as a single instrument, the combined instrument containing a written put is recognized as a liability (or assets in certain instances) and measured at fair value. If viewed as two freestanding instruments, the written put option is recognized as a liability pursuant to ASC 480 and the purchased call option is evaluated pursuant to ASC and ASC and may be recognized as an asset or equity (refer to discussion in the table above for separate written puts and purchased calls). Refer to freestanding analysis above Redeemable or convertible equity securities and UPREIT structures A real estate investment trust (REIT) with an umbrella partnership REIT structure (UPREIT) will typically have a consolidated operating partnership (OP) that has issued ownership units to noncontrolling parties. Based on the features typically found in the OP units, a REIT should carefully consider the guidance in ASC S99-3A when classifying and measuring noncontrolling OP units in the consolidated financial statements. When a REIT acquires a property, it may issue redeemable OP units to the seller (OP units generally are used to defer a taxable event for the sellers). Those sellers become noncontrolling investors in the OP. The structure of redemption features as part of the OP units or the unit holder agreement with the investor can vary based on various legal considerations for the parent REIT and the OP, including the state of incorporation or organization for the legal entity, interpretations of tax law or other factors. Financial reporting developments Consolidated and other financial statements 19

26 2 Nature and classification of the noncontrolling interest For example, arrangements vary as to with which entity the investor can redeem the units (e.g., only with the OP or only with the parent REIT or with the parent REIT deciding which entity will redeem the units). Typically, the redeeming entity (parent REIT or OP) will have the choice of the redemption consideration, which could be cash or shares of the parent REIT. The amount of the redemption could be based on a fixed amount, a formulaic amount, or most frequently, a fixed exchange ratio of OP units for parent REIT shares (or the then-current value of those public shares in cash). As the OP units are redeemable (or exchangeable) at the option of the investor, the OP units potentially represent redeemable noncontrolling interests in the consolidated financial statements. Pursuant to the redeemable equity guidance in ASC S99-3A, if the OP units may be redeemed for cash outside the control of the reporting entity (the consolidated REIT in this case), the noncontrolling interest should be classified in the mezzanine section and measured in accordance with the SEC s guidance. Therefore, identifying what settlement alternatives exist and whether they are solely within the control of the reporting entity is important. Based on discussions with the SEC staff, for the consolidated financial statements, we believe that the parent REIT and OP can be considered essentially a single decision maker in evaluating the redemption provisions if both of the following conditions are met: The parent REIT is the general partner in the operating partnership and the entities share the same corporate governance structures. The parent REIT can freely exercise all choices afforded it without conflicting with its fiduciary duties to its shareholders. This will often result in a conclusion that the parent REIT/OP can elect share settlement upon redemption of the OP units. However, as discussed in ASC S99-3A, the guidance in ASC should be evaluated to determine whether the parent REIT/OP controls the actions or events necessary to issue the maximum number of parent REIT shares that could be required to be delivered under share settlement of the contract. If the parent REIT/OP controls those actions or events, the OP units would not be within the scope of the SEC s guidance. However, if those actions or events are not completely within their control, the presentation and measurement guidance in ASC S99-3A would apply. There may be separate SEC reporting requirements for the OP. For example, if the OP has public debt outstanding, many of the concepts described above would be considered in determining the classification of the OP units in the stand-alone financial statements of the OP. However, it is important to realize that the OP units would be redeemable equity instruments rather than redeemable noncontrolling interests, and thus there would be different elements of ASC S99-3A to be considered Redeemable noncontrolling interest denominated in a foreign currency When a redeemable noncontrolling interest is denominated in a foreign currency, additional consideration should be given to the interaction of ASC 830 and ASC S99-3A s measurement guidance. Because neither ASC 830 nor ASC S99-3A provides specific guidance, judgment is required to determine whether and, if so, how to adjust the carrying amount of the redeemable noncontrolling interest for the effect of currency exchange rate movements while also respecting the redeemable equity measurement guidance. See Question 3.6 of our Financial Reporting Developments publication, Foreign currency matters (SCORE NO. BB2103), for additional guidance. Financial reporting developments Consolidated and other financial statements 20

27 2 Nature and classification of the noncontrolling interest Insurer s consolidation of fund partially owned by insurer s separate accounts on behalf of contract holders Question 2.1 How should an insurer consolidate a controlled investment fund if a portion of the consolidated investment fund is owned by the insurer s separate accounts? In accordance with ASC , the insurer should consolidate the investment fund in the following manner: The portion of the fund assets representing the contract holder s interests should be included as separate account assets and liabilities in accordance with ASC The remaining portion of the fund assets (including the portion owned by any other investors) should be included in the general account of the insurer on a line-by-line basis Noncontrolling interests should not be included in the separate account liability but rather classified as a liability or equity based on other applicable guidance It should be noted that pursuant to ASC , 13 when evaluating an entity for consolidation, an insurer should not consider any separate account interests held for the benefit of policy holders to be the insurer s interests, nor should it combine any separate account interests held for the benefit of policy holders with the insurer s general account interest in the same investment. Refer to our FRD, Consolidation of variable interest entities, for additional consolidation considerations. 13 The guidance applies if the separate account meets the conditions in ASC Financial reporting developments Consolidated and other financial statements 21

28 3 Attribution of net income or loss and comprehensive income or loss 3.1 Attribution procedure Excerpt from Accounting Standards Codification Consolidation Overall Other Presentation Matters Attributing Net Income and Comprehensive Income to the Parent and the Noncontrolling Interest Revenues, expenses, gains, losses, net income or loss, and other comprehensive income shall be reported in the consolidated financial statements at the consolidated amounts, which include the amounts attributable to the owners of the parent and the noncontrolling interest Net income or loss and comprehensive income or loss, as described in Topic 220, shall be attributed to the parent and the noncontrolling interest Losses attributable to the parent and the noncontrolling interest in a subsidiary may exceed their interests in the subsidiary s equity. The excess, and any further losses attributable to the parent and the noncontrolling interest, shall be attributed to those interests. That is, the noncontrolling interest shall continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance. While ASC requires net income or loss and comprehensive income or loss to be attributed to the controlling and noncontrolling interests, it does not prescribe a method for making these attributions. We believe that net income or loss, including other comprehensive income or loss, of a partially-owned subsidiary should be attributed between controlling and noncontrolling interests based on the terms of a substantive profit sharing agreement. If a substantive profit sharing agreement does not exist, we generally believe the relative ownership interests in the subsidiary should be used. Accordingly, in the latter case, the attribution may be as simple as multiplying the net income or loss and comprehensive income or loss of the partially-owned subsidiary by the relative ownership interests in the subsidiary Substantive profit sharing arrangements We believe that, if substantive, a contractual arrangement that specifies how net income or loss, including other comprehensive income or loss, are to be attributed among the subsidiary s owners should be used for financial reporting purposes. To be substantive, an arrangement should retain its purported economic outcome over time, and subsequent events should not have the potential to retroactively affect or unwind attributions of profit or loss from prior periods. Financial reporting developments Consolidated and other financial statements 22

29 3 Attribution of net income or loss and comprehensive income or loss Determining whether a profit sharing arrangement is substantive is a matter of individual facts and circumstances requiring the use of professional judgment. In particular, care should be exercised when different formulae are used to allocate cash distributions and liquidating distributions from taxable earnings. In these situations, the tax allocation should be carefully evaluated to ensure that the basis used for financial reporting purposes representationally reflects the allocations of earnings agreed by the parties. ASC provides guidance on this point. Specified profit and loss allocation ratios should not be used if the allocation of cash distributions and liquidating distributions are determined on some other basis. For example, if [an] agreement between two investors purports to allocate all depreciation expense to one investor and to allocate all other revenues and expenses equally, but further provides that irrespective of such allocations, distributions to the investors will be made simultaneously and divided equally between them, there is no substance to the purported allocation of depreciation expense. Additionally, we believe that it would be appropriate to disclose the terms and effects of any material substantive profit sharing arrangement. Also, the SEC staff has asked public companies to enhance their disclosures to include how such allocations among controlling and noncontrolling interests are made. Again, if a substantive profit sharing agreement does not exist, we generally believe the relative ownership interests in the subsidiary should be used. Accordingly, the attribution may be as simple as multiplying the net income or loss and comprehensive income or loss of the partially-owned subsidiary by the relative ownership interests in the subsidiary. Question 3.1 Can the hypothetical liquidation at book value (HLBV) method 14 be used to attribute net income or loss and comprehensive income or loss between the controlling and noncontrolling interests? As noted above, all attributions of net income or loss, including other comprehensive income or loss, should follow a substantive profit sharing agreement (or relative ownership percentage in the absence of a substantive profit sharing arrangement). When a substantive profit sharing arrangement exists, an entity will have to develop methodologies that reflect the substantive arrangement to allocate net income or loss and comprehensive income or loss. The HLBV allocation methodology is one such possible methodology. However any developed methodology is not necessarily a substantive profit sharing arrangement. Therefore, use of the HLBV method (or any other methodology) to make such attributions is only be appropriate if it reflects the terms of an existing substantive profit sharing arrangement. Determining whether the terms of an arrangement are substantive and whether the HLBV method (or any other allocation methodology) reflects that substance requires a careful evaluation of the individual facts and circumstances and requires the use of professional judgment. In evaluating the substance of the terms, the investor should consider whether the terms retain their purported economic outcome over time and whether subsequent events have the potential to retroactively affect or unwind prior attributions. 14 Under the HLBV method, an investor generally determines its interest in an investee at each balance sheet date by calculating the amount it would receive (or be obligated to pay) if the investee liquidated all of its assets at book value and distributed the resulting cash to its creditors and investors in accordance with the terms of the governing contractual arrangements. The difference between this amount and the same amount calculated at the end of the previous period represents the investor s share of the investee s net income or losses for that period. In this way, the investor s share of the investee s net income or losses reflects its share of the change in the investee s net asset book value. Financial reporting developments Consolidated and other financial statements 23

30 3 Attribution of net income or loss and comprehensive income or loss Attribution of losses Before Statement 160 was adopted, losses that otherwise would have been attributed to the noncontrolling interest were allocated to the controlling interest after the noncontrolling interest was reduced to zero. If the subsidiary subsequently became profitable, 100% of the net earnings would have been allocated to the controlling interest until it recovered the losses that were absorbed. Importantly, Statement 160 amended previous guidance to provide that losses are attributed to the noncontrolling interest, even when the noncontrolling interest s basis in the partially-owned subsidiary has been reduced to zero. Under the economic entity concept, the noncontrolling interest is considered equity of the consolidated group and participates in the risks and rewards of an investment in the subsidiary. Therefore, it should be attributed its share of losses just like the parent even if the noncontrolling interest balance becomes a deficit. Accordingly, any excess loss attributed to the noncontrolling interest is reported in consolidated financial statements as a deficit balance in the noncontrolling interest line in the equity section Distributions in excess of the noncontrolling interest s carrying amount We generally believe that because the noncontrolling interest balance can be reduced below zero under ASC 810 (that is, the noncontrolling interest can have a debit balance), the controlling interest is not required to recognize a loss when distributions exceed the noncontrolling interest s carrying value. Instead, the noncontrolling interest balance is reduced below zero when the transaction is recorded. Illustration 3-1 illustrates this concept using an example from the real estate industry, where these transactions may be more common. Illustration 3-1: Distributions in excess of the noncontrolling interest s carrying amount A real estate entity often refinances appreciated property and distributes the proceeds to its owners. Assume a real estate subsidiary has $100 of equity. The parent and noncontrolling interest own 80% and 20%, respectively, of the entity. As a result, the balance of noncontrolling interest is $20. The subsidiary s only asset is a building with a carrying amount of $100, but with a fair value of $1,100. Assume the subsidiary refinances the building by mortgaging the building for $1,000, and distributes the proceeds, proportionately, to its owners. The journal entries to record these transactions in the consolidated financial statements follow: Cash $ 1,000 Mortgage liability 1,000 To record the proceeds from the refinancing transaction Noncontrolling interest $ 200 Cash 200 To record the distribution to the noncontrolling interest As a result of this transaction, the noncontrolling interest balance would have a debit balance of $180. Financial reporting developments Consolidated and other financial statements 24

31 3 Attribution of net income or loss and comprehensive income or loss Attribution to noncontrolling interests held by preferred shareholders When a consolidated subsidiary is funded with a combination of common and preferred stock, care should be taken when attributing net income or loss and comprehensive income or loss between the controlling and noncontrolling interests. Unlike common stock, preferred stock is typically entitled to a liquidation preference, which generally will include a par amount and, in some cases, cumulative unpaid dividends. Preferred stock typically is entitled to a share of the subsidiary s earnings up to the stated dividend, and losses of the subsidiary typically do not reduce the amount due to the preferred stockholders in liquidation (although economically a portion of those losses may be funded by the preferred stock). For these reasons, preferred stock normally does not represent a residual equity interest in the subsidiary even though preferred stock is classified as a noncontrolling interest in the consolidated financial statements of Parent. We believe that a noncontrolling interest in a subsidiary that consists of preferred stock should be accounted for similar to preferred stock issued by the parent. Accordingly, any net income and comprehensive income of the subsidiary are allocated to the noncontrolling interest based on the preferred stock s stated dividend and liquidation rights, and any net losses and comprehensive losses of the subsidiary normally are not allocated to preferred stock. In other words, the balance of the preferred stock classified as noncontrolling interest generally should be equal to its liquidation preference. In some cases, the preferred stock does not have a liquidation preference and truly represents a residual equity interest in the entity (e.g., the equity interest may be called preferred stock because it participates disproportionally in returns but otherwise participates pari passu in losses). In these instances, the interest is tantamount to common stock. Therefore, in these circumstances, we believe it would be appropriate for a parent to charge net losses and comprehensive losses against the preferred stock noncontrolling interest, as it would the common interest. The guidance above only relates to preferred stock and should not necessarily be analogized to residual equity interests that provide preferential returns, which are common in partnerships Attribution of goodwill impairment ASC A states that if a reporting unit is less than wholly-owned, the fair value of the reporting unit and the implied fair value of its goodwill shall be determined in the same manner as it would be determined in a business combination pursuant to ASC 805. Any goodwill impairment that results from applying step two of the goodwill impairment model should be attributed to the controlling and noncontrolling interests on a rational basis. While the allocation of net income or loss and comprehensive income or loss to the controlling and noncontrolling interests may be as straightforward as multiplying earnings by the relative ownership percentages (when a substantive profit sharing arrangement does not exist), that approach will not be appropriate for allocating any goodwill impairment. Particular care must be taken in this instance because a premium is often paid to obtain control of an entity. And, as a result, the controlling and noncontrolling interests bases in acquired goodwill will not be proportional to ownership interests because the control premium is allocated only to the controlling interest. Chapter 3 of our FRD, Intangibles Goodwill and other, provides further guidance on goodwill impairment testing when a noncontrolling interest exists. Financial reporting developments Consolidated and other financial statements 25

32 3 Attribution of net income or loss and comprehensive income or loss Attributions related to business combinations effected before Statement 160 and Statement 141(R) were adopted Statement 160 was effective for the first annual reporting period beginning on or after 15 December 2008 (that is, 1 January 2009, for calendar year-end companies) and was required to be adopted concurrently with Statement 141(R). Statement 141(R) was to be adopted prospectively. Business combinations achieved in stages prior to the adoption of Statement 141(R) (e.g., business combinations accounted for pursuant to Statement 141) generally followed step acquisition accounting (that is, the noncontrolling interest was not initially measured at fair value). It is therefore inappropriate to determine the noncontrolling interest s basis in the assets and liabilities using its relative ownership in the subsidiary for the purposes of attributing net income or loss between controlling and noncontrolling interests when accounting for acquisitions effected prior to the adoption of Statement 141(R). Given the prohibition on retroactively applying Statement 141(R), the controlling and noncontrolling interests bases in assets and liabilities recognized prior to the adoption of Statement 141(R) should continue to be respected. Illustration 3-2: Attributions related to an acquisition prior to Statement 141(R) Assume that Acquirer acquired a 60%-controlling interest in Target on 1 January 2005, and the business combination was accounted for pursuant to Statement 141. Target had, on the acquisition date, a definite-lived intangible asset with a $100 fair value, but no book value. Pursuant to Statement 141, Acquirer would have measured the intangible asset in its financial statements at $60 (60% acquired plus carryover basis for the noncontrolling interest s ownership in the intangible asset, that is, zero). Assume at the acquisition date the intangible asset had a 10-year remaining useful life. Accordingly, Acquirer would have recognized annual amortization expense of $6 in its consolidated financial statements. Because the noncontrolling interest has no basis in the intangible asset, no amortization expense is allocated to the noncontrolling interest. This concept extends to the attribution of impairment charges between the controlling and noncontrolling interests. Because the noncontrolling interest does not have a basis in the intangible asset, if the intangible asset becomes impaired after the acquisition date, the entire impairment charge would be allocated to the controlling interest. Further, as described in ASC A, if a reporting unit includes goodwill that is attributable only to a parent s basis in a partially-owned subsidiary for which acquisition accounting was completed pursuant to Statement 141, any goodwill impairment charge (whether recognized before or after the effective date of Statement 160) would be attributed entirely to the parent Effect on effective income tax rate In certain instances, an entity s reported effective tax rate may be affected by the attribution of net income and losses and comprehensive income and losses to noncontrolling interests. This is particularly true for entities that consolidate subsidiaries that pay no income tax, but instead distribute any taxable income to their respective investors, such as limited liability companies and limited partnerships. In certain cases, the effective tax rate computed from the amounts included on the income statement may be significantly affected, requiring additional disclosure in the notes to the financial statements. Financial reporting developments Consolidated and other financial statements 26

33 3 Attribution of net income or loss and comprehensive income or loss Illustration 3-3 demonstrates the potential effect of attributions on an entity s effective tax rate. Illustration 3-3: Effect of attributions on an entity s effective tax rate Assume Entity A (a corporation) owns 60% of LP (a limited partnership) and consolidates LP. Further assume that Entity A s statutory income tax rate and stand-alone effective tax rate are both 35%, while LP pays no income tax because it distributes its taxable earnings to its investors. Each entity has the following standalone financial information. Entity A Income before income taxes $ 1,000 $ 900 Income taxes 350 Net income $ 650 $ 900 LP Entity A is required to pay income taxes on its portion of LP s earnings. Therefore, the income tax expense related to LP in Entity A s consolidated financial statements would be $189 ($900 x 60% interest x 35% tax rate). The consolidated financial information for Entity A would be presented as follows. Entity A - Consolidated Income before income taxes ($1000+$900) $ 1,900 Income taxes ($350+$189) 539 Net income 1,361 Net income attributable to noncontrolling interest ($900 x 40%) 360 Net income attributable to controlling interest $ 1,001 Based on the amounts from the consolidated financial information, Entity A s consolidated effective tax rate would be 28.4% ($539 / $1,900). This difference from 35% occurs because income before income taxes includes earnings allocable to the noncontrolling interest for which there is no tax expense provided. We believe that this is required to be explained in the effective income tax rate reconciliation disclosed in the footnotes to the consolidated financial statements pursuant to ASC 740. An example effective income tax rate reconciliation for Entity A follows: Effective income tax rate reconciliation Statutory income tax rate 35.0% Book income of consolidated partnership attributable to noncontrolling interest (6.6) Effective tax rate for controlling interest 28.4% Financial reporting developments Consolidated and other financial statements 27

34 4 Changes in a parent s ownership interest in a subsidiary while control is retained 4.1 Increases and decreases in a parent s ownership of a subsidiary Excerpt from Accounting Standards Codification Consolidation Overall Other Presentation Matters Changes in a Parent s Ownership Interest in a Subsidiary A The guidance in paragraphs through applies to the following: a. Transactions that result in an increase in ownership of a subsidiary b. Transactions that result in a decrease in ownership of either of the following while the parent retains a controlling financial interest in the subsidiary: 1. A subsidiary that is a business or a nonprofit activity, except for either of the following: i. A sale of in substance real estate (for guidance on a sale of in substance real estate, see Subtopic or ) ii. A conveyance of oil and gas mineral rights (for guidance on conveyances of oil and gas mineral rights and related transactions, see Subtopic ). 2. A subsidiary that is not a business or a nonprofit activity if the substance of the transaction is not addressed directly by guidance in other Topics that include, but are not limited to, all of the following: i. Topic 605 on revenue recognition ii. iii. iv. Topic 845 on exchanges of nonmonetary assets Topic 860 on transferring and servicing financial assets Topic 932 on conveyances of mineral rights and related transactions v. Topic 360 or 976 on sales of in substance real estate. A parent s ownership interest in a subsidiary might change while the parent retains its controlling financial interest in the subsidiary. For example, a parent s ownership interest in a subsidiary might change if any of the following occur: a. The parent purchases additional ownership interests in its subsidiary. b. The parent sells some of its ownership interests in its subsidiary. c. The subsidiary reacquires some of its ownership interests. d. The subsidiary issues additional ownership interests. Financial reporting developments Consolidated and other financial statements 28

35 4 Changes in a parent s ownership interest in a subsidiary while control is retained Changes in a parent s ownership interest while the parent retains its controlling financial interest in its subsidiary shall be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Therefore, no gain or loss shall be recognized in consolidated net income or comprehensive income. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the noncontrolling interest is adjusted shall be recognized in equity attributable to the parent. Example 1 (paragraph B) illustrates the application of this guidance A change in a parent s ownership interest might occur in a subsidiary that has accumulated other comprehensive income. If that is the case, the carrying amount of accumulated other comprehensive income shall be adjusted to reflect the change in the ownership interest in the subsidiary through a corresponding charge or credit to equity attributable to the parent. Example 1, Case C (paragraph F) illustrates the application of this guidance. ASC 810 requires that transactions that result in an increase in ownership of a subsidiary be accounted for as equity transactions. That is, no purchase accounting adjustments are made. ASC 810 further requires that transactions that result in a decrease in ownership interest while the parent retains its controlling financial interest be accounted for as equity transactions. ASC A(b) clarifies that the guidance related to decreases in a parent s ownership interest applies to interests in: A subsidiary that is a nonprofit activity 15 or a business, except for either a sale of in-substance real estate or a conveyance of oil and gas mineral rights A subsidiary that is not a business or a nonprofit activity but the substance of the transaction is not addressed directly by guidance in other ASC Topics Neither gains nor losses on these transactions are recognized in net income, and the carrying values of the subsidiary s assets (including goodwill) and liabilities should not be changed. The remainder of this chapter focuses on the accounting for increases in a parent s ownership interest in a subsidiary and decreases in ownership that do not result in a loss of control. For a discussion of the accounting for decreases in ownership that result in a loss of control of a subsidiary or a group of assets that constitute a business, see Chapter 6 Loss of control over a subsidiary or a group of assets Increases in a parent s ownership interest in a subsidiary A parent may increase its ownership interest in a subsidiary by: Directly purchasing additional outstanding shares of the subsidiary Causing the subsidiary to reacquire a portion of its outstanding shares (a treasury stock buy-back) Causing the subsidiary to issue additional shares to the parent 15 ASC defines a nonprofit activity as (a)n integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing benefits, other than goods or services at a profit or profit equivalent, as a fulfillment of an entity s purpose or mission (for example, goods or services to beneficiaries, customers, or members). As with a not-for-profit entity, a nonprofit activity possesses characteristics that distinguish it from a business or a for-profit business entity. Financial reporting developments Consolidated and other financial statements 29

36 4 Changes in a parent s ownership interest in a subsidiary while control is retained Under ASC 810 accounting for an increase in ownership of a subsidiary is generally similar to accounting for a decrease in ownership interest without a loss of control. That is, the carrying amount of the noncontrolling interest is adjusted (decreased in this case) to reflect the controlling interest s increased ownership interest in the subsidiary s net assets. Any difference between the consideration paid by the parent to a noncontrolling interest holder (or contributed by the parent to the net assets of the subsidiary) and the adjustment to the carrying amount of the noncontrolling interest in the subsidiary is recognized directly in equity attributable to the controlling interest (that is, additional paid-in capital). Illustration 4-1: To illustrate this concept, assume Parent owns an 80% interest in Subsidiary, which has net assets of $4,000. The carrying amount of the noncontrolling interest s 20% interest in Subsidiary is $800. Parent acquires an additional 10% interest in Subsidiary from the noncontrolling interest for $500, increasing its controlling interest to 90%. Under ASC 810, Parent would account for its increased ownership interest in Subsidiary as a capital transaction as follows: Stockholders equity noncontrolling interest $ 400 Additional paid-in capital 100 Cash $ Increases in a parent s ownership interest in a consolidated VIE We believe the primary beneficiary s subsequent acquisition of a noncontrolling interest in an existing consolidated variable interest entity (VIE) should be treated as an equity transaction, consistent with the principles of ASC Thus, any difference between the price paid and the carrying amount of the noncontrolling interest should not be reflected in net income, but instead reflected directly in equity. See Section for further discussion of this accounting Decreases in a parent s ownership interest in a subsidiary without loss of control A parent may decrease its ownership interest in a subsidiary by (1) selling a portion of the subsidiary s shares it holds or (2) causing the subsidiary to issue shares. In accounting for such transactions under ASC 810, assuming they meet the scope of ASC A(b), the carrying amount of the noncontrolling interest should be increased to reflect the change in the noncontrolling interest s ownership in the subsidiary s net assets (that is, the amount attributed to the additional noncontrolling interests should reflect its proportionate ownership percentage in the subsidiary s net assets acquired). Any difference between the consideration received (whether by the parent or the subsidiary) and the adjustment made to the carrying amount of the noncontrolling interest should be recognized directly in equity attributable to the controlling interest (that is, as an adjustment to additional paid-in capital). Financial reporting developments Consolidated and other financial statements 30

37 4 Changes in a parent s ownership interest in a subsidiary while control is retained Illustration 4-2: Decrease in a parent s ownership throughparent selling shares Assume Subsidiary A, a widget manufacturer, has 10,000 shares of common stock outstanding, all of which are owned by its parent, ABC Co. The carrying amount of Subsidiary A s equity is $200,000. ABC Co. sells 2,000 of its shares in Subsidiary A to an unrelated entity for $50,000 of cash, reducing its ownership interest from 100% to 80%. Under ASC 810, a noncontrolling interest of $40,000 is recognized ($200,000 x 20%). The $10,000 excess of the cash received ($50,000) over the adjustment to the carrying amount of the noncontrolling interest ($40,000) is recognized as an increase in additional paid-in capital attributable to ABC Co. as follows: Cash $ 50,000 Additional paid-in capital $ 10,000 Stockholders equity noncontrolling interest 40,000 Illustration 4-3: Decrease in a parent s ownership through a subsidiary issuing new shares Assume Subsidiary A, a widget manufacturer, has 10,000 shares of common stock outstanding. ABC Co. (the parent) owns 9,000 of the outstanding shares and other shareholders own the remaining 1,000 shares. The carrying amount of Subsidiary A s equity is $300,000, with $270,000 attributable to ABC Co. (the parent) and $30,000 attributable to the noncontrolling interest holders. Assume Subsidiary A sells 2,000 previously unissued shares to an unrelated entity for $120,000 cash, increasing the carrying amount of Subsidiary A s equity to $420,000 ($300,000 + $120,000). The transaction would reduce ABC Co. s ownership interest from 90% to 75% (9,000/12,000). However, the transaction would increase ABC Co. s Investment in Subsidiary A to $315,000 (75% of $420,000), an increase of $45,000 ($315,000 - $270,000). Therefore, the entry recorded by ABC Co. would be: Investment in Subsidiary A $ 45,000 Additional paid-in capital $ 45,000 In addition, the carrying amount of the noncontrolling interest would increase to $105,000 (25% of $420,000). This increase of $75,000 ($105,000 - $30,000) would be recorded by Subsidiary A as: Cash $ 120,000 Additional paid-in capital $ 45,000 Stockholders equity noncontrolling interest 75,000 In consolidation, the increase to Investment in Subsidiary A recorded on ABC Co. s balance sheet would eliminate against the increase in additional paid-in capital recorded on Subsidiary A s balance sheet. Refer to Chapter 5, Intercompany eliminations, for further discussion of elimination entries. Financial reporting developments Consolidated and other financial statements 31

38 4 Changes in a parent s ownership interest in a subsidiary while control is retained Question 4.1 For business combinations effected before Statement 160 and Statement 141(R) were adopted, how should companies account for subsequent acquisitions or dispositions of the noncontrolling interest by the parent while it maintains its controlling financial interest? We believe that all subsequent acquisitions or dispositions of ownership interests in subsidiaries meeting the scope of ASC A while the parent maintains control including those related to business combinations effected prior to the adoption of Statement 160 should be accounted for pursuant to Statement 160 s provisions. Pursuant to ASC 805, as amended by Statement No. 141(R), assets and liabilities that arose from business combinations whose acquisition dates preceded Statement 141(R) s effective date are not to be adjusted upon application of Statement 141(R). Accordingly, acquisitions of the noncontrolling interest by the parent while it maintains its controlling financial interest should not be accounted for as step acquisitions. Similarly, a parent s sales of its ownership interests in a subsidiary meeting the scope of ASC A over which it continues to maintain control should be accounted for as equity transactions Accounting for a stock option of subsidiary stock A subsidiary may grant a share-based payment award of its own stock to its employees that would result in a decrease in ownership and a noncontrolling interest when exercised. Questions arise as to whether these awards should be classified in the consolidated financial statements as a noncontrolling interest or as additional paid-in capital prior to exercise. Awards of this nature may arise in a business combination when the acquirer is not obligated to replace acquiree s awards and the awards remain in existence after the transaction. The accounting for these awards is addressed in Section 6.3 of our FRD, Business combinations. We believe this accounting would also apply to awards of subsidiary stock that do not arise in a business combination Scope exception for in-substance real estate transactions The decrease in ownership guidance in ASC does not apply if a transaction is a sale of insubstance real estate, even if that real estate is considered a business. Entities should apply the sale of real estate guidance in ASC and ASC to such transactions. However, guidance on noncontrolling interests in consolidated financial statements within ASC will continue to apply to increases in ownership of an entity that is in-substance real estate Scope exception for oil and gas conveyances Any conveyance of an oil and gas mineral right that is accounted for under the guidance in ASC is outside the scope of ASC 810 s derecognition provisions as well as ASC 810 s provisions regarding decrease in ownership in circumstances in which a controlling interest is retained. Therefore, if a company is conveying a mineral interest, the transaction would be accounted for under ASC 932. However, in a transaction in which a company sells all or a portion of a subsidiary or a group of assets that include oil and gas mineral rights (or contributes it to another entity), such transaction may be more appropriately accounted for under the guidance in ASC 810. Consideration of the illustrations and guidance in ASC 932 is required to determine whether a transaction represents a conveyance of a mineral property. If a transaction does not fall within the guidance of ASC 932, it should be accounted for under ASC 810. Financial reporting developments Consolidated and other financial statements 32

39 4 Changes in a parent s ownership interest in a subsidiary while control is retained The following example illustrates a transaction that is not in the scope of ASC 810: Illustration 4-4 Facts O&G Co. A owns a 100% gas mineral interest in a property in Colorado. O&G Co. A assigns an operating interest to Drilling Co. A and retains a non-operating interest in the property. The transaction requires Drilling Co. A to drill, develop and operate the property. O&G Co. A will participate in the production profits after Drilling Co. A recoups its costs. Analysis The accounting for the transaction described above (a pooling of assets in a joint undertaking) is addressed in ASC Therefore, the transaction should be accounted for in accordance with ASC 932, not ASC 810. The following example illustrates a transaction that is in the scope of ASC 810: Illustration 4-5 Facts O&G Co. A owns an operating subsidiary, Foreign Sub X. Foreign Sub X has oil and gas mineral properties as well as other energy related operations. Subsequently, O&G Co. A sells a 55% interest in those operations to O&G Co. B and loses control. Analysis In this fact pattern, O&G Co. A is selling 55% of its equity in Foreign Sub X, which results in the loss of control. 16 Because this transaction does not represent an oil or gas mineral property conveyance as contemplated in the guidance of ASC 932 or any of ASC 932 s implementation guidance illustrations, it should be accounted for under the derecognition guidance in ASC 810. We believe, in this circumstance, ASC 810 is the most appropriate guidance because this transaction represents the sale of a business that happens to include oil and gas mineral properties. This type of transaction is not addressed in the mineral property conveyance guidance in ASC Decreases in ownership of a subsidiary that is not a business or nonprofit activity If a decrease in ownership occurs in a subsidiary that is not a business or nonprofit activity, an entity first needs to evaluate the substance of the transaction and identify whether other applicable literature (e.g., transfers of financial assets as discussed in ASC 860, revenue recognition as discussed in ASC 605, etc.) may provide relevant guidance. If no such guidance exists, an entity should apply the guidance in ASC For example, if an enterprise sells the equity securities of a subsidiary that is not a business and all of the assets in the subsidiary are financial assets, the substance of the transaction should be evaluated under ASC 860. However, guidance on noncontrolling interests in consolidated financial statements within ASC will continue to apply to increases in ownership of an entity that is not a business or nonprofit activity. 16 A transaction with the same fact pattern, but in which there is a decrease in ownership without loss of control (for example, a sale of 20% of the equity), would result in the same conclusion (that is, the transaction is in the scope of ASC 810). Financial reporting developments Consolidated and other financial statements 33

40 4 Changes in a parent s ownership interest in a subsidiary while control is retained Issuance of preferred stock by a subsidiary Pursuant to ASC , changes in a parent s ownership interest while the parent retains control of a subsidiary should be accounted for as equity transactions. We generally believe that the preferred stock issuance by a subsidiary to noncontrolling interest holders should be reflected as noncontrolling interest in the financial statements of the parent at the amount of the cash proceeds received (e.g., the par amount). Unlike common stock, preferred stock of a subsidiary often does not represent a residual equity interest. Oftentimes, the holders of preferred stock are entitled to a liquidation preference, which generally includes a par amount and, in some cases, cumulative unpaid dividends. Additionally, the preferred stock holders of a subsidiary typically are entitled to a share of the subsidiary s earnings up to the stated dividend. Unlike an issuance of common stock by a subsidiary (which generally results in a change in the parent s ownership interest), the issuance of preferred stock by a subsidiary does not change the parent s ownership interest. When recording the issuance of preferred stock by a subsidiary that is not a residual interest, we would not expect to see an adjustment to the parent s equity accounts. (See Section for interpretive guidance on attributions to noncontrolling interests held by preferred shareholders) Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Pursuant to ASC , changes in a parent s ownership interest while the parent retains control of a subsidiary (e.g., partnership) should be accounted for as equity transactions. Partnerships can take various forms. Frequently, there is a substantive profit sharing arrangement whereby the profits of the partnership are allocated to the partners based on a predetermined formula. In some cases, the profit sharing arrangement may provide certain partners with preferences in profits from operations or in liquidation. In other cases, the substantive profit sharing arrangement may not provide for preferences in profits or in liquidation. To the extent it is determined that the issuance of partnership units represents the issuance of preferential units (e.g., such units have preference in operating or liquidating cash flows), we believe that the guidance on the issuance of preferred stock by a subsidiary should be followed (see Section ). That is, when recording the issuance of preferential units by a partnership subsidiary, there is generally no adjustment to the parent s equity accounts. Alternatively, if partnership units are issued without preferences, we believe that a parent of a partnership would follow the guidance in ASC See Question 4-2 for discussion of the accounting upon expiration of a preference period. We would expect a parent of a partnership to develop a reasonable policy with respect to this accounting and apply that policy consistently. Question 4.2 How should the provisions of ASC be applied to a consolidated Master Limited Partnership s issuance of preferential limited partnership units? A Master Limited Partnership (MLP) is a limited partnership whose units are available to investors and traded on public exchanges, just like corporate stock. MLPs usually involve (1) a general partner (GP), who typically holds a small percentage (commonly 2%) of the outstanding partnership units and manages the operations of the partnership, and (2) limited partners (LPs), who provide capital and hold most of the ownership but have limited influence over the operations. Enterprises that form MLPs typically do so to take advantage of the special tax treatment of the partnership structure (although MLPs may also provide an attractive exit strategy for owners of private equity assets). To qualify for the tax benefits, 90% of an MLPs income must be derived from activities in natural resources, real estate or commodities. As a result, the energy industry has experienced a dramatic rise in the use of the MLP structure. Financial reporting developments Consolidated and other financial statements 34

41 4 Changes in a parent s ownership interest in a subsidiary while control is retained The GP frequently consolidates the MLP. For the issuance of LP interests, all sales first should be evaluated to determine if they represent in-substance sales or partial sales of real estate under ASC through (refer to our FRD, Real estate sales, for further interpretive guidance). Assuming the sale is not in-substance a sale or partial sale of real estate, a consolidated subsidiary that issues shares while the parent maintains control of the subsidiary should be accounted for as a capital transaction pursuant to the decrease in ownership guidance. However, the decrease in ownership guidance may not apply when an MLP issues limited partnership units that have a preference in distributions or liquidation rights (referred to as the common LP units). It is common for an MLP partnership agreement to provide that, during a subordination period, the common LP units will have the right to receive distributions of available cash each quarter based on a minimum quarterly distribution, plus any arrearages, before any distributions of available cash may be made on the subordinated LP units. Furthermore, no arrearages will be paid on the subordinated units. The practical effect of the subordinated LP units is to increase the likelihood that during the subordination period there will be available cash to be distributed on the common LP units. When subordinated LP units are held by the parent/gp of an MLP, common LP units do not possess the characteristics of a residual equity interest given the common LP units preference over the subordinated LP units. As such, we believe that the accounting guidance related to changes in a parent s ownership interest in a subsidiary would not apply. Therefore, if the parent/gp owns subordinated LP units in the MLP, the parent/gp should reflect the proceeds from issuance of common LP units as noncontrolling interest in its financial statements with no adjustment to additional paid-in capital. We believe that if the class of security issued by the subsidiary has a preference in distribution or liquidation rights over any other class of equity security, then it is analogous to preferred stock. As such, we do not believe the guidance above would apply to such transactions. See above for additional discussion. MLP partnership agreements include provisions for the subordination period to expire after a specific period of time if the minimum quarterly distributions have been made to the holders of the common LP units. Upon the expiration of the subordination period, all subordinated LP units held by the parent/gp have the same distribution and liquidation rights as the other common LP units. Although the common LP units previously issued by the MLP to the holders of the noncontrolling interest no longer have a preference in distributions due to the expiration of the subordination period, we believe this loss of preference has no immediate accounting consequences. The accounting for changes in noncontrolling interests only applies to changes in a parent s ownership interest in a subsidiary, which includes circumstances in which, (a) the parent purchases additional ownership interests in its subsidiary, (b) the parent sells some of its ownership interests in its subsidiary, (c) the subsidiary reacquires some of its ownership interests, or (d) the subsidiary issues additional ownership interests (ASC ). We believe the expiration of the subordination period is not a change in the parent s ownership interest in a subsidiary because the expiration does not result in a change in ownership interest in the MLP. As such, there is no adjustment to be recognized to the equity accounts of the parent (that is, no adjustment to additional paid-in capital) or noncontrolling interest as a result of the expiration of the preferences Accumulated other comprehensive income considerations When a change in a parent s ownership interest that does not result in the loss of control occurs in a subsidiary meeting the scope of ASC A that has a balance of accumulated other comprehensive income (AOCI), the AOCI balance is adjusted to reflect a change in the parent s proportionate interest in that AOCI balance by an adjustment to the parent s consolidated additional paid-in-capital. Financial reporting developments Consolidated and other financial statements 35

42 4 Changes in a parent s ownership interest in a subsidiary while control is retained Illustration 4-6 For example, assume Parent owns an 80% interest in Subsidiary, a retailer of children s toys, which has net assets of $4,000. The carrying amount of the noncontrolling shareholders 20% interest in Subsidiary is $800, which includes $200 that represents the noncontrolling interest s share of $1,000 of AOCI credits. Parent acquires an additional 10% interest from a third party in Subsidiary for $500, increasing its controlling ownership interest to 90%. As a result of this purchase, Parent s interest in Subsidiary s AOCI balance increases by $100 ($1,000 x 10%). Under ASC 810, Parent will account for its increased ownership interest in Subsidiary as follows: Stockholders equity noncontrolling interest $ 400 Additional paid-in capital 200 Cash $ 500 AOCI 100 If a decrease in a parent s controlling ownership interest that does not result in a loss of control occurs in a subsidiary meeting the scope of ASC A(b) and that has AOCI, the accounting under ASC 810 is similar to that described in the example above. That is, a proportionate share of AOCI is attributed to the noncontrolling interest. Illustration 4-7 For example, assume Parent owns 100% of Subsidiary, which has net assets of $4,000, including $1,000 of AOCI. Assume Subsidiary is a business and is in the scope of ASC A(b). Parent sells a 10% interest in Subsidiary for $500, decreasing its interest to 90%. As a result of the sale, Parent s interest in Subsidiary s AOCI balance decreases by $100 ($1,000 x 10%). Under ASC 810, Parent will account for the change in its ownership interest in Subsidiary as follows: Cash $ 500 AOCI 100 Stockholders equity noncontrolling interest $ 400 Additional paid-in capital Accounting for foreign currency translation adjustments upon a change in parent s ownership interest without loss of control The recognition of accumulated foreign currency translation adjustments as gains or losses on sales of foreign entity shares is precluded unless accompanied by a loss of control. This provision aligns the accumulated foreign currency translation recognition requirements with the general principles in ASC 810 pertaining to recognition of other comprehensive income items, as discussed in this section. See Section 6.1 for a summary of recent discussions of the EITF regarding a parent s accounting for accumulated foreign currency translation adjustments when accompanied by a loss of control Allocating goodwill upon change in parent s ownership interest Although the total goodwill balance is not adjusted upon a change in parent s ownership interest, for the purposes of testing for impairment, goodwill should be reallocated between the controlling and noncontrolling interests based on the changes in ownership interests. Financial reporting developments Consolidated and other financial statements 36

43 4 Changes in a parent s ownership interest in a subsidiary while control is retained Illustration 4-8 To illustrate this concept, assume Parent initially acquires 80% of Subsidiary. The business combination is accounted for under ASC 805 and $100 of goodwill is recognized ($80 attributable to Parent and $20 attributable to the noncontrolling interest, assuming no control premium). If Parent acquires an additional 10% interest in Subsidiary, the consolidated amount of goodwill does not change, but the goodwill balance is reallocated between Parent and the noncontrolling interest based on the revised percentage ownership interest (that is, $90 would be attributable to Parent and $10 would be attributable to the noncontrolling interest) Accounting for transaction costs incurred in connection with changes in ownership ASC 810 provides that gains or losses should not be recognized upon changes in a parent s ownership of a subsidiary meeting the scope of ASC A while control is retained because the entities are considered one economic entity. Accordingly, we believe that these transactions are analogous to treasury stock transactions. Based on this, we believe that specific, direct and incremental costs (but not management salaries or other general and administrative expenses) related to changes in a parent s ownership percentage while control is maintained may be accounted for as part of the equity transaction. However, the provisions of ASC , which address multiple arrangements that are to be considered as a single transaction, should be considered. We observe that some believe that transaction costs incurred in connection with changes in ownership of consolidated subsidiaries meeting the scope of ASC A while control is retained are not analogous to treasury stock transactions and, therefore, should be expensed as incurred. We believe that until further guidance is issued, a reporting enterprise should adopt and consistently apply an accounting policy for these costs Chart summarizing accounting for changes in ownership The following chart summarizes ASC s accounting in the consolidated financial statements for changes in a parent s ownership interest in a subsidiary (within the scope of ASC A) while maintaining a controlling financial interest: Parent acquires additional ownership interest Reduce noncontrolling interest based on proportion acquired. APIC adjusted for difference between the amount by which noncontrolling interest is reduced and the amount of consideration paid. Adjust accumulated other comprehensive income with corresponding adjustment to APIC, as appropriate. Subsidiary acquires noncontrolling interest Reduce noncontrolling interest based on proportion acquired. APIC adjusted for difference between the amount by which noncontrolling interest is reduced and consideration paid. Adjust accumulated other comprehensive income with corresponding adjustment to APIC, as appropriate. Parent sells a portion of its ownership interest Increase noncontrolling interest for proportion of parent s ownership interest it sold. APIC adjusted for difference between the amount by which noncontrolling interest is increased and the amount of consideration received. Adjust accumulated other comprehensive income with corresponding adjustment to APIC, as appropriate. Subsidiary issues shares to noncontrolling interest Calculate shares effectively sold by parent. Increase noncontrolling interest for proportion of parent s ownership interest it effectively sold. Difference between consideration received and book value of parent s shares reflected in APIC. Adjust accumulated other comprehensive income with corresponding adjustment to APIC, as appropriate. Financial reporting developments Consolidated and other financial statements 37

44 4 Changes in a parent s ownership interest in a subsidiary while control is retained 4.2 Comprehensive example The following example illustrates the accounting in consolidation for changes in a parent s ownership interest while the parent maintains control of the subsidiary meeting the scope of ASC A. Work paper adjusting entries are numbered sequentially. Illustration 4-9 Assume on 1 January 20X1, Company P which is newly formed raises $45,000 of capital. Company P issues 1,500 shares of $1 par stock for $36,000 and raises $9,000 by issuing debt. Company P acquires, for $45,000, 70% of the common stock of Company S, a distributor of video games qualifying as a business pursuant to ASC 805, as amended by Statement No. 141(R). Company S s fair value is $64,286. Company S s acquisition-date balance sheet is presented in Figure 4-1. Income taxes have been ignored. This example uses simplifying assumptions. For example, it would be unusual for no identifiable intangible assets to be recognized as part of the business combination (and for all the excess purchase price to be allocated to goodwill). Additionally, this example also assumes there is no control premium. Figure 4-1: Acquisition-date balance sheet for Company S at 1 January 20X1 (all amounts in dollars) Book value Fair Value Cash 3,000 3,000 Marketable securities (available-for-sale) 12,000 12,000 Inventory 30,000 34,500 Buildings and equipment, net 60,000 85, , ,000 Accounts payable 75,000 75,000 Common stock 25,000 Accumulated other comprehensive income 5, ,000 For illustrative purposes, Company S s income statement has been made constant for each year of this example and is presented in Figure 4-2. Figure 4-2: Income statement for Company S for each year (all amounts in dollars) Revenues 96,000 Cost of revenues 42,000 Gross profit 54,000 Selling and administrative (including 6,000 of depreciation) 24,000 Net income 30, Consolidation at the acquisition date ASC 805 generally requires the acquirer to measure the identifiable assets acquired, the liabilities assumed and noncontrolling interest in the acquiree at their acquisition-date fair values if the acquiree meets ASC 805 s business definition. (Except for the requirement to recognize goodwill, ASC 805 s provisions are also generally followed for consolidated variable interest entities, as that term is identified by ASC s variable interest model). Financial reporting developments Consolidated and other financial statements 38

45 4 Changes in a parent s ownership interest in a subsidiary while control is retained Illustration 4-10 The consolidation procedures illustrated in this example reflect the revaluation of the subsidiary s assets and liabilities through the adjustments column of a consolidating work paper. The subsidiary s assets and liabilities have not been revalued directly on the subsidiary s financial statements. That is, while push-down accounting may be required pursuant to other literature in certain situations, it is not illustrated here, but is presented in Appendix A. Figure 4-3: Acquisition-date consolidating work paper to arrive at consolidated balance sheet, 1 January 20X1 (all amounts in dollars) Company P Company S Debit Adjustments Credit Consolidated Cash 3,000 3,000 Marketable securities 12,000 12,000 Inventory 30,000 (1) 4,500 34,500 Buildings and equipment, net 60,000 (2) 25,500 85,500 Investment in Company S 45,000 (3) 45,000 Goodwill (4) 4,286 4,286 Total assets 45, , ,286 Accounts payable 75,000 75,000 Debt 9,000 9,000 Total liabilities 9,000 75,000 84,000 Common stock 1,500 30,000 (5) 30,000 1,500 Additional paid-in capital 34,500 34,500 Retained earnings Total parent shareholders equity 36,000 30,000 36,000 Noncontrolling interest (6) 19,286 19,286 Total equity 36,000 30,000 55,286 Total liabilities and equity 45, , ,286 Figure 4-3 illustrates the elimination of Company P s investment in Company S and allocation of the purchase price ($45,000) to the acquired assets, liabilities and noncontrolling interest, as follows: (1) Inventory is measured at fair value. (2) Buildings and equipment are measured at fair value. (3) Company P s investment in Company S is eliminated. (4) Goodwill is determined by subtracting the fair value of Company S s net identifiable assets from the fair value of Company S s net assets. As stated above, the fair value of Company S is $64,286. As the fair value of Company S s net identifiable assets is $60,000, goodwill is calculated to be $4,286. For illustrative purposes, 70% and 30% of the goodwill is allocable to Company P and Company S, respectively, because although not realistic, no control premium is assumed in this example merely for simplicity (that is, the goodwill is allocated to the controlling and noncontrolling interests proportionately). (5) Company S s common stock is eliminated. (6) Noncontrolling interest is calculated by subtracting the fair value of Company S s net assets acquired by Company P ($64,286 x 70% = $45,000) from Company S s total net assets ($64,286). As indicated in note (4), no control premium has been assumed. Financial reporting developments Consolidated and other financial statements 39

46 4 Changes in a parent s ownership interest in a subsidiary while control is retained Consolidation in year of combination Illustration 4-11 Assume that on 31 December 20X1, Company S pays cash dividends of $36,000, of which Company P s share is $25,200. In addition, the fair value of Company S s marketable securities at that date is $17,000. Company S s income statement for the year ended 31 December 20X1, is presented in Figure 4-2. Figure 4-4: Consolidating work paper to arrive at consolidated income statement, year of combination, 31 December 20X1 (all amounts in dollars) Company P Company S Debit Adjustments Credit Consolidated Revenues 96,000 96,000 Cost of revenues 42,000 (7) 4,500 46,500 Gross profit 54,000 49,500 Income from equity method investment 16,065 (8) 16,065 Selling and administrative 24,000 (9) 2,550 26,550 Net income 16,065 30,000 22,950 Net income attributable to noncontrolling interest (10) 6,885 6,885 Net income attributable to controlling interest 16,065 30,000 16,065 Importantly consolidated net income includes the portion attributable to the noncontrolling interest. Figure 4-4 presents the consolidating work paper to arrive at the consolidated income statement in the year of combination, which includes: (7) An increase to cost of revenues to reflect the sold inventory s measurement at fair value at the acquisition date (this example assumes that all acquisition-date inventory was sold). (8) The elimination of income recognized by Company P under the equity method ($22,950 x 70%). (9) An increase to selling and administrative expenses to reflect additional depreciation because buildings and equipment were recognized at fair value at the acquisition date. The depreciation expense recognized by Company S was $6,000 (on a beginning balance in buildings and equipment of $60,000). Accordingly, the equipment has a 10-year estimated useful life ($60,000 / $6,000). Applying this useful life to the excess fair value of buildings and equipment ($25,500) creates additional depreciation expense of $2,550 ($25,500 / 10). (10) Because net income is attributed based on outstanding voting interests in this example, net income attributable to the controlling and noncontrolling interests is $16,065 ($22,950 x 70%) and $6,885 ($22,950 x 30%), respectively. Financial reporting developments Consolidated and other financial statements 40

47 4 Changes in a parent s ownership interest in a subsidiary while control is retained Figure 4-5: Consolidating work paper to arrive at consolidated balance sheet, year of combination, 31 December 20X1 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash (11) 25,200 3,000 28,200 Marketable securities 17,000 17,000 Inventory 30,000 30,000 Buildings and equipment, net 54,000 (13) 22,950 76,950 Investment in Company S (12) 39,365 (14) 39,365 Goodwill (15) 4,286 4,286 Total assets 64, , ,436 Accounts payable 75,000 75,000 Debt 9,000 9,000 Total liabilities 9,000 75,000 84,000 Common stock 1,500 30,000 (19) 30,000 1,500 Additional paid-in capital 34,500 34,500 Accumulated other comprehensive income (16) 3,500 5,000 (20) 5,000 3,500 Retained earnings (deficit) (17) 16,065 (18) (6,000) (21) 6,000 16,065 Total parent shareholders equity 55,565 29,000 55,565 Noncontrolling interest (22) 16,871 16,871 Total equity 55,565 29,000 72,436 Total liabilities and equity 64, , ,436 Figure 4-5 presents the consolidating work paper to arrive at the 31 December 20X1 consolidated balance sheet, which includes: (11) The $25,200 cash dividend received from Company S ($36,000 x 70%). (12) The balance of the investment in Company S, adjusted for the earnings and dividends of the equity method investee Beginning balance $ 45,000 Attributed earnings 16,065 Attributed other comprehensive income (see adjustment 16) 3,500 Attributed dividends (25,200) Ending balance $ 39,365 (13) Buildings and equipment at fair value (adjustment 2), less the current year excess depreciation (adjustment 9) ($25,500 $2,550). (16) Company P s proportion of other comprehensive income from the increase in value of Company S s marketable securities in accordance with the equity method of accounting ($5,000 x 70%). (17) Company P s retained earnings to reflect the attributed earnings (see calculation in Figure 4-4) from Company S under the equity method of accounting. (18) Company S s retained deficit that reflects net income of $30,000 less cash dividends of $36,000. (20) Elimination of Company S s accumulated other comprehensive income. (21) Elimination of Company S s retained deficit. Financial reporting developments Consolidated and other financial statements 41

48 4 Changes in a parent s ownership interest in a subsidiary while control is retained (22) Noncontrolling interest is rolled forward from 1 January 20X1 (see Figure 4-3), as follows: Beginning balance $ 19,286 Attributed earnings 6,885 Attributed other comprehensive income 1,500 Attributed dividends (10,800) Ending balance $ 16,871 Adjustments (14), (15) and (19) are consistent with adjustments (3), (4) and (5), respectively, in the acquisition-date consolidating balance sheet work paper in Figure 4-3 of Illustration Consolidation after purchasing an additional interest Illustration 4-12 Assume on 1 January 20X2, Company P borrows $18,000 and uses that cash plus $21,000 of the cash from the cash dividend received from Company S to purchase, for $39,000, an additional 20% interest in Company S, bringing its total interest to 90%. The fair value of Company S s net assets at the date of the additional investment by Company P is $75,000 (20% of which is $15,000). This example assumes for purposes of simplicity that the consideration paid in excess of the fair value of the net identifiable assets purchased is attributed to goodwill for purposes of reflecting the parent s equity in Company S on the equity method. This assumption is not to be used in practice. Figure 4-6: Consolidating work paper to arrive at consolidated balance sheet, 1 January 20X2 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash (23) 4,200 3,000 7,200 Marketable securities 17,000 17,000 Inventory 30,000 30,000 Buildings and equipment, net 54,000 (25) 22,950 76,950 Investment in Company S (24) 78,365 (26) 78,365 Goodwill (27) 4,286 4,286 Total assets 82, , ,436 Accounts payable 75,000 75,000 Debt (28) 27,000 27,000 Total liabilities 27,000 75, ,000 Common stock 1,500 30,000 (32) 30,000 1,500 Additional paid-in capital 34,500 (35) 28,753 5,747 Accumulated other comprehensive income (29) 3,500 5,000 (33) 5,000 (35) 1,000 4,500 Retained earnings (deficit) (30) 16,065 (31) (6,000) (34) 6,000 16,065 Total parent shareholders equity 55,565 29,000 27,812 Noncontrolling interest (35) 11,247 (35) 16,871 5,624 Total equity 55,565 29,000 33,436 Total liabilities and equity 82, , ,436 Once control is obtained, subsequent purchases and sales of noncontrolling interests while control is maintained are accounted for as equity transactions in consolidation. Therefore, the 1 January 20X2, balance sheet is consolidated in Figure 4-6, as follows: Financial reporting developments Consolidated and other financial statements 42

49 4 Changes in a parent s ownership interest in a subsidiary while control is retained (23) The cash balance is calculated as follows: Beginning balance $ 25,200 Cash received from loan 18,000 Cash paid for additional interest (39,000) Ending balance $ 4,200 (24) The investment in Company S is increased for the purchase of an additional interest in Company S: Beginning balance $ 39,365 Additional interest purchased 39,000 Ending balance $ 78,365 (28) Company P incurred additional debt of $18,000 to partially fund the purchase of the additional interest in Company S. (35) The 31 December 20X1 balance for noncontrolling interest was $16,871. This amount represented a 30% interest in Company S. Company P purchased an additional 20% interest in Company S from the noncontrolling interest holders, which was equivalent to two-thirds of this balance ($16,871 x 2/3 = $11,247). Accordingly, the noncontrolling interest balance is reduced by $11,247, resulting in a balance of $5,624 ($16,871 $11,247). 17 In addition, accumulated other comprehensive income is adjusted to reflect the portion of the accumulated other comprehensive income that was purchased ($1,000) from the noncontrolling interest and is now attributable to Company P ($5,000 x 20%). The 20% additional interest purchased and the adjustment to accumulated other comprehensive income are reflected as follows: Noncontrolling interest $ 11,247 Additional paid-in capital 27,753 Cash $ 39,000 Additional paid-in capital $ 1,000 Accumulated other comprehensive income $ 1,000 This example calculates the noncontrolling interest based on a rollforward of the noncontrolling interest balance. Alternatively, a parent company could maintain a separate ledger for the subsidiary on a push-down basis (which is the approach used in Appendix A). If this method is used, the controlling interest and noncontrolling interest should still be tracked separately because in certain situations, income may be attributed differently from the ownership interests. Adjustments (25) (27) and (29) (34) are consistent with adjustments (13)-(15) and (16)-(21), respectively, made in the prior year in Figure 4-5 of Illustration In this example, the adjustment to the carrying amount of noncontrolling interest is determined by comparing the percentage change in the parent s ownership interest to the percentage owned by the noncontrolling interest holders on the date of the transaction. An alternative method to calculate this adjustment would be to apply the percentage change in the parent s ownership interest to the total carrying amount of the subsidiary s net assets as of the date of the transaction. However, determining the carrying amount of a subsidiary s net assets for use in this calculation may be difficult in certain circumstances. For example, the entity may not apply push-down accounting or may not allocate certain intercompany eliminations to the subsidiary in its accounting records. In these circumstances, deriving the adjustment using the method reflected in this example may be a more practical alternative. Financial reporting developments Consolidated and other financial statements 43

50 4 Changes in a parent s ownership interest in a subsidiary while control is retained Consolidation in year 2 Illustration 4-13 Assume on 31 December 20X2, Company S pays cash dividends of $36,000 of which Company P s share is $32,400. The current market value of Company S s marketable securities has decreased to $15,500. Figure 4-7: Consolidating work paper to arrive at consolidated income statement for year ended 31 December 20X2 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 96,000 96,000 Cost of revenues 42,000 42,000 Gross profit 54,000 54,000 Income from equity method investment 24,705 (36) 24,705 Selling and administrative 24,000 (37) 2,550 26,550 Net income 24,705 30,000 27,450 Net income attributable to noncontrolling interest (38) 2,745 2,745 Net income attributable to controlling interest 24,705 30,000 24,705 The 31 December 20X2 income statement is consolidated in Figure 4-7, as follows: (38) Net income is attributed to the controlling and noncontrolling interests based on ownership. The controlling and noncontrolling interests own 90% and 10% of the outstanding stock, respectively. Thus, net income attributable to the controlling and noncontrolling interests is $24,705 ($27,450 x 90%) and $2,745 ($27,450 x 10%), respectively. See Figure 4-4 of Illustration 4-11, adjustments (8) and (9), for descriptions of adjustments (36) and (37), respectively. Figure 4-8: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X2 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash (39) 36,600 3,000 39,600 Marketable securities 15,500 15,500 Inventory 30,000 30,000 Buildings and equipment, net 48,000 (41) 20,400 68,400 Investment in Company S (40) 69,320 (42) 69,320 Goodwill (43) 4,286 4,286 Total assets 105,920 96, ,786 Accounts payable 75,000 75,000 Debt 27,000 27,000 Total liabilities 27,000 75, ,000 Common stock 1,500 30,000 (47) 30,000 1,500 Additional paid-in capital 34,500 (48) 28,753 5,747 Accumulated other comprehensive income (44) 2,150 3,500 (49) 3,500 (48) 1,000 3,150 Retained earnings (deficit) (45) 40,770 (46) (12,000) (50) 12,000 40,770 Total parent shareholders equity 78,920 21,500 51,167 Noncontrolling interest (51) 4,619 4,619 Total equity 78,920 21,500 55,786 Total liabilities and equity 105,920 96, ,786 Financial reporting developments Consolidated and other financial statements 44

51 4 Changes in a parent s ownership interest in a subsidiary while control is retained Figure 4-8 presents the consolidating work paper to arrive at the year-end consolidated balance sheet in the year in which the additional interest was purchased, as follows: (39) The parent received $32,400 as a cash dividend from Company S ($36,000 x 90%). The cash balance is as follows: Beginning balance $ 4,200 Dividends received 32,400 Ending balance $ 36,600 (40) The investment in Company S was adjusted for the earnings and dividends of the equity method investee: Beginning balance (after purchase of additional interest) $ 78,365 Attributed earnings 24,705 Attributed other comprehensive loss (1,350) Attributed dividends (32,400) Ending balance $ 69,320 (44) Company P recognized its proportion of other comprehensive loss for the year (from the decrease in value of Company S s marketable securities) in accordance with the equity method of accounting ($1,500 x 90%). This amount was subtracted from last year s balance of $3,500 ($3,500 $1,350) to arrive at Company P s accumulated other comprehensive income. For this example, Company P has no comprehensive income other than its proportionate share of Company S s comprehensive income. (45) Retained earnings for Company P reflects the attributed earnings from Company S under the equity method of accounting. Although a statement of shareholders equity would generally be presented, for illustrative purposes, the statement has been excluded. A rollforward of retained earnings follows: Beginning balance $ 16,065 Earnings recognized under the equity method of accounting 24,705 Ending balance $ 40,770 (46) Retained deficit for Company S is rolled forward as follows: Beginning balance $ (6,000) Net income 30,000 Dividends declared (36,000) Ending balance $ (12,000) (51) Noncontrolling interest is calculated by rolling forward the balance from 1 January 20X2 (see Figure 4-6), as follows: Beginning balance $ 5,624 Attributed earnings 2,745 Attributed other comprehensive loss (150) Attributed dividends (3,600) Ending balance $ 4,619 Adjustments (41) (43) and (47) (50) are consistent with adjustments (25) (27) and (32) (35), respectively, in the prior year in Figure 4-6 of Illustration Financial reporting developments Consolidated and other financial statements 45

52 4 Changes in a parent s ownership interest in a subsidiary while control is retained Consolidation after selling an interest without loss of control Illustration 4-14 Assume on 1 January 20X3, Company P sells a 30% interest in Company S for $22,500 cash, decreasing its total interest to 60%. Figure 4-9: Consolidating work paper to arrive at consolidated balance sheet, 1 January 20X3 (all amounts in dollars) Company P Company S Debit Adjustments Credit Consolidated Cash (52) 59,100 3,000 62,100 Marketable securities 15,500 15,500 Inventory 30,000 30,000 Buildings and equipment, net 48,000 (54) 20,400 68,400 Investment in Company S (53) 46,820 (55) 46,820 Goodwill (56) 4,286 4,286 Total assets 105,920 96, ,286 Accounts payable 75,000 75,000 Debt 27,000 27,000 Total liabilities 27,000 75, ,000 Common stock 1,500 30,000 (60) 30,000 1,500 Additional paid-in capital 34,500 (62) 28,753 (64) 9,693 15,440 Accumulated other comprehensive income (57) 2,150 3,500 (63) 4,550 (62) 1,000 2,100 Retained earnings (deficit) (58) 40,770 (59) (12,000) (61) 12,000 40,770 Total parent shareholders equity 78,920 21,500 59,810 Noncontrolling interest (64) 18,476 18,476 Total equity 78,920 21,500 78,286 Total liabilities and equity 105,920 96, ,286 Once control is obtained, purchases and sales of noncontrolling interests are accounted for as equity transactions. Therefore, the 1 January 20X3 balance sheet is consolidated in Figure 4-9, as follows: (52) The cash balance rollforward is as follows: Beginning balance $ 36,600 Cash received from sale 22,500 Ending balance $ 59,100 (53) The investment in Company S adjusted for the sale of a partial interest in Company S is as follows: Beginning balance $ 69,320 Partial interest sold (22,500) 18 Ending balance $ 46, Under ASC 323 and the equity method of accounting, only the carrying amount of the portion of the investment sold would be deducted from the investment account, with a gain or loss being recognized for the difference between the fair value of the consideration received and the carrying value of the investment. For simplicity, the entire fair value of the consideration received has been deducted from the investment account. If the gain or loss had been recognized, it would be eliminated in consolidation. Financial reporting developments Consolidated and other financial statements 46

53 4 Changes in a parent s ownership interest in a subsidiary while control is retained (63) To eliminate the accumulated other comprehensive income of Company S ($3,500), plus the adjustment related to the sale of the partial interest ($1,050), as discussed in item 64 below. (64) The 31 December 20X2 balance for noncontrolling interest is $4,619. This amount represented a 10% interest in Company S. Company P sold a 30% interest in Company S, which was equivalent to three times this balance. Accordingly, the noncontrolling interest balance is adjusted to $18,476 ($4,619 + $13,857). 17 In addition, accumulated other comprehensive income is adjusted to reflect the portion of the accumulated other comprehensive income that was sold ($1,050) and is no longer attributable to Company P ($3,500 x 30%). The adjusting entries made to reflect the sale of the 30% additional interest and adjust accumulated other comprehensive income are as follows: Cash $ 22,500 Noncontrolling interest $ 13,857 Additional paid-in capital 8,643 Accumulated other comprehensive income $ 1,050 Additional paid-in capital $ 1,050 This example calculates the noncontrolling interest based on a rollforward of the noncontrolling interest balance. Alternatively, a parent company could maintain a separate ledger for the subsidiary on a push-down basis (the approach used in Appendix A). If this method is used, the controlling interest and noncontrolling interest should still be tracked separately because in certain situations, income may be attributed differently from the ownership interests. Adjustments (54) (60) (61), and (62) are consistent with (41)-(47), (50), and (48), respectively, in the prior year in Figure 4-8 of Illustration Consolidation in year 3 Illustration 4-15: On 31 December 20X3, Company S pays cash dividends of $36,000 of which Company P s share is $21,600. The fair value of Company S s marketable securities has increased to $17,500. Figure 4-10: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X3 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 96,000 96,000 Cost of revenues 42,000 42,000 Gross profit 54,000 54,000 Income from equity method investment 16,470 (65) 16,470 Selling and administrative 24,000 (66) 2,550 26,550 Net income 16,470 30,000 27,450 Net income attributable to noncontrolling interest (67) 10,980 10,980 Net income attributable to controlling interest 16,470 30,000 16,470 Financial reporting developments Consolidated and other financial statements 47

54 4 Changes in a parent s ownership interest in a subsidiary while control is retained The 31 December 20X3 income statement is consolidated in Figure 4-10, as follows: (67) Net income is attributed to the controlling and noncontrolling interest based on ownership interests. The controlling and noncontrolling interests own 60% and 40% of the outstanding stock, respectively. Thus, net income attributable to the controlling and noncontrolling interests is $16,470 ($27,450 x 60%) and $10,980 ($27,450 x 40%), respectively. See Figure 4-4 of Illustration 4-11, adjustments (8) and (9), for explanations of adjustments (65) and (66), respectively. Figure 4-11: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X3 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash (68) 80,700 3,000 83,700 Marketable securities 17,500 17,500 Inventory 30,000 30,000 Buildings and equipment, net 42,000 (70) 17,850 59,850 Investment in Company S (69) 42,890 (71) 42,890 Goodwill (72) 4,286 4,286 Total assets 123,590 92, ,336 Accounts payable 75,000 75,000 Debt 27,000 27,000 Total liabilities 27,000 75, ,000 Common stock 1,500 30,000 (76) 30,000 1,500 Additional paid-in capital 34,500 (77) 28,753 (79) 9,693 15,440 Accumulated other comprehensive income (73) 3,350 5,500 (78) 6,550 (77) 1,000 3,300 Retained earnings (deficit) (74) 57,240 (75) (18,000) (80) 18,000 57,240 Total parent shareholders equity 96,590 17,500 77,480 Noncontrolling interest (81) 15,856 15,856 Total equity 96,590 17,500 93,336 Total liabilities and equity 123,590 92, ,336 The balance sheet is consolidated as of 31 December 20X3 in Figure 4-11, as follows: (68) Company P received $21,600 as a cash dividend from Company S ($36,000 x 60%). The cash balance rollforward is as follows: Beginning balance $ 59,100 Dividend received 21,600 Ending balance $ 80,700 (69) The rollforward of the investment in Company S, adjusted for the earnings and dividends of the equity method investee is as follows: Beginning balance $ 46,820 Attributed earnings 16,470 Attributed other comprehensive income 1,200 Attributed dividends (21,600) Ending balance $ 42,890 Financial reporting developments Consolidated and other financial statements 48

55 4 Changes in a parent s ownership interest in a subsidiary while control is retained (73) Company P recognized its proportion of other comprehensive income for the year (from the increase in value of Company S s marketable securities) in accordance with the equity method of accounting ($2,000 x 60%), which was added to last year s balance of $2,150. (74) Retained earnings for Company P reflect the attributed earnings from Company S under the equity method of accounting. Although a statement of shareholders equity would generally be presented, for illustrative purposes, the statement has been excluded. A rollforward of retained earnings is as follows: Beginning balance $ 40,770 Earnings recognized under the equity method of accounting 16,470 Ending balance $ 57,240 (75) Retained deficit for Company S is rolled forward as follows: Beginning balance $ (12,000) Net income 30,000 Dividends declared (36,000) Ending balance $ (18,000) (78) To eliminate the accumulated other comprehensive income of Company S ($5,500), as well as last year s adjustment related to the sale of a partial interest in Company S ($1,050). (81) The rollforward of the noncontrolling interest balance from 1 January 20X3 (see Figure 4-9), as follows: Beginning balance $ 18,476 Attributed earnings 10,980 Attributed other comprehensive income 800 Attributed dividends (14,400) Ending balance $ 15,856 Adjustments (70) (72), (76), (77), (79) and (80) are consistent with adjustments (54)-(56), (60), (62), (64), and (61), respectively in Figure 4-9 of Illustration Financial reporting developments Consolidated and other financial statements 49

56 5 Intercompany eliminations 5.1 Procedures for eliminating intercompany balances and transactions Excerpt from Accounting Standards Codification Consolidation Overall Other Presentation Matters Procedures In the preparation of consolidated financial statements, intra-entity balances and transactions shall be eliminated. This includes intra-entity open account balances, security holdings, sales and purchases, interest, dividends, and so forth. As consolidated financial statements are based on the assumption that they represent the financial position and operating results of a single economic entity, such statements shall not include gain or loss on transactions among the entities in the consolidated group. Accordingly, any intra-entity profit or loss on assets remaining within the consolidated group shall be eliminated; the concept usually applied for this purpose is gross profit or loss (see also paragraph ) The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings When a subsidiary is initially consolidated during the year, the consolidated financial statements shall include the subsidiary's revenues, expenses, gains, and losses only from the date the subsidiary is initially consolidated Shares of the parent held by a subsidiary shall not be treated as outstanding shares in the consolidated statement of financial position and, therefore, shall be eliminated in the consolidated financial statements and reflected as treasury shares If income taxes have been paid on intra-entity profits on assets remaining within the consolidated group, those taxes shall be deferred or the intra-entity profits to be eliminated in consolidation shall be appropriately reduced. An entity required to consolidate another entity must apply consolidation procedures to present the results of operations and financial position of the group (that is, the parent and the entities required to be consolidated) as a single consolidated entity. The separate financial statements of each entity are combined and adjusted to eliminate intercompany transactions and ownership interests in order to present transactions and ownership interests only with parties outside the consolidated group. This is consistent with the economic entity concept. Financial reporting developments Consolidated and other financial statements 50

57 5 Intercompany eliminations As consolidated financial statements represent the financial position and operating results of a single economic entity, such financial statements should not include any intercompany receivables, payables, investments, capital, revenues, costs of sales or profits or losses between the entities within the consolidated group. Accordingly, any intercompany profit or loss on assets or liabilities remaining within the consolidated entity should be eliminated, resulting in the carrying value of the assets and liabilities being adjusted to the historical carrying value that existed prior to the intercompany transaction. The elimination of intercompany receivables and payables is not complex if balance sheet date cut-offs for intercompany transactions are consistent among entities within the consolidated group. If inventories or other assets of a consolidated group are transferred between members of the consolidated group, intercompany revenues, cost of sales and profit or loss recorded by the transferor should be eliminated in consolidation. The goal of intercompany income elimination is to remove the income (or loss) arising from transactions between companies within the consolidated entity and to adjust the carrying amount of the assets to their historical cost basis (as compared with the intercompany asset transfer price basis) of the transferred asset in the consolidated financial statements. This practice is continued until the income is realized through a sale to outside parties or in the case of depreciable assets, the asset is depreciated over its estimated useful life. The elimination of intercompany losses should be consistent with the elimination of intercompany profits. Accordingly, if losses have been recognized on inventory acquired in an intercompany transaction, those losses must be eliminated to state the inventory in the consolidated statement of financial position at its cost to the consolidated entity. However, careful consideration should be given to the lower-of-cost-ormarket test of inventory for the purchasing company. The market value of the inventory must not be less than the selling company s cost. If the market value is exceeded by the consolidated inventory cost, the loss that would have otherwise been eliminated in consolidation should be adjusted downward. That is, intercompany losses should not be eliminated if they represent a lower-of-cost-or-market adjustment Effect of noncontrolling interest on elimination of intercompany amounts Excerpt from Accounting Standards Codification Consolidation Overall Other Presentation Matters Procedures The amount of intra-entity income or loss to be eliminated is not affected by the existence of a noncontrolling interest. The complete elimination of the intra-entity income or loss is consistent with the underlying assumption that consolidated financial statements represent the financial position and operating results of a single economic entity. The elimination of the intra-entity income or loss may be allocated between the parent and noncontrolling interests. The existence of a noncontrolling interest in the consolidated group creates complexities related to the elimination of intercompany profits. ASC 810 provides guidance for preparing consolidated financial statements, including the treatment of noncontrolling interest, in ASC ASC 810 provides for no distinction between wholly-owned and partially-owned entities with respect to the need for the elimination of intercompany transactions. In both cases, all transactions with members of the consolidated group are considered internal transactions that must be eliminated fully, regardless of the percentage ownership. Financial reporting developments Consolidated and other financial statements 51

58 5 Intercompany eliminations Because individual companies in a consolidated group generally record transactions with members of the consolidated group in a manner similar to transactions with entities outside of the group, sales, cost of goods sold and profit may be recognized by the selling entity even though there has not been a transaction outside of the consolidated group. Because income cannot be recognized by the consolidated group until it has been realized in a transaction with a third party, there may be unrealized intercompany profit or loss requiring elimination. Because noncontrolling interest is a component of equity, transfers of assets between entities in the consolidated group are accounted for as internal transfers for which no earnings are recognized until they are realized through an exchange transaction with a party outside of the consolidated group. Unrealized intercompany income and losses are always eliminated fully in preparing consolidated financial statements. While the entire amount must be eliminated, when there is a noncontrolling interest, in certain circumstances, a determination must be made as to how that elimination should be allocated between the controlling and noncontrolling interests. When a sale is from a parent to a subsidiary (downstream transaction), profit or loss is recognized by the parent. Accordingly, we believe the full amount of the elimination of the intercompany profit or loss should be against the controlling interest. Otherwise, the parent would continue to recognize a portion of the unrealized income or loss in income even though ASC requires intercompany transactions to be eliminated fully. When a subsidiary sells to the parent (upstream transaction) and intercompany profit or loss arises, the profit or loss may be eliminated against the controlling and noncontrolling interest proportionately. In either case, the amount of profit eliminated from the consolidated carrying amount of the asset is not affected by the existence of noncontrolling interest in the subsidiary. Illustration 5-1: Parent sells to a majority-owned subsidiary (downstream transaction) In a transaction in which a parent sells inventory to a majority-owned subsidiary, and some or all of the inventory remains on hand at a period-end, ASC 810 requires that the full amount of the profit arising from the intercompany transaction related to the inventory remaining on hand be eliminated against the parent s interest and eliminated from the carrying amount of the asset. That is, because only the parent has recognized the revenues, costs of sale, and resultant profit and loss in its financial statements, no portion of these items may be allocated to noncontrolling interests. Assumptions: Company P owns an 80% interest in Company S. The 1 January 20X6, beginning-of-year balance sheets for Company P and Company S are as follows (all amounts in dollars): Company P Company S Cash 300,000 Inventory 200,000 50,000 Buildings and equipment, net 150,000 Investment in Company S 400,000 Total assets 600, ,000 Current liabilities 100,000 Common stock 200, ,000 Retained earnings 300,000 Noncontrolling interest Total liabilities and equity 600, ,000 Financial reporting developments Consolidated and other financial statements 52

59 5 Intercompany eliminations 1) During the year, Company P sells inventory to Company S, which remains in Company S s inventory at year end. A summary of the effect of the transaction on Company P s income statement is as follows: Revenues $ 100,000 Cost of sales 70,000 Gross profit $ 30,000 2) The inventory sale is the only transaction between Company P and Company S during 20X6. Further, the inventory remains on hand at Company S at year end. 3) Prior to consolidation, Company P accounts for its investment in Company S using the equity method. Figure 5-1: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 500, ,000 (1) 100, ,000 Cost of revenues 200, ,000 (2) 70, ,000 Gross profit 300, , ,000 Selling and administrative 100,000 20, ,000 Net income 200, , ,000 Net income attributable to noncontrolling interest (3) 30,000 30,000 Net income attributable to controlling interest 200, , ,000 Figure 5-1 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows: (1) Intercompany revenue from the downstream sale is eliminated. (2) Intercompany cost of revenues from the downstream sale is eliminated. (3) Net income of Company S is attributed to the noncontrolling interest ($150,000 x 20%). Figure 5-2: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 200, , ,000 Intercompany receivable 100,000 (4) 100,000 Inventory 200, ,000 (5) 30, ,000 Buildings and equipment, net 150, ,000 Investment in Company S 400,000 (6) 400,000 Total assets 900, ,000 1,120,000 Current liabilities 200, ,000 Intercompany payable 100,000 (4) 100,000 Total liabilities 200, , ,000 Capital stock 200, ,000 (7) 500, ,000 Retained earnings 500, ,000 (8) 180,000 (9) 120, ,000 Total parent shareholders equity 700, , ,000 Noncontrolling interest (10) 130, ,000 Total equity 700, , ,000 Total liabilities and equity 900, ,000 1,120,000 Financial reporting developments Consolidated and other financial statements 53

60 5 Intercompany eliminations Figure 5-2 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows: (4) Intercompany receivable and payable from the downstream sale are eliminated. (5) Intercompany profit remaining in inventory at year end from the downstream sale is eliminated (see notes 1 and 2, under Assumptions). (6) Company P s investment in Company S is eliminated. (7) Company S s common stock is eliminated. (8) Company S s retained earnings balance is eliminated ($150,000) and the intercompany profit on the downstream sale is eliminated ($30,000). (9) Company P recognizes its proportionate share (80%) of income from Company S. (10) Noncontrolling interest is recognized at its initial balance of $100,000 ($500,000 x 20%) plus its proportionate share of income from Company S ($30,000). Under the economic unit concept, 100% of intercompany sales, receivables, payables, purchases, cost of sales and unrealized intercompany profits and losses are eliminated. Profits and losses on downstream transactions are eliminated completely against the controlling interest. No profit accrues to the stockholders of the selling entity under the economic unit concept because both the controlling and noncontrolling interests are owners of a single economic unit (albeit with different claims on the entity s assets). After incorporating elimination entries, transfers of inventory are to be accounted for on the same basis as internal transfers between departments of a single entity at cost. Illustration 5-2: Majority-owned subsidiary sells to parent (upstream transaction) Assumptions: Same as Illustration 5-1, except for the following: 1) Rather than a downstream sale from P to S, during the year, S sells inventory to P, which remains in P s inventory at year-end. A summary of the result of the transaction on S s income statement is as follows: Revenues $ 100,000 Cost of sales 70,000 Gross profit $ 30,000 Under the economic unit concept, the transfer of inventory between a subsidiary and its parent is viewed as a transfer between departments or divisions/components of a single entity. When a majority-owned subsidiary sells inventory to its parent, under ASC 810 the unrealized profit may be proportionately eliminated against the parent s interest and the noncontrolling interest. Financial reporting developments Consolidated and other financial statements 54

61 5 Intercompany eliminations Figure 5-3: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 500, ,000 (11) 100, ,000 Cost of revenues 200, ,000 (12) 70, ,000 Gross profit 300, , ,000 Selling and administrative 100,000 20, ,000 Net income 200, , ,000 Net income attributable to noncontrolling interest (13) 24,000 24,000 Net income attributable to controlling interest 200, , ,000 Figure 5-3 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows: (13) Net income of Company S is attributed to the noncontrolling interest, including its proportionate share of the elimination of the intercompany transaction (($150,000 $30,000) x 20%). For explanations of items (11) and (12), see items (1) and (2), respectively, in Figure 5-1. Figure 5-4: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 300, , ,000 Intercompany receivable 100,000 (14) 100,000 Inventory 200, ,000 (15) 30, ,000 Building, net 150, ,000 Investment in Company S 400,000 (16) 400,000 Total assets 900, ,000 1,120,000 Current liabilities 100, , ,000 Intercompany payable 100,000 (14) 100,000 Total liabilities 200, , ,000 Capital stock 200, ,000 (17) 500, ,000 Retained earnings 500, ,000 (18) 150,000 (19) 96, ,000 Total parent shareholders equity 700, , ,000 Noncontrolling interest (20) 124, ,000 Total equity 700, , ,000 Total liabilities and equity 900, ,000 1,120,000 Figure 5-4 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows: (19) Company P recognizes its proportionate share (80%) of income from Company S, including its share of the intercompany profit elimination (($150,000 $30,000) x 80%). (20) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($24,000, see explanation in income statement). For explanations of items (14) (18), see items (4) (8) in Figure 5-2. Financial reporting developments Consolidated and other financial statements 55

62 5 Intercompany eliminations The net income attributable to the controlling interest in Illustration 5-2 exceeds the net income attributable to the controlling interest in Illustration 5-1 by $6,000 because a portion of the elimination of the unrealized income, which is reflected in the subsidiary with the noncontrolling interest, has been allocated to the noncontrolling interest ($30,000 x 20% = $6,000). Net income of the consolidated entity is the same in both examples because of the requirement to fully eliminate the intercompany income or loss. As described in Illustration 5-1, under the economic entity concept, 100% of intercompany sales, receivables, payables, purchases, cost of sales and unrealized intercompany profits and losses are eliminated. Profits and losses are eliminated in proportion to the interests in the selling entity. No profit accrues to the stockholders of the selling entity under the economic entity concept because both the controlling and noncontrolling interests are owners of a single economic entity (albeit with different claims on the entity s net assets). After incorporating elimination entries, transfers of inventory are to be accounted for on the same basis as internal transfers between departments of a single entity at cost. Illustration 5-3: Parent makes an intercompany loan to a majority-owned subsidiary and the interest is expensed Assumptions: Same as Illustration 5-1, except for the following: 1) During the year, P makes an intercompany loan to S for $1,000,000 with an annual interest rate of 10%. 2) S expenses the current year interest on the intercompany loan and remits cash to P for the annual interest incurred on the intercompany loan. 3) The loan is the only transaction between P and S during 20X6 (that is, the intercompany sales described in Illustration 5-1 did not occur). Figure 5-5: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 500, , ,000 Cost of revenues 200, , ,000 Gross profit 300, , ,000 Selling and administrative 100,000 20, ,000 Interest income 100,000 (21) 100,000 Interest expense 100,000 (21) 100,000 Net income 300,000 50, ,000 Net income attributable to noncontrolling interest (22) 10,000 10,000 Net income attributable to controlling interest 300,000 50, ,000 Figure 5-5 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows: (21) Intercompany interest income and expense are eliminated. (22) Net income of Company S is attributed to the noncontrolling interest. Financial reporting developments Consolidated and other financial statements 56

63 5 Intercompany eliminations Figure 5-6: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 300,000 1,350,000 1,650,000 Inventory 200, , ,000 Buildings and equipment, net 150, ,000 Intercompany loan 1,000,000 (23) 1,000,000 Investment in Company S 400,000 (24) 400,000 Total assets 1,900,000 1,650,000 2,150,000 Current liabilities 1,100, ,000 1,200,000 Intercompany loan 1,000,000 (23) 1,000,000 Total liabilities 1,100,000 1,100,000 1,200,000 Capital stock 200, ,000 (25) 500, ,000 Retained earnings 600,000 50,000 (26) 50,000 (27) 40, ,000 Total parent shareholders equity 800, , ,000 Noncontrolling interest (28) 110, ,000 Total equity 800, , ,000 Total liabilities and equity 1,900,000 1,650,000 2,150,000 Figure 5-6 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows: (23) Intercompany loan is eliminated. (27) Company P recognizes its proportionate share (80%) of income from Company S ($50,000 x 80%). (28) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($10,000). For explanations of items (24) (26), see items (6)-(8) in Figure 5-2. Prior to taking into consideration the noncontrolling interest in S, the elimination of the intercompany interest income and expense has no effect on the combined net income of P and S. However, as S has absorbed an expense of $100,000, P receives the benefit of the interest to the extent of the noncontrolling interest. This benefit is realized immediately as S recorded the full amount of the interest as a current period expense. Financial reporting developments Consolidated and other financial statements 57

64 5 Intercompany eliminations Illustration 5-4: Parent makes an intercompany loan to a majority-owned subsidiary and the interest is capitalized Assumptions: Same as Illustration 5-1, except for the following: 1) During the year, P makes an intercompany loan to S with a principal of $1,000,000 with an annual interest rate of 10%. The proceeds of the loan are used to construct a building. 2) S capitalizes the current year interest on the intercompany loan as part of the cost of the building and remits cash to P for the annual interest incurred on the intercompany loan. 3) The loan is the only transaction between P and S during 20X6 (that is, the intercompany sales described in Illustration 5-1 did not occur). Figure 5-7: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 500, , ,000 Cost of revenues 200, , ,000 Gross profit 300, , ,000 Selling and administrative 100,000 20, ,000 Interest income 100,000 (29) 100,000 Interest expense Net income 300, , ,000 Net income attributable to noncontrolling interest (30) 30,000 30,000 Net income attributable to controlling interest 300, , ,000 Figure 5-7 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows: (29) Interest income on the intercompany loan recognized by Company P is eliminated. (30) Net income of Company S is attributed to the noncontrolling interest ($150,000 x 20%). Figure 5-8: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 300, , ,000 Inventory 200, , ,000 Buildings and equipment, net 1,250,000 (31) 100,000 1,150,000 Intercompany loan 1,000,000 (32) 1,000,000 Investment in Company S 400,000 (33) 400,000 Total assets 1,900,000 1,750,000 2,150,000 Current liabilities 1,100, ,000 1,200,000 Intercompany loan 1,000,000 (32) 1,000,000 Total liabilities 1,100,000 1,100,000 1,200,000 Capital stock 200, ,000 (34) 500, ,000 Retained earnings 600, ,000 (35) 250,000 (36) 120, ,000 Total parent shareholders equity 800, , ,000 Noncontrolling interest (37) 130, ,000 Total equity 800, , ,000 Total liabilities and equity 1,900,000 1,750,000 2,150,000 Financial reporting developments Consolidated and other financial statements 58

65 5 Intercompany eliminations Figure 5-8 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows: (31) Capitalized interest from outstanding intercompany loan is eliminated. (32) The intercompany loan is eliminated. (35) The retained earnings of Company S are eliminated ($150,000), and the interest income recognized by Company P on the intercompany loan is eliminated ($100,000). (36) Company P recognizes its proportionate share (80%) of income from Company S ($150,000 x 80%). (37) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($30,000). For explanations of items (33) and (34), see items (6) and (7), respectively, in Figure 5-2. As S has capitalized the interest expense paid by the subsidiary as part of the cost of its building, the interest has not been expensed in the income statement of S. As such, P does not receive any benefit of the interest income until the expense is recognized which will occur as the building is depreciated by S. Year 2 In Year 2, Assume S depreciates the newly constructed building over 10 years which results in annual depreciation expense of $125,000 ($1,250,000 / 10 years = $125,000) that is included in S s cost of revenues. Further, for simplicity, assume (1) P had no other transactions during Year 2 and (2) S does not incur any additional interest expense in Year 2. Figure 5-9: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X7 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 400, ,000 Cost of revenues 250,000 (38) 10, ,000 Gross profit 150, ,000 Net income 150, ,000 Net income attributable to noncontrolling interest (39) 30,000 30,000 Net income attributable to controlling interest 150, ,000 Figure 5-9 illustrates the elimination of intercompany transactions between Company P and Company S for the Year 2 consolidated income statement, as follows: (38) The excess depreciation from the capitalized interest on the intercompany loan is eliminated. (39) Net income of Company S is attributed to the noncontrolling interest ($150,000 x 20%). Financial reporting developments Consolidated and other financial statements 59

66 5 Intercompany eliminations Figure 5-10: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X7 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 300, , ,000 Inventory 200, , ,000 Buildings and equipment, net 1,125,000 (40) 90,000 1,035,000 Intercompany loan 1,000,000 (41) 1,000,000 Investment in Company S 400,000 (42) 400,000 Total assets 1,900,000 1,900,000 2,310,000 Current liabilities 1,100, ,000 1,200,000 Intercompany loan 1,000,000 (41) 1,000,000 Total Liabilities 1,100,000 1,100,000 1,200,000 Capital stock 200, ,000 (43) 500, ,000 Retained earnings 600, ,000 (44) 300,000 (46) 120, ,000 (45) 100,000 (47) 130,000 Total parent shareholders equity 800, , ,000 Noncontrolling interest (48) 160, ,000 Total equity 800, ,000 1,110,000 Total liabilities and equity 1,900,000 1,900,000 2,310,000 Figure 5-10 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet in Year 2, as follows: (40) Capitalized interest expense from the prior year ($100,000) less current year depreciation ($10,000) is eliminated. (45) Retained earnings is eliminated for the prior year recognition of interest income ($100,000) by Company P. (46) Prior year income attributable to the controlling interest ($120,000) is added to retained earnings. (47) Company P recognizes its attributable share of income from Company S (($150,000 + $10,000) x 80%). (48) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S of $30,000 for both Years 1 and 2. For explanations of items (41) (44), see items (5)-(8) in Figure 5-2 and (32)-(35) in Figure 5-8. Financial reporting developments Consolidated and other financial statements 60

67 5 Intercompany eliminations Illustration 5-5: Assumptions: Parent charges subsidiary a management fee Same as Illustration 5-1, except for the following: 1) During the year, Company P charges Company S a management fee of $1,500 for its accounting and finance services. 2) The management fee is the result of a contractual arrangement negotiated between P and S. 3) The management fee is the only transaction between P and S during 20X6 (that is, the intercompany sales described in Illustration 5-1 did not occur). Figure 5-11: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 500, , ,000 Cost of revenues 200, , ,000 Gross profit 300, , ,000 Selling and administrative 100,000 20, ,000 Intercompany expense 1,500 (49) 1,500 Intercompany revenue 1,500 (49) 1,500 Net income 201, , ,000 Net income attributable to noncontrolling interest (50) 29,700 29,700 Net income attributable to controlling interest 201, , ,300 Figure 5-11 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows: (49) Intercompany revenue and expense resulting from the management fee of $1,500 paid to Company P are eliminated. (50) Net income of Company S is attributed to the noncontrolling interest, including its attributable share of the management fee (($150,000 $1,500) x 20%). Figure 5-12: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 200, , ,000 Inventory 200, , ,000 Buildings and equipment, net 150, ,000 Investment in Company S 400,000 (51) 400,000 Total assets 800, ,000 1,150,000 Current liabilities 98, , ,000 Total liabilities 98, , ,000 Capital stock 200, ,000 (52) 500, ,000 Retained earnings 501, ,500 (53) 148,500 (55) 120, ,300 (54) 1,500 Total parent shareholders equity 701, , ,300 Noncontrolling interest (56) 129, ,700 Total equity 701, , ,000 Total liabilities and equity 800, ,000 1,150,000 Financial reporting developments Consolidated and other financial statements 61

68 5 Intercompany eliminations Figure 5-12 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows: (54) The income recognized by Company P from the management fee is eliminated from retained earnings. (55) Company P recognizes its attributable share of income from Company S, including the realization of the portion of the management fee attributable to the noncontrolling interest ($150,000 x 80% + $1,500 x 20%). (56) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($29,700). For explanations of items (51) (53), see items (6)-(8) in Figure 5-2. Variable interest entities Question 5.1 How should intercompany eliminations be attributed to the noncontrolling interests for consolidated variable interest entities? The principles described above (see Section 5.1.1) and reflected in the Illustrations are equally applicable to all consolidated entities, including variable interest entities. It is common for variable interest entities to have substantive profit sharing arrangements and therefore the use of relative ownership percentages may not be appropriate. Our FRD, Consolidation of variable interest entities, provides further interpretive guidance and examples on attributing intercompany eliminations to noncontrolling interests. Financial reporting developments Consolidated and other financial statements 62

69 6 Loss of control over a subsidiary or a group of assets 6.1 Deconsolidation of a subsidiary or derecognition of certain groups of assets Excerpt from Accounting Standards Codification Consolidation Overall Derecognition Deconsolidation of a Subsidiary or Derecognition of a Group of Assets A The deconsolidation and derecognition guidance in this Section applies to the following: a. A subsidiary that is a nonprofit activity or a business, except for either of the following: 1. A sale of in substance real estate (for guidance on a sale of in substance real estate, see Subtopic or Subtopic ) 2. A conveyance of oil and gas mineral rights (for guidance on conveyances of oil and gas mineral rights and related transactions, see Subtopic ). b. A group of assets that is a nonprofit activity or a business, except for either of the following: 1. A sale of in substance real estate (for guidance on a sale of in substance real estate, see Subtopic or Subtopic ) 2. A conveyance of oil and gas mineral rights (for guidance on conveyances of oil and gas mineral rights and related transactions, see Subtopic ). c. A subsidiary that is not a nonprofit activity or a business if the substance of the transaction is not addressed directly by guidance in other Topics that include, but are not limited to, all of the following: 1. Topic 605 on revenue recognition 2. Topic 845 on exchanges of nonmonetary assets 3. Topic 860 on transferring and servicing financial assets 4. Topic 932 on conveyances of mineral rights and related transactions 5. Topic 360 or 976 on sales of in substance real estate A parent shall deconsolidate a subsidiary or derecognize a group of assets specified in the preceding paragraph as of the date the parent ceases to have a controlling financial interest in that subsidiary or group of assets. See paragraph A for related implementation guidance. Financial reporting developments Consolidated and other financial statements 63

70 6 Loss of control over a subsidiary or a group of assets Implementation Guidance and Illustrations Deconsolidation of a Subsidiary A All of the following are circumstances that result in deconsolidation of a subsidiary under paragraph : a. A parent sells all or part of its ownership interest in its subsidiary, and as a result, the parent no longer has a controlling financial interest in the subsidiary. b. The expiration of a contractual agreement that gave control of the subsidiary to the parent. c. The subsidiary issues shares, which reduces the parent s ownership interest in the subsidiary so that the parent no longer has a controlling financial interest in the subsidiary. d. The subsidiary becomes subject to the control of a government, court, administrator, or regulator. Derecognition Deconsolidation of a Subsidiary If a parent deconsolidates a subsidiary or derecognizes a group of assets through a nonreciprocal transfer to owners, such as a spinoff, the accounting guidance in Subtopic applies. Otherwise, a parent shall account for the deconsolidation of a subsidiary or derecognition of a group of assets specified in paragraph A by recognizing a gain or loss in net income attributable to the parent, measured as the difference between: a. The aggregate of all of the following: 1. The fair value of any consideration received 2. The fair value of any retained noncontrolling investment in the former subsidiary or group of assets at the date the subsidiary is deconsolidated or the group of assets is derecognized 3. The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated. b. The carrying amount of the former subsidiary s assets and liabilities or the carrying amount of the group of assets A parent may cease to have a controlling financial interest in a subsidiary through two or more arrangements (transactions). Circumstances sometimes indicate that the multiple arrangements should be accounted for as a single transaction. In determining whether to account for the arrangements as a single transaction, a parent shall consider all of the terms and conditions of the arrangements and their economic effects. Any of the following may indicate that the parent should account for the multiple arrangements as a single transaction: a. They are entered into at the same time or in contemplation of one another. b. They form a single transaction designed to achieve an overall commercial effect. c. The occurrence of one arrangement is dependent on the occurrence of at least one other arrangement. d. One arrangement considered on its own is not economically justified, but they are economically justified when considered together. An example is when one disposal is priced below market, compensated for by a subsequent disposal priced above market. Financial reporting developments Consolidated and other financial statements 64

71 6 Loss of control over a subsidiary or a group of assets Note: The Emerging Issues Task Force (EITF) currently is considering agenda Issue 11-A, Parent s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. The EITF s conclusions on this Issue would make certain amendments to the Codification excerpt above. In September 2012, the FASB exposed the EITF s conclusions for public comment. The comment period on the EITF s proposal ends 10 December Readers should monitor developments in this area closely Loss of control A parent company deconsolidates a subsidiary or derecognizes a group of assets when that parent company no longer controls the subsidiary or group of assets specified in ASC A. When control is lost, the parent-subsidiary relationship no longer exists and the parent derecognizes the assets and liabilities of the qualifying subsidiary or group of assets. The FASB concluded that the loss of control and the related deconsolidation of a subsidiary or derecognition of a group of assets specified in ASC A is a significant economic event that changes the nature of the investment held in the subsidiary or group of assets. Based on this consideration, a gain or loss is recognized upon the deconsolidation of a subsidiary or derecognition of a group of assets. Any remaining ownership interest in the subsidiary or entity acquiring the group of assets specified in ASC A (which would then be classified as a noncontrolling interest) is measured at its fair value. That ownership interest is subsequently accounted for in accordance with ASC 320, ASC 323 or other applicable GAAP. If the retained noncontrolling interest is accounted for as an equity method investment, the former parent would be required to identify and determine the acquisition date fair value of the underlying assets and liabilities of the investee (with certain exceptions),pursuant to ASC 323. While the former parent would not recognize those identified assets and liabilities, it must track its bases in them (often through a process referred to as memo accounting) to account for the effect of any differences between its bases and the bases recognized by the investee. Chapter 4 of our FRD, Equity method investments provides further guidance on applying the equity method. We believe the guidance in ASC 810 applies to the loss of control and deconsolidation of any subsidiary or group of assets specified in ASC A, regardless of the manner in which control was lost (except for nonreciprocal transfers to owners). Several events may lead to a loss of control of a subsidiary specified in ASC A, and not all events are the direct result of actions taken by the parent company. The simplest example of the loss of control of a subsidiary is when a parent company decides to sell all of its interest in a subsidiary. Actions of the subsidiary also can cause a loss of control. When a subsidiary issues shares to third parties, the parent s interest is diluted, potentially to the point in which the parent no longer controls the subsidiary. A loss of control can also result if a government, court, administrator or regulator takes legal control of a subsidiary or a group of assets as specified in ASC A Nonreciprocal transfers to owners ASC 810 s provisions do not apply to spinoffs or other nonreciprocal transactions with owners. A spinoff occurs when a parent company transfers the subsidiary s stock or a group of assets that it owns to its own shareholders. Spinoffs should be accounted for in accordance with ASC 845. Financial reporting developments Consolidated and other financial statements 65

72 6 Loss of control over a subsidiary or a group of assets Gain/loss recognition When a subsidiary or a group of assets specified in ASC A is deconsolidated or derecognized, the carrying amounts of the previously consolidated subsidiary s assets and liabilities or a group of assets are removed from the consolidated statement of financial position. Generally, a gain or loss is recognized as the difference between: 1) The sum of the fair value of any consideration received, the fair value of any retained noncontrolling investment in the former subsidiary or group of assets at the date the subsidiary is deconsolidated or the group of assets is derecognized, and the carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated, and 2) The carrying amount of the former subsidiary s assets and liabilities or the carrying amount of the group of assets. Importantly, because the loss of control is deemed to be a significant economic event, when an entity loses control of a subsidiary or a group of assets specified in ASC A but retains a noncontrolling interest in the former subsidiary or entity that acquired the group of assets, that retained interest is measured at fair value and is included in the calculation of the gain/loss on deconsolidation of the subsidiary or the derecognition of a group of assets. In recognizing a gain, SAB Topic 5-E (codified in ASC S99-5) states that an entity should identify all of the elements of the divesture arrangement and allocate the consideration exchanged to each of those elements. For example, if the divesture arrangement included elements of guarantees and promissory notes, the entity would recognize the guarantees at fair value in accordance with ASC 460 and recognize the promissory notes in accordance with ASC 835, ASC 470 and ASC 310. As indicated in ASC , the gain/loss calculation is affected by the carrying amount of any noncontrolling interest in the former subsidiary specified in ASC A. However, adjustments to the carrying amount of a redeemable noncontrolling interest from the application of ASC S99-3A do not initially enter into the determination of net income (see Section and for additional discussion of the application of ASC S99-3A). For this reason, the SEC staff believes that the carrying amount of the noncontrolling interest used in the gain/loss calculation similarly should not include any adjustments made to that noncontrolling interest from the application of ASC S99-3A. Rather, previously recorded adjustments to the carrying amount of a noncontrolling interest from the application of ASC S99-3A should be eliminated in the same manner in which they were initially recorded (that is, by recording a credit to equity of the parent). Illustration 6-1: Assume Company A has a 90% controlling interest in Company B, a public retailer of athletic wear. On 31 December 20X6, the carrying amount of Company B s net assets is $100 million, and the carrying amount attributable to the noncontrolling interest in Company B (including the noncontrolling interest s share of accumulated other comprehensive income) is $10 million. On 1 January 20X7, Company A sells 70% of Company B to a third party for cash proceeds of $108 million. As a result of the sale, Company A loses control of Company B but retains a 20% noncontrolling interest in Company B. The fair value of the retained interest on that date is $24 million. 19 The gain on sale of the 70% interest in Company B is calculated as follows (in millions): 19 This number is assumed (and cannot be determined based on the acquisition of the 70% interest because that price includes a control premium). Financial reporting developments Consolidated and other financial statements 66

73 6 Loss of control over a subsidiary or a group of assets Cash proceeds $ 108 Fair value of retained interest 24 Carrying amount of the nonredeemable noncontrolling interest Less: Carrying amount of Company B s net assets 100 Gain $ 42 The journal entry to record Company B s deconsolidation follows: Cash $ 108 Investment in Company B 24 Noncontrolling interest 10 Net assets of Company B $ 100 Gain on sale 42 Company A subsequently may account for its retained interest as an available-for-sale or trading security pursuant to ASC 320 (with a cost basis of $24). If Company A s retained 20% noncontrolling interest provided it with significant influence over Company B and was to be accounted for as an equity method investment, Company A would be required to identify and determine the acquisition date fair value of the underlying assets and liabilities of the investee (with certain exceptions), pursuant to ASC 323. While Company A would not recognize those identified assets and liabilities, it must track its bases in them (often through a process referred to as memo accounting) to account for the effect of any differences between its bases and the bases recognized by the investee. Chapter 4 of our FRD, Equity method investments provides further guidance on applying the equity method Measuring the fair value of consideration received and any retained noncontrolling investment When determining the gain or loss upon deconsolidation, the fair value of any consideration received and the fair value of any retained noncontrolling investment in the former subsidiary or groups of assets must be determined. When the consideration received is cash or when the retained noncontrolling investment in the former subsidiary or group of assets is a publicly traded equity interest, this determination may be relatively straightforward. However, in other circumstances, the determination may prove more challenging. The facts and circumstances of a deconsolidating event should be evaluated carefully before recording a gain or loss. Consistent with the disclosure provisions included within ASC B and discussed further in Chapter 9, we believe that it is appropriate to disclose the details of the computation of any material gain or loss. Consideration received may take many forms, including cash, tangible and intangible assets, financial instruments and contingent consideration. Because ASC indicates that the consideration received is to be measured at fair value, we generally believe that it is appropriate to measure consideration received at its fair value regardless of its form (see Section below for further discussion of contingent consideration). In evaluating the nature and amount of consideration received, it may be helpful to consider the guidance in ASC 805 regarding consideration transferred. Refer to our FRD, Business combinations, for further discussion of consideration transferred. We believe the determination of the fair value of any consideration received should contemplate any off- Financial reporting developments Consolidated and other financial statements 67

74 6 Loss of control over a subsidiary or a group of assets market executory contracts (e.g., leases). To illustrate, if upon deconsolidation, a favorable lease contract (from the reporting entity s perspective) exists between the reporting entity and its former subsidiary, we believe that an intangible asset should be recorded by the reporting entity for the offmarket component of the lease contract. The effect of this accounting is to increase the gain (or reduce the loss) recorded upon deconsolidation, as presumably the consideration received was reduced by the favorable lease contract. A retained noncontrolling investment may take many forms, including common stock investments, preferred stock investments, and debt interests (see Section ). We also generally believe that it is appropriate to measure any noncontrolling investment at its fair value regardless of its form Accounting for contingent consideration in deconsolidation In certain instances, a transfer of a controlling interest in a subsidiary involves contingent consideration. For example, when an entity sells a controlling interest in a subsidiary, the acquirer may promise to deliver cash, additional equity interests or other assets to the seller after the sale date if certain specified events occur or conditions are met in the future. These contingencies frequently are based on future earnings or changes in the market price of the subsidiary s stock over specified periods after the date of the sale; however, they might be based on other factors (e.g., components of earnings, product development milestones, cash flow levels or the successful completion of third-party contract negotiations). The basis for recognition and measurement of contingent consideration in deconsolidation is not addressed in ASC 810 and therefore it is necessary to look to other guidance. If contingent consideration meets the definition of a derivative, it should be accounted for pursuant to ASC 815. When contingent consideration does not meet the definition of a derivative, the ASC does not provide detailed guidance. In this circumstance, we believe the basis for recognition and measurement of contingent consideration receivable by the seller is an accounting policy choice that should be applied on a consistent basis. Discussed below are two policy alternatives that are applied in practice. Alternative 1: Fair value approach ASC requires that the measurement of any gain or loss on deconsolidation of a subsidiary include the fair value of any consideration received. We believe the reference to any consideration received in ASC could be interpreted to include contingent consideration. Thus, we believe that the seller may initially recognize an asset from the buyer equal to the fair value of any contingent consideration received upon deconsolidation. We note that this view is consistent with ASC 805 s requirement that an acquirer recognize contingent consideration obligations as of the acquisition date as part of consideration transferred in exchange for an acquired business. If a seller follows an accounting policy to initially recognize an asset equal to the fair value of the contingent consideration, we believe the seller also must elect an accounting policy to subsequently measure the contingent consideration under either of the following approaches: a. Subsequent remeasurement at fair value by electing the fair value option provided in ASC (assuming the gain contingency is a financial instrument eligible for the fair value option). b. Recognize increases in the carrying value of the asset using the gain contingency guidance in ASC and recognize impairments based on the guidance in ASC Financial reporting developments Consolidated and other financial statements 68

75 6 Loss of control over a subsidiary or a group of assets Alternative 2: Loss recovery approach We also believe it is reasonable to conclude that contingent consideration is not required to be measured at fair value. In that circumstance, we believe it is acceptable to apply a loss recovery approach by analogizing to the accounting for insurance recoveries on property and casualty losses. Property and casualty losses are accounted for in accordance with ASC Pursuant to that guidance, when a nonmonetary asset (e.g., property or equipment) is involuntarily converted to a monetary asset (e.g., receipt of insurance proceeds upon the occurrence of an insured event), the loss on the derecognition of the nonmonetary asset must be recognized, even when an entity reinvests, or is obligated to reinvest, the monetary assets in a replacement asset. Anticipated insurance proceeds up to the amount of the loss recognized are called insurance recoveries and may be recognized when it is probable 20 that they will be received. Some or all of the anticipated insurance recoveries therefore may be recognized. Specifically, anticipated insurance recoveries may be recognized at the lesser of the amount of: a) the proceeds that are probable of receipt or b) the total loss recognized. Insurance proceeds in excess of the amount of the loss recognized are subject to the gain contingency guidance in ASC , and are not recognized until all contingencies related to the insurance claim are resolved. When analogizing insurance recovery accounting to the initial recognition of contingent consideration in deconsolidation, an entity would compare the fair value of the consideration received, excluding the contingent consideration, to the carrying amount of the assets that are deconsolidated pursuant to ASC 810. If the fair value of the consideration received, excluding the contingent consideration, is less than the carrying amount of the deconsolidated assets, the initial measurement of the contingent consideration asset would be limited to the difference between those amounts. That is, if it is probable that contingent consideration will be received, an asset would be recognized and measured initially at the lesser of the amount of probable future proceeds or the difference between the fair value of the consideration received, excluding the contingent consideration, and the carrying amount of the deconsolidated assets. Subsequent recognition and measurement would be based on the gain contingency guidance in ASC (i.e., a contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization). Any subsequent impairments would be recognized based on the guidance in ASC If the fair value of the consideration received, excluding the contingent consideration, is greater than the carrying amount of the deconsolidated assets, no contingent consideration asset would be recognized initially. Subsequent recognition and measurement of the contingent consideration would be based on the gain contingency model pursuant to ASC and any subsequent impairment would be recognized based on the guidance in ASC Illustration 6-2 demonstrates these two alternatives. Illustration 6-2 Assume Company A has a 100% controlling interest in Company B, a public retailer of athletic wear. On 31 December 20X6, the carrying amount of Company B s net assets is $150 million. On 1 January 20X7, Company A sells 100% of Company B to a third party for cash proceeds of $75 million and a promise by the third party to deliver additional cash annually over the next five years, determined based on a percentage of Company B s annual earnings above an agreed upon target. The fair value of the contingent consideration is determined to be $175 million on 1 January 20x7. Company A determines it is probable that $225 million 21 in total contingent consideration will be received over the life of this arrangement. 20 The ASC master glossary defines probable as: the future event or events are likely to occur. 21 This amount reflects the total cash that is probable of receipt under the terms of the arrangement, as determined using a reasonable estimate of the earnings of Company B over the next five years. No discount factor or other fair value adjustments are applied in determining this amount. Financial reporting developments Consolidated and other financial statements 69

76 6 Loss of control over a subsidiary or a group of assets Fair value approach The gain on sale of the 100% interest in Company B is calculated as follows (in millions): Cash proceeds $ 75 Fair value of the contingent consideration Less: Carrying amount of Company B s net assets 150 Gain $ 100 The journal entry to record Company B s deconsolidation follows: Cash $ 75 Contingent consideration receivable 175 Net assets of Company B $ 150 Gain on sale 100 If Company A applies the fair value accounting policy, we believe Company A also must elect an accounting policy to subsequently measure the contingent consideration under either of the following approaches: (a) Subsequent remeasurement at fair value by electing the fair value option provided in ASC (b) Recognize increases in the carrying amount of the asset using the gain contingency guidance in ASC and recognize impairments based on the guidance in ASC Loss recovery approach Company A would compare the fair value of the consideration received, excluding the contingent consideration, to the carrying amount of the assets that are deconsolidated pursuant to ASC 810. Cash proceeds $ 75 Less: Carrying amount of Company B s net assets 150 Difference $ (75) Because the fair value of the consideration received, excluding the contingent consideration, is less than the carrying amount of the deconsolidated assets, an asset would be recognized and measured initially at the lesser of the amount of probable future proceeds or the difference between those amounts. In this example, the difference of $75 calculated above is less than the probable future proceeds of $225. Therefore, the contingent consideration asset would be recognized and measured initially at $75. In this way, no gain would be recognized when initially recording this transaction. The journal entry to record Company B s deconsolidation would be as follows: Cash $ 75 Contingent consideration receivable 75 Net assets of Company B $ 150 If Company A elects to apply this alternative, subsequent increases in the carrying amount of the asset would be recognized using the gain contingency guidance in ASC and any subsequent impairments would be recognized based on the guidance in ASC Financial reporting developments Consolidated and other financial statements 70

77 6 Loss of control over a subsidiary or a group of assets Accounting for a retained creditor interest in deconsolidation The FASB concluded that the loss of control and the related deconsolidation of a subsidiary or derecognition of a group of assets specified in ASC A is a significant economic event that changes the nature of the investment held in the subsidiary or group of assets. Upon deconsolidation, an entity therefore is required to record any remaining noncontrolling investment in the subsidiary or a group of assets specified in ASC A at fair value. Consistent with this approach, we believe that a loan to the former subsidiary also should be measured at fair value at the deconsolidation date. Thus, any difference between the carrying amount of the loan to the subsidiary and the fair value should be included in the gain/loss calculation upon deconsolidation of the subsidiary Accounting for accumulated other comprehensive income in deconsolidation As described in Chapter 3, accumulated other comprehensive income (AOCI) of a subsidiary or group of assets specified in ASC A is attributed to both the controlling and noncontrolling interests. As part of deconsolidation, the parent should derecognize any portion of AOCI attributable to the noncontrolling interest as the underlying asset or liability of the subsidiary or group of assets specified in ASC A that generated the AOCI is no longer recorded on the books of the parent. While ASC 810 does not specify the treatment of the AOCI attributable to the parent, we believe that the reversal of any AOCI attributable to the parent should be included in the gain or loss recognized on deconsolidation. The basis for this conclusion is that the assets or liabilities of the former subsidiary or group of assets specified in ASC A that generated the amounts in AOCI have been derecognized upon the loss of control. The fair value of any retained interest is its new carrying amount and, if that investment is accounted for as an equity method investment, the former parent would be required to identify and determine the acquisition date fair value of the underlying assets and liabilities of the investee (with certain exceptions), pursuant to ASC 323. While the former parent would not recognize those identified assets and liabilities, it must track its bases in them (often through a process referred to as memo accounting) to account for the effect of any differences between its bases and the bases recognized by the investee. (Chapter 4 of our FRD, Equity method investments provides further guidance on applying the equity method). Because the investment, as well as the underlying assets and liabilities of an equity method investment, is recognized with a new basis, no AOCI is recognized upon deconsolidation. However, subsequent accounting for the investment (for example, pursuant to ASC 320) or the underlying assets and liabilities (pursuant to ASC 323) may generate AOCI after deconsolidation Deconsolidation through multiple arrangements As discussed in Chapter 4, changes in ownership interests while maintaining control generally are accounted for as equity transactions, while a loss of control generally gives rise to the recognition of a gain or loss (as discussed in this Chapter). The FASB recognized that, because of these accounting differences, transactions might be structured to achieve a specific accounting result. Consequently, ASC provides the following considerations when determining whether multiple arrangements or transactions should be considered a single transaction: 1. They are entered into at the same time or in contemplation of one another. 2. They form a single transaction designed to achieve an overall commercial effect. 3. The occurrence of one arrangement is dependent on the occurrence of at least one other arrangement. 4. One arrangement considered on its own is not economically justified but they are economically justified when considered together. An example is when one disposal is priced below market, compensated for by a subsequent disposal priced above market. Financial reporting developments Consolidated and other financial statements 71

78 6 Loss of control over a subsidiary or a group of assets Assessing whether multiple transactions should be considered as a single transaction is a matter of facts and circumstances requiring the use of professional judgment. Such a determination should be clearly and contemporaneously documented Deconsolidation through a bankruptcy proceeding Excerpt from Accounting Standards Codification Consolidation Overall Objectives General a 1. A majority-owned entity shall not be consolidated if control does not rest with the majority owner for instance, if any of the following are present: i. The subsidiary is in legal reorganization ii. iii. The subsidiary is in bankruptcy The subsidiary operates under foreign exchange restrictions, controls or other governmentally imposed uncertainties so severe that they cast significant doubt on the parent's ability to control the subsidiary. The bankruptcy status of entities within a consolidated group may affect whether the entities continue to be consolidated. Consolidation considerations include the status of the bankruptcy proceedings as well as the facts and circumstances of the parent s relationship with the subsidiary (that is, majority shareholder, priority debt holder, single largest creditor). Generally, when a subsidiary enters into bankruptcy, the parent does not maintain control over the substantive operations of the subsidiary as the rights and responsibilities over the entity are held by the Bankruptcy Court. Additionally, consolidation of the subsidiary by the parent often would be precluded if the parent and subsidiary were both in bankruptcy, but the parent and subsidiary were not under the oversight of the same Bankruptcy Court. However, if the parent and subsidiary are both in bankruptcy and the proceedings are both in the same Court, the parent may conclude based on the status of the bankruptcy proceeding that the subsidiary should continue to be consolidated. Refer to our FRD, Bankruptcies and liquidations, for further discussion of the accounting considerations, including additional discussion on consolidation and other accounting implications related to entities in, or entering into, bankruptcy. Question 6.1 ASC A is clear that a parent entity must consider ASC for sales of in-substance real estate. However, does ASC also apply when a reporting entity loses control of an insubstance real estate subsidiary through means other than a sale? In ASU , the FASB clarified that ASC applies when a reporting entity loses control of an in-substance real estate subsidiary as a result of a default by the subsidiary on its nonrecourse debt. ASU is effective for public companies for fiscal years beginning on or after 15 June 2012 and interim periods within those fiscal years. For nonpublic companies, the consensus is effective for fiscal years ending after 15 December 2013, and interim and annual periods thereafter. The standard is to be applied prospectively and early adoption is permitted. The accounting in ASU is not required for lenders. Financial reporting developments Consolidated and other financial statements 72

79 6 Loss of control over a subsidiary or a group of assets However, the EITF did not address other scenarios in which a reporting entity loses a controlling financial interest in an in-substance real estate subsidiary through means other than sale. For those transactions, we believe a reporting entity generally should consider the real estate sales guidance or other real estate literature (e.g., ASC ) prior to removing the real estate from its statement of financial position. We believe that the real estate literature provides relevant considerations for evaluating whether it is appropriate to derecognize real estate in the statement of financial position. Refer to our FRD, Real estate sales, for further interpretive guidance Gain/loss classification and presentation ASC does not provide guidance on the classification of the gain/loss on deconsolidation in the income statement. We believe a gain/loss on deconsolidation of a subsidiary would in many cases be most appropriately presented as part of non-operating income because, in most cases, the deconsolidation will not be a part of an entity s primary revenue- and expense-generating activities. Before the issuance of Statement 160, the SEC staff s view articulated in SAB Topic 5-H was that gains (or losses) arising from issuances by a subsidiary of its own stock, if recorded in income by the parent, should be presented as a separate line item in the consolidated income statement without regard to materiality and clearly be designated as non-operating income. While SAB Topic 5-H was removed after the issuance of Statement 160 and addressed a circumstance in which a gain or loss may have been recognized while control was maintained (which is no longer acceptable after the adoption of Statement 160), and the decrease in the parent s ownership percentage was due to the direct issuance of unissued shares by a consolidated subsidiary, we believe its guidance on the classification of resulting gains or losses is consistent with the notion that these transactions are generally not an entity s primary revenue- and expense-generating activity. We believe an entity should clearly disclose the income statement classification of significant gains or losses resulting from deconsolidation of a subsidiary. Entities should carefully evaluate the nature of the deconsolidation to appropriately determine the proper classification and presentation of related gain/loss and should consistently apply that evaluation. For example, it would not be appropriate to classify gains in operating income and losses in non-operating income for similar transactions. Note that if a gain or loss is recognized from a deconsolidation that relates to a discontinued operation, that gain or loss should be included and presented as part of the income (loss) from discontinued operations Subsequent accounting for retained noncontrolling investment After the subsidiary or group of assets specified in ASC A is deconsolidated or derecognized, any retained ownership interest is initially recognized at fair value (see Section 6.1 for further discussion of this accounting). After initial recognition, the retained ownership interest is subject to other existing accounting literature, as appropriate. If the former parent exercises significant influence over the investee, as defined in ASC through 15-8, then the investment should be accounted for under the equity method. The former parent would be required to identify and determine the acquisition date fair value of the underlying assets and liabilities of the investee (with certain exceptions), pursuant to ASC 323. While the former parent would not recognize those identified assets and liabilities, it must track its bases in them (often through a process referred to as memo accounting) to account for the effect of any differences between its bases and the bases recognized by the investee. Chapter 4 of our FRD, Equity method investments provides further guidance on applying the equity method. Financial reporting developments Consolidated and other financial statements 73

80 6 Loss of control over a subsidiary or a group of assets If it is determined that the investor is not able to exercise significant influence over the investee, the investment is accounted for as an equity security, generally in accordance with ASC 320 or at cost, as appropriate. 6.2 Comprehensive example Illustration 6-3 The comprehensive example in this chapter describing the accounting for a loss of control continues from the comprehensive example presented in Chapter 4. In that example, Company P acquired a controlling financial interest in Company S, a distributor of video games qualifying as a business pursuant to ASC 805, as of 1 January 20X1. As of 31 December 20X3, Company P owned 60% of Company S. For reference, Figure 6-1 presents the consolidating work paper to arrive at the consolidated balance sheet of Company P as of 31 December 20X3. This consolidating work paper is taken from Figure 4-11 in Illustration 4-14 of Chapter 4. Figure 6-1: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X3 (all amounts in dollars) Adjustments Company P Company S Debit (1) Credit (1) Consolidated Cash 80,700 3,000 83,700 Marketable securities 17,500 17,500 Inventory 30,000 30,000 Buildings and equipment, net 42,000 17,850 59,850 Investment in Company S 42,890 42,890 Goodwill 4,286 4,286 Total assets 123,590 92, ,336 Accounts payable 75,000 75,000 Debt 27,000 27,000 Total liabilities 27,000 75, ,000 Common stock 1,500 30,000 30,000 1,500 Additional paid-in capital 34,500 28,753 9,693 15,440 Accumulated other comprehensive income 3,350 5,500 6,550 1,000 3,300 Retained earnings (deficit) 57,240 (18,000) 18,000 57,240 Total parent shareholders equity 96,590 17,500 77,480 Noncontrolling interest 15,856 15,856 Total equity 96,590 17,500 93,336 Total liabilities and equity 123,590 92, ,336 (1) The adjustments reflected here are described in notes (70)-(72) and (76)-(81) in Figure 4-11 of Chapter 4. Consistent with the comprehensive example in Chapter 4, the adjustments column includes adjustments to revalue Subsidiary S s assets and liabilities at acquisition (i.e., as of 1 January 20X1) as well as subsequent adjustments to those amounts (e.g., depreciation of buildings and equipment). These amounts have not been pushed down to the separate financial statements of Subsidiary S in the example (see Appendix A for a comprehensive example in which these adjustments have been pushed down to the subsidiary s financial statements). Financial reporting developments Consolidated and other financial statements 74

81 6 Loss of control over a subsidiary or a group of assets Deconsolidation by selling entire interest Illustration 6-4 Assume on 1 January 20X4, Company P sells its remaining 60% interest in Company S for $60,000 of cash and repays its outstanding debt. Company P no longer has a controlling financial interest in the subsidiary through the sale of its entire interest in Company S. Once control is lost, a parent deconsolidates the subsidiary or derecognizes a group of assets specified in ASC A, and a gain or loss should be recognized based on the difference between: (1) The aggregate of the fair value of consideration received, the fair value of any retained noncontrolling interest in the former subsidiary or group of assets at the date the subsidiary is deconsolidated or the group of assets is derecognized, and the carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated, and (2) The carrying amount of the former subsidiary s assets and liabilities or the carrying amount of the group of assets. Company P s gain is calculated as follows: Cash proceeds $ 60,000 Carrying amount of the noncontrolling interest 15,856 AOCI attributable to Company P 3,300 79,156 Carrying amount of Company S s net assets (39,636) Gain $ 39,520 On a consolidated basis, Company S s assets, liabilities and noncontrolling interest should be derecognized, and the cash proceeds and gain should be recognized through the following journal entry: Cash $ 60,000 Noncontrolling interest 15,856 Accounts payable 75,000 AOCI 3,300 Cash $ 3,000 Marketable securities 17,500 Inventory 30,000 Buildings and equipment, net 59,850 Goodwill 4,286 Gain on sale of investment 39,520 Alternatively, on a parent-only basis, the investment in Company S and accumulated other comprehensive income are derecognized, and the gain and cash proceeds are recognized. In addition, the adjustments to additional paid-in capital made while Company S was consolidated would be recognized on the parent s books and are derived from the example in Chapter 4. Financial reporting developments Consolidated and other financial statements 75

82 6 Loss of control over a subsidiary or a group of assets Cash $ 60,000 Additional paid-in capital 19,060 AOCI 3,350 Investment in Company S $ 42,890 Gain on sale of investment 39,520 Figure 6-2 presents Company P s balance sheet at 1 January 20X4, after the sale of Company S. Figure 6-2: Company P balance sheet, 1 January 20X4, entire interest sold (all amounts in dollars) Company P Cash (1) 113,700 Total assets 113,700 Common stock 1,500 Additional paid-in capital (3) 15,440 Accumulated other comprehensive income (2) Retained earnings (4) 96,760 Total parent shareholders equity 113,700 Noncontrolling interest Total equity 113,700 (1) Cash is rolled forward as follows: Beginning balance $ 80,700 Proceeds from sale 60,000 Repayment of debt (27,000) Ending balance $ 113,700 (2) The investment, debt and accumulated other comprehensive income are zero after the sale of Company S and the repayment of Company P s debt. (3) Additional paid-in capital was reduced to reflect the adjustments made during consolidation relating to the purchase/sale of interests in Company S while control was maintained (accounted for as equity transactions). (4) The rollforward of the retained earnings balance is as follows: Beginning balance $ 57,240 Gain from sale of investment 39,520 Ending balance $ 96,760 Financial reporting developments Consolidated and other financial statements 76

83 6 Loss of control over a subsidiary or a group of assets Deconsolidation by selling a partial interest Illustration 6-5 Assume that instead of selling its entire interest in Company S on 1 January 20X4, Company P sells a 30% interest in Company S (leaving Company P with a remaining 30% interest) for $24,000 cash. The fair value of the remaining 30% interest is also $24,000. Company P uses the proceeds to extinguish its outstanding debt. In this example, Company P s investment in Company S is recognized at fair value and is reflected as part of the sales proceeds. Company P s gain is calculated as follows: Proceeds $ 24,000 Fair value of retained noncontrolling interest 24,000 Carrying value of noncontrolling interest 15,856 AOCI attributable to Company P 3,300 67,156 Carrying amount of Company S s net assets (39,636) Gain $ 27,520 On a consolidated basis, Company S s assets, liabilities and noncontrolling interest should be derecognized, and the cash proceeds, gain and retained interest in Company S should be recognized through the following journal entry: Cash $ 24,000 Noncontrolling interest 15,856 Accounts payable 75,000 AOCI 3,300 Investment in Company S 24,000 Cash $ 3,000 Accounts receivable 17,500 Inventory 30,000 Buildings and equipment, net 59,850 Goodwill 4,286 Gain on sale of investment 27,520 Alternatively, on a parent-only basis, the investment in Company S is reduced to $24,000, the accumulated other comprehensive income balance is derecognized, and the gain and cash proceeds are recognized. In addition, the adjustments to paid-in capital made while Company S was consolidated would be recognized on the parent s books and are derived from the example in Chapter 4. Cash $ 24,000 Additional paid-in capital 19,060 AOCI 3,350 Investment in Company S $ 18,890 Gain on sale of investment 27,520 Financial reporting developments Consolidated and other financial statements 77

84 6 Loss of control over a subsidiary or a group of assets Figure 6-3 presents Company P s balance sheet at 1 January 20X4, reflecting the sale of Company S. Figure 6-3 Company P balance sheet, 1 January 20X4, partial interest sold (all amounts in dollars) Company P Cash (5) 77,700 Investment in Company S (6) 24,000 Total assets 101,700 Common stock 1,500 Paid-in capital (8) 15,440 Accumulated other comprehensive income (7) Retained earnings (9) 84,760 Total parent shareholders equity 101,700 Noncontrolling interest Total equity 101,700 Total liabilities and equity 101,700 (5) The rollforward of cash is as follows: Beginning balance $ 80,700 Proceeds from sale 24,000 Repayment of debt (27,000) Ending balance $ 77,700 (6) The investment in Company S account was adjusted to equal the fair value of the retained interest in Company S at the date of deconsolidation ($24,000). (7) The debt and accumulated other comprehensive income are zero after the sale of Company S and the repayment of Company P s debt. (8) Additional paid-in capital was reduced to reflect the adjustments made during consolidation relating to the purchase/sale of interests in Company S while control was maintained (accounted for as equity transactions). (9) The rollforward of retained earnings is as follows: Beginning balance $ 57,240 Gain from sale of investment 27,520 Ending balance $ 84,760 Financial reporting developments Consolidated and other financial statements 78

85 7 Combined financial statements 7.1 Purpose of and procedures for combined financial statements Excerpt from Accounting Standards Codification Consolidation Overall Implementation Guidance and Illustrations Combined Financial Statements B To justify the preparation of consolidated financial statements, the controlling financial interest shall rest directly or indirectly in one of the entities included in the consolidation. There are circumstances, however, in which combined financial statements (as distinguished from consolidated financial statements) of commonly controlled entities are likely to be more meaningful than their separate financial statements. For example, combined financial statements would be useful if one individual owns a controlling financial interest in several entities that are related in their operations. Combined financial statements might also be used to present the financial position and results of operations of entities under common management. Other Presentation Matters If combined financial statements are prepared for a group of related entities, such as a group of commonly controlled entities, intra-entity transactions and profits or losses shall be eliminated, and noncontrolling interests, foreign operations, different fiscal periods, or income taxes shall be treated in the same manner as in consolidated financial statements. Control is the primary basis for presentation of consolidated financial statements. There are, however, certain circumstances when the presentation of financial statements of individual entities is not as meaningful as the presentation of combined financial statements for related entities. ASC 810 states that combined financial statements may be useful to present related entities under common control or related entities with common management, though there are no conditions specified under which combined financial statements would be required. Combined financial statements are most frequently presented for filings in accordance with various statutory or regulatory requirements. The fundamental difference between combined and consolidated financial statements is that there is no controlling financial interest present between or among the combined entities under either the variable interest or voting interest models Common management We believe that the determination of whether entities are under common management is a determination to be made based on individual facts and circumstances. To justify combined presentation, we would expect evidence to exist that indicates that the subsidiaries are not operated as if they were autonomous. This evidence could include: A common CEO Common facilities and costs Financial reporting developments Consolidated and other financial statements 79

86 7 Combined financial statements Commitments, guarantees or contingent liabilities among the entities Commonly financed activities This list is not all-inclusive, and there could be other factors relevant to the determination of whether or not subsidiaries are under common management. The following illustration demonstrates these concepts. Illustration 7-1: Presenting combined versus consolidated financial statements Facts Assume that Company S has 2,000 common shares and 1,000 preferred shares outstanding. The preferred shareholders have the same rights as the common shareholders, except the right to vote. Of the 2,000 common shares outstanding, 1,000 shares are owned by Company P, and 1,000 shares are owned by an individual who also owns all of the outstanding common shares of Company P. The preferred shares of Company S are owned by a third party. Analysis In this situation, Company P does not control Company S directly or indirectly, and, therefore, consolidation under either the variable interest or voting interest models in ASC 810 is not appropriate. Combined financial statements could be presented as long as the circumstances are such that combined financial statements of Company S and Company P are more meaningful than presenting Company S s separate financial statements Procedures applied in combining entities for financial reporting The procedures applied to combining entities are the same as those applied when preparing consolidated financial statements. All transactions between the entities in the combined presentation and the related profit and loss must be eliminated. In addition, the accounting in combined financial statements for noncontrolling interests, foreign operations, different fiscal periods and income taxes is the same as that used in consolidated financial statements. The reference to noncontrolling interests in ASC relates to the noncontrolling interests in each of the combining entities subsidiaries as reflected in the individual combining entities financial statements. We believe interests held by parties outside of the control group in each of the respective combining entities themselves would not constitute noncontrolling interests in the combined financial statements. The fundamental difference between combined and consolidated financial statements is that there is no direct controlling financial interest present between or among the combined entities. Therefore, we believe equity holdings in each of the combining entities regardless of who holds such equity (that is, whether they are held by parties outside of the control group or not) should be reflected as ownership interests in the combined financial statements. Illustration 7-2: Noncontrolling interests in combined financial statements Assume Company P consolidates less-than-wholly-owned Subsidiaries A, B and C. If combined financial statements were to be prepared for Subsidiaries A and B, interests held by parties other than Company P in Subsidiaries A and B would not constitute noncontrolling interests in the combined financial statements. Only the noncontrolling interests that would be reflected in Subsidiaries A and B s individual financial statements, if any, would be reflected as such in the combined financial statements. For example, if Subsidiary A has an 80%-owned subsidiary (Subsidiary A1), the 20% noncontrolling interest held by a third party in Subsidiary A1 would be reflected as noncontrolling interest in the combined financial statements. Financial reporting developments Consolidated and other financial statements 80

87 8 Parent-company financial statements 8.1 Purpose of and procedures for parent-company financial statements Excerpt from Accounting Standards Codification Consolidation Overall Other Presentation Matters Parent Entity Financial Statements In some cases parent-entity financial statements may be needed, in addition to consolidated financial statements, to indicate adequately the position of bondholders and other creditors or preferred shareholders of the parent. Consolidating financial statements, in which one column is used for the parent and other columns for particular subsidiaries or groups of subsidiaries, often are an effective means of presenting the pertinent information. However, consolidated financial statements are the general-purpose financial statements of a parent having one or more subsidiaries; thus, parent-entity financial statements are not a valid substitute for consolidated financial statements. ASC 810 permits the presentation of parent-company financial statements but clarifies that such financial statements may not be issued as the primary financial statements of the reporting entity and are not a valid substitute for consolidated financial statements. Certain SEC registrants must present condensed parent-company financial information pursuant to Regulation S-X, Rule 12-04, Condensed Financial Information of Registrant, in Schedule I of their Form 10-K. This schedule is required whenever restricted net assets of consolidated subsidiaries exceed 25% of consolidated net assets at the end of the fiscal year. Registrants are required to present information required by Rule as a separate schedule or in the notes to the financial statements. Our publication, SEC annual reports, provides additional guidance for applying these quantitative tests and summarizes the related disclosure requirements. Not-for-profit entities 22 such as health care providers also occasionally prepare parent-company financial statements. Consolidation with respect to not-for-profit entities is addressed in ASC Investments in subsidiaries Parent-company financial statements generally present the parent company s investment in consolidated subsidiaries under the equity method in accordance with ASC 323. Under ASC 805 and ASC 810, additional investment activity in consolidated subsidiaries that does not result in a change in control is accounted for as an equity transaction. Importantly, because ASC 323 uses step-acquisition accounting, 22 ASC defines a not-for-profit entity as (a)n entity that possesses the following characteristics, in varying degrees, that distinguish it from a business entity: (a) contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return, (b) operating purposes other than to provide goods or services at a profit, (c) absence of ownership interests like those of business entities. Entities that clearly fall outside this definition include the following: (a) all investor-owned entities and (b) entities that provide dividends, lower costs or other economic benefits directly and proportionately to their owners, members or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives and employee benefit plans. Financial reporting developments Consolidated and other financial statements 81

88 8 Parent-company financial statements basis differences may exist between the application of the equity method and the parent s proportion of the subsidiary s equity. While it is not specifically addressed by the accounting literature, we believe that parents that determine the value of their equity method investments in parent-company financial statements at an amount equal to the value of its controlling interest should continue this practice. Otherwise, the equity and earnings of the parent company in the parent-company financial statements may differ from the corresponding amounts in the consolidated financial statements Investments in non-controlled entities Investments accounted for at cost or under the equity method in consolidated financial statements should follow that same basis in the parent-company financial statements. Moreover, their carrying amounts should generally be the same between the parent-company financial statements and the consolidated financial statements Disclosure requirements When parent-company financial statements are presented as other than the primary financial statements of the reporting entity, the notes to the financial statements should include a statement to that effect. In addition, the accounting policy note should describe the policy used to account for investments in subsidiaries. The following is an example of such a note. Illustration 8-1: Noncontrolling interests in combined financial statements Note A Accounting Policies Basis of Presentation. In the parent-company financial statements, the Company s investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since the date of acquisition. The Company s share of net income of its unconsolidated subsidiaries is included in consolidated income using the equity method. Parent-company financial statements should be read in conjunction with the Company s consolidated financial statements. Financial reporting developments Consolidated and other financial statements 82

89 9 Presentation and disclosures 9.1 Certain presentation and disclosure requirements related to consolidation Excerpt from Accounting Standards Codification Consolidation Overall Disclosure Consolidation Policy Consolidated financial statements shall disclose the consolidation policy that is being followed. In most cases this can be made apparent by the headings or other information in the financial statements, but in other cases a footnote is required. Parent with a Less-than-Wholly-Owned Subsidiary A A parent with one or more less-than-wholly-owned subsidiaries shall disclose all of the following for each reporting period: a. Separately, on the face of the consolidated financial statements, both of the following: 1. The amounts of consolidated net income and consolidated comprehensive income 2. The related amounts of each attributable to the parent and the noncontrolling interest. b. Either in the notes or on the face of the consolidated income statement, amounts attributable to the parent for any of the following, if reported in the consolidated financial statements: 1. Income from continuing operations 2. Discontinued operations 3. Extraordinary items. c. Either in the consolidated statement of changes in equity, if presented, or in the notes to consolidated financial statements, a reconciliation at the beginning and the end of the period of the carrying amount of total equity (net assets), equity (net assets) attributable to the parent, and equity (net assets) attributable to the noncontrolling interest. That reconciliation shall separately disclose all of the following: 1. Net income 2. Transactions with owners acting in their capacity as owners, showing separately contributions from and distributions to owners 3. Each component of other comprehensive income. d. In notes to the consolidated financial statements, a separate schedule that shows the effects of any changes in a parent s ownership interest in a subsidiary on the equity attributable to the parent. Financial reporting developments Consolidated and other financial statements 83

90 9 Presentation and disclosures Deconsolidation of a Subsidiary B In the period that either a subsidiary is deconsolidated or a group of assets is derecognized in accordance with paragraph A, the parent shall disclose all of the following: a. The amount of any gain or loss recognized in accordance with paragraph b. The portion of any gain or loss related to the remeasurement of any retained investment in the former subsidiary or group of assets to its fair value c. The caption in the income statement in which the gain or loss is recognized unless separately presented on the face of the income statement d. A description of the valuation technique(s) used to measure the fair value of any direct or indirect retained investment in the former subsidiary or group of assets e. Information that enables users of the parent s financial statements to assess the inputs used to develop the fair value in item (d) f. The nature of continuing involvement with the subsidiary or entity acquiring the group of assets after it has been deconsolidated or derecognized g. Whether the transaction that resulted in the deconsolidation or derecognition was with a related party h. Whether the former subsidiary or entity acquiring a group of assets will be a related party after deconsolidation Consolidated statement of comprehensive income presentation ASC 810 requires that consolidated net income and consolidated comprehensive income of the consolidated entity include the revenues, expenses, gains and losses from both the parent and the noncontrolling interest. The FASB believes that consolidated financial statements are more relevant if the user is able to distinguish between amounts attributable to both the owners of the parent company and the noncontrolling interest. For the user to make that determination, the amounts of consolidated net income and consolidated comprehensive income allocable to both the parent s owners and the noncontrolling interest should be presented on the face of the financial statements. In addition, the amounts attributable to the parent for income from continuing operations, discontinued operations and extraordinary items should be disclosed either on the face of the income statement or in the notes to the consolidated financial statements. Earnings per share will continue to be calculated based on consolidated net income allocable to the parent s owners Reconciliation of equity presentation ASC 810 also requires a reconciliation of the carrying amount of total equity from the beginning of the period to the end of the period. This reconciliation includes total equity, equity allocable to the parent and equity allocable to the noncontrolling interest. It should separately disclose net income, transactions with owners acting in their capacity as owners (showing separately contributions from and distributions to owners) and each component of other comprehensive income. For SEC registrants, this requirement is satisfied with the inclusion of equity allocable to the noncontrolling interest in the statement of changes in equity. Entities not registered with the SEC are not required to include a statement of changes in equity; therefore, the disclosure requirements related to this reconciliation can be satisfied by the inclusion of a statement of changes in equity or with the inclusion of the required information in the Financial reporting developments Consolidated and other financial statements 84

91 9 Presentation and disclosures notes to the consolidated financial statements. In addition to the reconciliation of the carrying amount of equity, the effect of any changes in the parent s ownership interest in a subsidiary on equity allocable to the parent should be disclosed in the notes to the consolidated financial statements Presentation of redeemable noncontrolling interests in equity reconciliation The SEC staff has indicated that registrants with redeemable noncontrolling interests (that is, mezzanine equity) should not include these items in any caption titled total equity in the reconciliation of equity required under ASC A(c). ASC A(c) and the SEC s technical amendments to Regulation S-X Rule 3-04 require registrants to reconcile total equity at the beginning of the period to total equity at the end of the period. ASC S99-3A specifies that securities that are redeemable at the option of the holder or outside the control of the issuer are to be presented outside permanent equity (in the mezzanine section of the statement of financial position) and prohibits such instruments from being included in any caption titled total equity. The SEC staff has identified two potentially acceptable means of presentation to satisfy the requirements of both ASC S99-3A and ASC A(c): Provide a column for redeemable noncontrolling interests in the equity reconciliation but exclude the related amounts from any total column. For example, this column could be presented separately to the right of the column reconciling total equity. In that case, the reconciliation could include a row for net income or a supplemental table identifying the allocation of net income among controlling interests, noncontrolling interests and redeemable noncontrolling interests. Exclude redeemable noncontrolling interests from the equity reconciliation but provide a supplemental table, reconciling the beginning and ending balance of redeemable noncontrolling interests. The supplemental table may be in either the notes to the financial statements or the statement of changes in equity and noncontrolling interests. In this case, the caption net income in the equity reconciliation could note parenthetically the amount related to redeemable noncontrolling interests. The SEC staff acknowledged that other means of presenting the reconciliation of total equity may be acceptable and that the appropriateness of such presentation would be evaluated based on the specific facts and circumstances Interim reporting period requirements ASC A(c) s introduction indicates that a parent with one or more less-than-wholly-owned subsidiaries shall disclose for each reporting period (emphasis added) Thus, this provision requires that the equity reconciliation be provided for interim reporting periods. Some reporting entities may choose to present this reconciliation in the form of a consolidated statement of changes in equity. If a consolidated statement of changes in equity is not presented on an interim basis, a reporting entity must provide the disclosure in the notes to the consolidated financial statements. We believe that the reconciliation of the carrying amount of total equity (net assets), equity (net assets) attributable to the parent and equity (net assets) attributable to the noncontrolling interest should be presented on a year-to-date basis. This approach is consistent with the presentation requirements for the statement of cash flows, which provides information about the activity of balance sheet amounts (that is, cash and cash equivalents) between periods. However, it would also be acceptable for a registrant to provide a reconciliation of the relevant equity amounts on a quarter-to-date basis in addition to the year-to-date disclosures. Financial reporting developments Consolidated and other financial statements 85

92 9 Presentation and disclosures Consolidated statement of financial position presentation Although ASC 810 does not explicitly require that a subtotal for total parent shareholders equity be presented on the face of the statement of financial position, we believe that, based upon the example in ASC , such presentation should be made. ASC A(c) requires that an entity disclose a reconciliation at the beginning and the end of the period of the carrying amount of equity attributable to the parent, either in the consolidated statement of changes in equity, if presented, or in the notes to the consolidated financial statements. The illustrative example in ASC presents a subtotal for the total parent shareholders equity. Therefore, we believe that an entity should present a subtotal for the total parent shareholders equity on the face of the statement of financial position separately from noncontrolling interest and before arriving at total equity Consolidated statement of cash flows presentation ASC 810 does not affect statement of cash flow presentation and therefore entities with noncontrolling interests should continue to look to ASC 230 for guidance. ASC 230 requires entities to provide a reconciliation of net income to net cash flows from operating activities regardless of whether the direct or indirect method is used for presenting net cash flows from operating activities. Therefore, entities should start with net income in their statement of cash flow presentation when applying the indirect method rather than net income attributable to the parent. Illustration 9-1 provides an example of this presentation. Illustration 9-1: Starting point for indirect method For Company A, assume for the years ended 31 December 20x9 and 20x8: Net income was $1,200 and $1,000, respectively Net income attributable to the noncontrolling interests was $240 and $200, respectively Net income attributable to the Parent was $960 and $800, respectively In preparing the statement of cash flows under the indirect method, Company A would begin with net income inclusive of income attributable to the noncontrolling interests. Therefore, Company A would begin with net income amounts of $1,200 and $1,000 for the years ended 31 December 20x9 and 20x8, respectively. While ASC 230 does not provide specific guidance on the statement of cash flow presentation for transactions with noncontrolling interest holders (e.g., dividends and purchases/sales of noncontrolling interest while control is maintained), ASC and state that proceeds from issuing equity instruments and payment of dividends and other distributions to owners, including outlays to reacquire the enterprise s equity instruments are financing activities. We believe that transactions with noncontrolling interest holders, while control is maintained, should generally be reported as financing activities in the statement of cash flows. This view is consistent with the economic entity concept that all residual economic interest holders have an equity interest in the consolidated entity, even if the residual interest is relative to a subsidiary, and ASC 810 s requirement to present noncontrolling interests in the consolidated statement of financial position as a separate component of equity. Further, this view is consistent with the requirement for changes in a parent s ownership interest in a subsidiary meeting the scope of ASC A while the parent retains a controlling financial interest to be accounted for as equity transactions. Financial reporting developments Consolidated and other financial statements 86

93 9 Presentation and disclosures Presentation of transaction costs in statement of cash flow Disclosure As discussed in 4.1.5, companies will have to make a policy election concerning whether to reflect transaction costs associated with purchases and sales of noncontrolling interests as an expense in the consolidated statement of income or as a direct charge to equity. We believe the most appropriate classification of transaction costs in the consolidated statement of cash flows would be consistent with that accounting. Accordingly, if transaction costs are reflected as an expense, we believe the related cash flows would be most appropriately reflected as an operating activity. Alternatively, if the transaction costs are reflected as a direct charge to equity, we believe the related cash flows would be most appropriately classified as a financing activity. ASC 810 also required disclosure of any gain/loss recognized on the deconsolidation of a subsidiary or derecognition of a group of assets. The amount of any gain/loss and the classification of the gain/loss in the income statement (see ) are disclosed in the notes to the consolidated financial statements along with the amount of the gain/loss related to the remeasurement of any retained interest in the deconsolidated subsidiary or group of assets. ASC 810 requires disclosure of a description of the valuation technique(s) used to measure the fair value of any direct or indirect retained investment in a deconsolidated subsidiary or group of assets (e.g., a discounted cash flow approach). Disclosure is also required of the information that enables users of the parent s financial statements to assess the inputs used to develop the fair value measurements used to measure the retained interest in the former subsidiary or group of assets. For example, for a discounted cash flow approach, disclosures may include information on discount rates and the assumed capital structure, capitalization rates for terminal cash flows, assumptions about expected growth in revenues, expected profit margins, expected capital expenditures, expected depreciation and amortization, expected working capital requirements and other assumptions that may have a significant effect on the valuation, such as discounts for lack of marketability or lack of control, as applicable. For a market approach, disclosures may include information on the valuation multiples used in the analysis, a description of the population of the guideline companies or similar transactions from which the multiples were derived, the timeliness of the market data used, the method by which the multiples were selected (e.g., use of the median, use of an average, the extent to which the financial performance of the subject company was compared to the relative performance of the guideline companies), discounts for lack of marketability and lack of control, as applicable. An entity also is required to disclose the valuation techniques used to measure an equity interest in an acquiree held by the entity immediately before the acquisition date in a business combination achieved in stages. Furthermore, disclosure must be provided about the nature of continuing involvement with the subsidiary or entity acquiring the group of assets after it has been deconsolidated and whether a related party relationship exists. This disclosure is intended to highlight circumstances in which a gain or loss is recognized, but the continuing relationship may affect the ultimate amounts realized from the sale and resulting relationship. Financial reporting developments Consolidated and other financial statements 87

94 9 Presentation and disclosures 9.2 Comprehensive example Illustration 9-2: Presentation and disclosure example To illustrate ASC 810 s presentation and quantitative disclosure requirements, following are the financial statements and selected notes for Company P, which are based on the comprehensive example illustrated in Chapters 4 and 6. Note that the qualitative disclosure requirements of ASC B(d)-(h) are not included in the following comprehensive example. Further, the quantitative disclosures required by ASC A(c) are reflected in the consolidated statement of changes in equity in the example below. Alternatively, these may also be reflected in the notes to the consolidated financial statements. Company P Consolidated Statement of Financial Position (all amounts in dollars) 31 December, Assets: Cash 83,700 39,600 Marketable securities 17,500 15,500 Inventory 30,000 30,000 Buildings and equipment, net 59,850 68,400 Goodwill 4,286 4,286 Total assets 195, ,786 20X3 20X2 Liabilities: Accounts payable 75,000 75,000 Debt 27,000 27,000 Total liabilities 102, ,000 Equity: Company P shareholders equity: Common stock 1,500 1,500 Additional paid-in capital 15,440 5,747 Accumulated other comprehensive income 3,300 3,150 Retained earnings 57,240 40,770 Total Company P shareholders equity 77,480 51,167 Noncontrolling interest 15,856 4,619 Total equity 93,336 55,786 Total liabilities and equity 195, ,786 In the consolidated statement of financial position, Company P separately identifies Company P s shareholders equity and the noncontrolling interest. Consolidated net income is attributed to the controlling and noncontrolling interests. Financial reporting developments Consolidated and other financial statements 88

95 9 Presentation and disclosures Company P Consolidated Statement of Income (all amounts in dollars, except share amounts) Year Ended 31 December, 20X3 20X2 20X1 Revenues 96,000 96,000 96,000 Cost of revenues 42,000 42,000 46,500 Gross profit 54,000 54,000 49,500 Selling and administrative 26,550 26,550 26,550 Consolidated net income 27,450 27,450 22,950 Less: Net income attributable to noncontrolling interest 10,980 2,745 6,885 Net income attributable to Company P 16,470 24,705 16,065 Earnings per share basic and diluted: Net income attributable to Company P common shareholders Weighted-average shares outstanding 1,500 1,500 1,500 Company P Consolidated Statement of Comprehensive income (all amounts of dollars) Year Ended 31 December, 20X3 20X2 20X1 Net income 27,450 27,450 22,950 Other comprehensive income and reclassification adjustments: Unrealized holding gain (loss) on available-for-sale securities and reclassification adjustments 2,000 (1,500) 5,000 Total other comprehensive income and reclassification adjustments 2,000 (1,500) 5,000 Comprehensive income 29,450 25,950 27,950 Less: Comprehensive income attributable to noncontrolling interest 11,780 2,595 8,385 Comprehensive income attributable to Company P 17,670 23,355 19,565 The consolidated statement of changes in equity includes an additional column representing the changes in noncontrolling interest. Financial reporting developments Consolidated and other financial statements 89

96 9 Presentation and disclosures Financial reporting developments Consolidated and other financial statements 90

97 9 Presentation and disclosures Financial reporting developments Consolidated and other financial statements 91

98 9 Presentation and disclosures Financial reporting developments Consolidated and other financial statements 92

99 9 Presentation and disclosures Company P also discloses the effects of changes in Company P s ownership interest in its subsidiary on Company P s equity. This schedule would be presented as a note in the company s financial statements, as follows. Company P Notes to Consolidated Financial Statements Years Ended 31 December, 20X3, 20X2, 20X1 (all amounts in dollars) Net Income Attributable to Company P and Transfers (to) from the Noncontrolling Interest 20X3 20X2 20X1 Net income attributable to Company P 16,470 24,705 16,065 Transfers (to) from the noncontrolling interest Increase in Company P s paid-in capital for sale of 9,000 Company S common shares 9,693 Decrease in Company P s paid-in capital for purchase of 6,000 Company S common shares (28,753) Net transfers (to) from noncontrolling interest 9,693 (28,753) Change from net income attributable to Company P and transfers (to) from noncontrolling interest 26,163 (4,048) 16,065 Financial reporting developments Consolidated and other financial statements 93

100 A Comprehensive example This appendix provides a comprehensive example of the concepts described in this publication: 1. Control resulting from an increase in ownership interest 2. Changes in a parent s ownership interest while the parent maintains control of the subsidiary meeting the scope of ASC A 3. The elimination of intercompany transactions 4. Deconsolidation of subsidiary Work paper consolidating entries are numbered sequentially. While there are different ways to apply consolidation procedures, this comprehensive example illustrates consolidation based on push-down accounting to the subsidiary which is a retailer of luxury handbags qualifying as a business pursuant to ASC 805. The use of push-down accounting is the primary difference between this example and the comprehensive examples in Chapters 4, 5 and 6. Those examples cover the same concepts, but attribute the purchase price in consolidation. Illustration A-1: Year 20X2 Assumptions: 1. As of 31 December 20X1, Company P (P) owns 40% of Company S (S), which is a retailer of luxury handbags and a voting interest entity, with net assets of $650,000. The carrying amount of Company P s 40% investment in Company S is $260, P purchases an additional 40% of the common stock of S on 1 January 20X2 for $400,000, increasing its ownership interest to 80% (assume no control premium). The fair value of S is $1,000,000, and the fair value of the identifiable net assets of S is $800, During the year, S sells inventory to P (upstream transaction) which P holds at year end. A summary of the effect of the transaction on S s income statement is as follows: Revenues $ 100,000 Cost of revenues 70,000 Gross profit $ 30, During the year, P sells inventory to S (downstream transaction) which S holds at year end. A summary of the effect of the transaction on P s income statement is as follows: Revenues $ 150,000 Cost of revenues 80,000 Gross profit $ 70, During the year, P makes an intercompany loan to S with principal of $1,000,000 and an annual interest rate of 10%. S capitalizes the current year s interest on the intercompany loan as part of the cost to construct a building and remits cash to P for the annual interest incurred on the intercompany loan. Financial reporting developments Consolidated and other financial statements A-1

101 A Comprehensive example 6. During the year, P charges S a management fee of $1,500 for management services. 7. Company S has other comprehensive income of $25,000 from unrealized gains on available-forsale securities for the year. 8. The remaining useful life of the buildings and equipment at 1 January 20X2 is 10 years. 9. Assume inventory held by S at the beginning of the year and affected by the step up to fair value on 1 January 20X2 is sold in the current year. 10. S pays cash dividends of $50,000 during the year, of which P s share is $40,000. Figure A-1: Balance sheet for Company P, 31 December 20X1 (all amounts in dollars) Cash 640,000 Accounts receivable 190,000 Inventory 184,000 Buildings and equipment, net 220,000 Investment in Company S 260,000 1,494,000 Accounts payable 125,000 Other liabilities 250,000 Common stock 200,000 Additional paid-in capital 500,000 Retained earnings 419,000 Figure A-2: 1,494,000 Acquisition-date balance sheet for Company S, 1 January 20X2 (all amounts in dollars) Book value Fair value Cash 250, ,000 Available-for-sale securities 100, ,000 Accounts receivable 100, ,000 Inventory 150, ,000 Buildings and equipment, net 200, , , ,000 Accounts payable 150, ,000 Common stock 650, ,000 Financial reporting developments Consolidated and other financial statements A-2

102 A Comprehensive example Figure A-3: Acquisition-date consolidating work paper to arrive at consolidated balance sheet, 1 January 20X2 (all amounts in dollars) Adjustments Company P Company S Consolidated Cash 240, , ,000 Available-for-sale securities 100, ,000 Accounts receivable 190, , ,000 Inventory 184,000 (1) 200, ,000 Buildings and equipment, net 220,000 (2) 300, ,000 Investment in Company S (3) 800,000 (5) 800,000 Goodwill (4) 200, ,000 Total assets 1,634,000 1,150,000 1,984,000 Debit Credit Accounts payable 125, , ,000 Other liabilities 250, ,000 Total liabilities 375, , ,000 Common stock 200,000 (7) 800,000 (9) 800, ,000 Additional paid-in capital 500, ,000 Retained earnings (6) 559, ,000 Total parent shareholders equity 1,259, ,000 1,259,000 Noncontrolling interest (8) 200, ,000 Total equity 1,259,000 1,000,000 1,459,000 Total liabilities and equity 1,634,000 1,150,000 1,984,000 Figure A-3 illustrates the consolidating entries between P and S for the 1 January 20X2 business combination. (1) Inventory of S is adjusted to fair value. (2) Buildings and equipment of S are adjusted to fair value. (3) The $400,000 investment purchased on 1 January 20X2 is added to the book value of the original investment ($260,000). In addition, a gain is recognized on the original investment to increase it to fair value. This gain on investment of $140,000 is calculated as the fair value of the original 40% investment ($400,000) less the book value of the original investment. (4) Goodwill is determined by subtracting the fair value of S s net identifiable assets acquired ($800,000) from the fair value of S s net assets ($1,000,000). In push-down accounting, the goodwill is recorded on the books of S. (5) P s investment in S is eliminated. (6) Retained earnings includes the original retained earnings of P ($419,000) and the gain on the investment in S ($140,000). (7) In push-down accounting, the basis of the equity is increased to equal the fair value of the net assets less the noncontrolling interest. (8) Noncontrolling interest is calculated by taking the fair value of S s net assets ($1,000,000) and subtracting the fair value of P s 80% investment in S ($800,000). For illustrative purposes, no control premium is assumed. In push-down accounting, the noncontrolling interest is recorded on the books of S. (9) S s common stock is eliminated. Financial reporting developments Consolidated and other financial statements A-3

103 A Comprehensive example Figure A-4: Work paper of consolidated income statement, for year ended 31 December 20X2 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 500, ,000 (13) 250, ,000 Cost of revenues 200,000 (10) 145,000 (14) 150, ,000 Gross profit 300, , ,000 Depreciation expense 60,000 (11) 60, ,000 Selling and administrative 40,000 3,500 43,500 Management fee expense 1,500 (15) 1,500 Management fee revenue 1,500 (15) 1,500 Interest income 100,000 (16) 100,000 Dividend income 40,000 (17) 40,000 Gain on investment 140, ,000 Net income 481,500 90, ,500 Net income attributable to noncontrolling interest (12) 18,000 (18) 6,000 12,000 Net income attributable to controlling interest 481,500 72, ,500 Adjustments Company P Company S Debit Credit Consolidated Net income 481,500 90,000 (19) 391,500 (19) 151, ,500 Other comprehensive income: Unrealized gain on available-for-sale securities 25,000 25,000 Comprehensive income 481, , ,500 Comprehensive income attributable to noncontrolling interest (20) 23,000 (19) 6,000 17,000 Comprehensive income attributable to controlling interest 341, , ,500 Figure A-4 illustrates the consolidating entries between P and S for the year ended 31 December 20X2. (10) The cost of revenues includes the fair value adjustment made to inventory at the beginning of the year because the inventory was sold during the year. (11) Depreciation expense includes 20X2 depreciation of $10,000 ($100,000 / 10 years) related to the step up in fair value at 1 January 20X2. (12) Net income attributable to the noncontrolling interest on a push-down basis is based on the percentage ownership interest of the noncontrolling interest (20%) and calculated as a percentage of S s income on a push-down basis ($90,000 x 20%). (13) Intercompany revenues from the upstream ($100,000) and downstream ($150,000) sales are eliminated. (14) Intercompany cost of revenues from the upstream ($70,000) and downstream ($80,000) sales are eliminated. (15) Intercompany revenue and expense for the management fee charged to S is eliminated. (16) Interest income on the outstanding intercompany loan is eliminated. Financial reporting developments Consolidated and other financial statements A-4

104 A Comprehensive example (17) The income recognized by P from the dividends received from S is eliminated. (18) The intercompany profits from the upstream sale are eliminated in items (13) and (14). A proportionate share of the upstream elimination is attributed to the noncontrolling interest ($30,000 x 20%). The elimination of the downstream sale is 100% attributable to the parent. (19) Adjustments to net income from the income statement. See prior explanations of eliminations. (20) Comprehensive income attributable to the noncontrolling interest on a push-down basis is based on the percentage ownership interest of the noncontrolling interest (20%) and calculated as a percentage of S s comprehensive income on a push-down basis ($115,000 x 20%). Figure A-5: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X2 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 200, , ,000 Available-for-sale securities 125, ,000 Accounts receivable 104, , ,000 Intercompany receivable (21) 150,000 (21) 100,000 (23) 250,000 Inventory 106, ,000 (24) 100, ,000 Buildings and equipment, net 340,000 1,410,000 (25) 100,000 1,650,000 Intercompany loan (22) 1,000,000 (26) 1,000,000 Investment in Company S 800,000 (27) 800,000 Goodwill 200, ,000 Total assets 2,700,000 2,340,000 2,790,000 Accounts payable 279, , ,000 Intercompany payable (21) 100,000 (21) 150,000 (23) 250,000 Intercompany loan (22) 1,000,000 (26) 1,000,000 Other liabilities 720, ,000 Total liabilities 1,099,500 1,275,000 1,124,500 Common stock 200, ,000 (32) 800, ,000 Additional paid-in capital 500, ,000 Retained earnings (28) 900,500 (29) 32,000 (33) 240,000 (34) 40, ,500 (35) 6,000 Accumulated other comprehensive income (30) 20,000 20,000 Total parent shareholders equity 1,600, ,000 1,458,500 Noncontrolling interest (31) 213,000 (35) 6, ,000 Total equity 1,600,500 1,065,000 1,665,500 Total liabilities and equity 2,700,000 2,340,000 2,790,000 The balance sheet is consolidated in Figure A-5, as follows: (21) Intercompany receivables and payables are recorded from the sales transactions between P and S. (22) An intercompany loan was made to finance the construction of a new building for S. (23) Intercompany receivables and payables from the upstream ($100,000) and downstream ($150,000) sales are eliminated. (24) Intercompany profit remaining in inventory at year end from the upstream ($30,000) and downstream ($70,000) sales is eliminated. (25) Interest capitalized from the intercompany loan is eliminated. Financial reporting developments Consolidated and other financial statements A-5

105 A Comprehensive example (26) Outstanding intercompany loan is eliminated. (27) P s investment in S is eliminated. (28) P s retained earnings are rolled forward as follows: 31 December 20X1 balance $ 419,000 Current year income 481, December 20X2 balance $ 900,500 (29) S s retained earnings are rolled forward as follows. In push-down accounting, only the earnings and dividends attributable to the controlling interest are recorded in retained earnings. 31 December 20X1 balance $ Income attributable to controlling interest 72,000 Dividends declared (40,000) 31 December 20X2 balance $ 32,000 (30) In push-down accounting, only the other comprehensive income attributable to the controlling interest is recorded by S ($25,000 x 80%). (31) Noncontrolling interest, on a push-down basis, is rolled forward as follows: 31 December 20X1 $ Creation of noncontrolling interest 200,000 Attributed net income 18,000 Attributed other comprehensive income 5,000 Dividends received (10,000) 31 December 20X2 balance $ 213,000 (32) The common stock of S is eliminated. (33) Net adjustments to net income from income statement. See items in income statement for explanations of adjustments. (34) The intercompany dividend is eliminated from S s retained earnings. (35) The intercompany profit from the upstream sale is proportionately eliminated from the noncontrolling interest. For illustrative purposes, this entry has been made as a consolidation entry; however, it typically would be made directly to the retained earnings and noncontrolling interest on S s books. Illustration A-2: Year 20X3 Assumptions: 1. P sells a 20% interest in S on 1 January 20X3 for $300, During the year, S sells inventory to P, which P holds at year end. A summary of the effect of the transaction on S s income statement is as follows: Revenues $ 130,000 Cost of revenues 50,000 Gross profit $ 80,000 Financial reporting developments Consolidated and other financial statements A-6

106 A Comprehensive example 3. During the year, P sells inventory to S, which S holds at year end. A summary of the effect of the transaction on P s income statement is as follows: Revenues $ 100,000 Cost of revenues 60,000 Gross profit $ 40, The intercompany loan of $1,000,000 remains outstanding. Construction on the building is complete, so S does not capitalize the interest payment for the current year. Depreciation begins on the completed building (including the depreciation of the previously capitalized interest). The useful life of the building is ten years. 5. During the year, P charges S a management fee of $1,500 for management services. 6. S has other comprehensive income for the year of $15,000 from unrealized gains on available-forsale securities. 7. All inventory held by S and P at 31 December 20X2 resulting from upstream and downstream intercompany sales is sold to a nonaffiliated party. 8. S pays cash dividends of $50,000 during the year, of which P s share is $30,000. Figure A-6: Work paper of consolidated income statement for year ended 31 December 20X3 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Revenues 600, ,000 (37) 230, ,000 Cost of revenues 200, ,000 (38) 110, ,000 (39) 100,000 Gross profit 400, , ,000 Depreciation expense 70, ,000 (40) 10, ,000 Selling and administrative 30,000 3,500 33,500 Management fee expense 1,500 (41) 1,500 Management fee revenue 1,500 (41) 1,500 Dividend income 30,000 (42) 30,000 Interest income 100,000 (43) 100,000 Interest expense 100,000 (43) 100,000 Gain on sale of investment 100,000 (44) 100,000 Net income 531,500 45, ,500 Net income (loss) attributable to noncontrolling interest (36) 18,000 (45) 32,000 (46) 12,000 (2,000) Net income attributable to controlling interest 531,500 27, ,500 Adjustments Company P Company S Debit Credit Consolidated Net income 531,500 45,000 (47) 461,500 (47) 321, ,500 Other comprehensive income: Unrealized gain on available-for-sale securities 15,000 15,000 Comprehensive income 531,500 60, ,500 Comprehensive income attributable to noncontrolling interests (48) 24,000 (47) 32,000 (47) 12,000 4,000 Comprehensive income attributable to controlling interest 531,500 36, ,500 Financial reporting developments Consolidated and other financial statements A-7

107 A Comprehensive example Figure A-6 illustrates the consolidating entries between P and S for the year ended 31 December 20X3. (36) Net income attributable to the noncontrolling interest on a push-down basis is based on the new percentage ownership interest of the noncontrolling interest (40%) and calculated as a percentage of S s income on a push-down basis ($45,000 x 40%). (37) Intercompany revenues from the upstream ($130,000) and downstream ($100,000) sales are eliminated. (38) Intercompany cost of revenues from the upstream ($50,000) and downstream ($60,000) sales is eliminated. (39) Reversal of elimination of intercompany profit in inventory held by S and P at 31 December 20X2 to cost of revenues as inventory is sold to a nonaffiliated party during the first inventory turn of the year. (40) Excess depreciation of $10,000 ($100,000 / 10 years) due to capitalized interest in the prior year is eliminated. (41) Intercompany revenue and expense for the management fee charged to S is eliminated. (42) The income recognized by P from the dividends received from S is eliminated. (43) Interest income and expense from the intercompany loan are eliminated. (44) P recognized a gain on its investment in S (on its stand alone financial statements), calculated as the excess of cash received ($300,000) over the carrying value of the portion of the investment sold ($200,000). This gain is eliminated. (45) The intercompany profits from the upstream sale are eliminated in items (37) and (38). A proportionate share of the upstream elimination is attributed to the noncontrolling interest ($80,000 x 40%). The elimination of the downstream sale is 100% attributable to the parent. (46) The intercompany profit from 20X2 on the upstream sale is realized in the current year because the inventory was sold to a nonaffiliated party. A proportionate share of the profit is attributable to the noncontrolling interest ($30,000 x 40%). (47) Adjustments to net income from the income statement. See items above for explanations of adjustments. (48) Comprehensive income attributable to the noncontrolling interest on a push-down basis is based on the percentage ownership interest of the noncontrolling interest (40%) and calculated as a percentage of S s comprehensive income on a push-down basis ($60,000 x 40%). Financial reporting developments Consolidated and other financial statements A-8

108 A Comprehensive example Figure A-7: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X3 (all amounts in dollars) Adjustments Company P Company S Debit Credit Consolidated Cash 310, , ,000 Available-for-sale securities 140, ,000 Accounts receivable 230, , ,000 Intercompany receivable 100, ,000 (50) 230,000 Inventory 300, ,000 (51) 120, ,000 Buildings and equipment, net 500,000 1,285,000 (52) 90,000 1,695,000 Intercompany loan 1,000,000 (53) 1,000,000 Investment in Company S (49) 600,000 (54) 600,000 Goodwill 200, ,000 Total assets 3,040,000 2,505,000 3,505,000 Accounts payable 190, , ,000 Intercompany payable 130, ,000 (50) 230,000 Intercompany loan 1,000,000 (53) 1,000,000 Other liabilities 588, ,000 Total liabilities 908,000 1,430,000 1,108,000 Common stock 200,000 (56) 593,000 (60) 593, ,000 Additional paid-in capital 500,000 (61) 98, ,000 Retained earnings (55) 1,432,000 (57) 35,000 (62) 250,000 (63) 30,000 1,177,000 (64) 90,000 (65) 32,000 (66) 12,000 Accumulated other comprehensive income (58) 29,000 (61) 5,000 24,000 Total parent shareholders equity 2,132, ,000 1,999,000 Noncontrolling interest (59) 418,000 (65) 32,000 (66) 12, ,000 Total equity 2,132,000 1,075,000 2,397,000 Total liabilities and equity 3,040,000 2,505,000 3,505,000 The balance sheet is consolidated in Figure A-7, as follows: (49) P sold 20% of S (25% of its investment in S). The investment was reduced by 25% ($200,000) to $600,000. (50) Intercompany receivables and payables from the upstream ($130,000) and downstream ($100,000) sales are eliminated. (51) Intercompany profit remaining in inventory at year end from the upstream ($80,000) and downstream ($40,000) sales is eliminated. (52) Interest capitalized in 20X2 from the intercompany loan is eliminated ($100,000), less current year excess depreciation ($10,000). (53) Outstanding intercompany loan is eliminated. (54) P s investment in S is eliminated. (55) P s retained earnings are rolled forward as follows: 31 December 20X2 balance $ 900,500 Current year income 531, December 20X3 balance $1,432,000 Financial reporting developments Consolidated and other financial statements A-9

109 A Comprehensive example (56) P sold a 20% interest in S for $300,000 on 1 January 20X3. On that date, the noncontrolling interest s carrying value was $207,000, which represented a 20% interest in S. Thus, an additional 20% interest ($207,000) was transferred from S s common stock to the noncontrolling interest. (57) S s retained earnings are rolled forward as follows. In push-down accounting, only the earnings and dividends attributable to the controlling interest are recorded in retained earnings. 31 December 20X2 balance $ 32,000 Noncontrolling interest profit elimination from 20X2 booked to S 6,000 Income attributable to controlling interest 27,000 Dividends paid (30,000) 31 December 20X3 balance $ 35,000 (58) Accumulated other comprehensive income is rolled forward as follows: 31 December 20X2 balance $ 20,000 Comprehensive income attributable to controlling interest 9, December 20X3 balance $ 29,000 (59) Noncontrolling interest, on a push-down basis, is rolled forward as follows: 31 December 20X2 balance $ 213,000 Noncontrolling interest profit from 20X2 elimination booked to S (6,000) Additional interest sold by P 207,000 Current year income 18,000 Current year other comprehensive income 6,000 Dividends received (20,000) 31 December 20X3 balance $ 418,000 (60) The common stock of S is eliminated. (61) P sold a 20% interest in S for $300,000 on 1 January 20X3. This sale is treated as an equity transaction with no gain or loss recognized. The difference between the cash received and carrying value of the interest sold ($207,000) is recorded as an adjustment to APIC. In addition, AOCI is adjusted to reallocate AOCI for the interest sold by P. The 31 December 20X2 balance in AOCI was $25,000. Since a 20% interest in S was sold, $5,000 (20% x $25,000) was transferred out of AOCI and recorded as an adjustment to APIC. (62) Net adjustments to net income from income statement. See items in income statement for explanations of adjustments. (63) The intercompany dividend is removed from S s retained earnings. (64) Interest income recognized by P in 20X2 is eliminated ($100,000), less current year depreciation ($10,000). (65) The intercompany profit from the upstream sale is proportionately removed from the noncontrolling interest. For illustrative purposes, this entry has been made as a consolidation entry; however, it ordinarily would be made directly to the retained earnings and noncontrolling interest on S s books. (66) The intercompany profit from Year 20X2 on the upstream sale is realized in the current year because the inventory was sold externally. A proportionate share of the profit is attributable to the noncontrolling interest ($30,000 x 40%). Financial reporting developments Consolidated and other financial statements A-10

110 A Comprehensive example Illustration A-3: Year 20X4 As of 31 December 20X3, P owns 60% of S, which has net assets of $945,000. The carrying amount of the noncontrolling interest s 40% interest in Company S is $398,000, which includes $16,000 of accumulated other comprehensive income. Assumptions: 1. P sells an additional 15% of its ownership for $300,000, assuming no control premium on Company S, on 1 January 20X4, resulting in a loss of control and deconsolidation of S on 1 January 20X4. The fair value of the retained 45% interest in S is $900, The fair value of the intercompany loan on 1 January 20X4 is $1,000,000. Figure A-8: Consolidating work paper to arrive at consolidated balance sheet, 1 January 20X4 (all amounts in dollars) Company P Debit Adjustments Credit Consolidated Cash 310,000 (68) 300, ,000 Accounts receivable 230,000 (69) 100, ,000 Intercompany receivable 100,000 (69) 100,000 Inventory 300,000 (70) 80, ,000 Buildings and equipment, net 500, ,000 Intercompany loan (67) 1,000,000 1,000,000 Investment in Company S 600,000 (71) 300, ,000 Total assets 3,040,000 3,560,000 Accounts payable 190,000 (69) 130, ,000 Intercompany payable 130,000 (69) 130,000 Intercompany loan Other liabilities 588, ,000 Total liabilities 908, ,000 Common stock 200, ,000 Additional paid-in capital 500,000 (72) 98, ,000 Retained earnings 1,432,000 (73) 255,000 (74) 677,000 1,854,000 Accumulated other comprehensive income Total parent shareholders equity 2,132,000 2,652,000 Noncontrolling interest Total equity 2,132,000 2,652,000 Total liabilities and equity 3,040,000 3,560,000 Figure A-8 illustrates the deconsolidating entries between P and S, as follows: (67) The creditor interest in S would be adjusted to fair value. For illustrative purposes, the carrying value of the intercompany loan is equal to the fair value of the intercompany loan at the date of deconsolidation. (68) Cash is received on the sale of 15% interest. (69) Intercompany receivable and payable are reclassified to accounts receivable and accounts payable. Financial reporting developments Consolidated and other financial statements A-11

111 A Comprehensive example (70) The intercompany profit included in inventory held by P at 1 January 20X4 is eliminated. (71) The retained 45% interest in S is adjusted to fair value. (72) APIC is adjusted for the sale of a 20% interest in S in 20X3, treated as an equity transaction. (73) Retained earnings of P is adjusted for all prior intercompany adjustments and earnings of S. (74) Company P s gain is calculated as follows: Proceeds $ 300,000 Fair value of retained interest 900,000 Carrying value of noncontrolling interest 398,000 AOCI attributable to P 24,000 1,622,000 Carrying amount of S s net assets (945,000) Gain $ 677,000 On a consolidated basis, Company S s assets, liabilities and noncontrolling interest should be derecognized, and the cash proceeds and gain should be recognized through the following journal entry: Cash $ 300,000 Noncontrolling interest 398,000 Accounts payable 330,000 Intercompany loan 1,000,000 Intercompany payable 100,000 AOCI 24,000 Investment in Company S 900,000 Cash $ 330,000 Available-for-sale securities 140,000 Accounts receivable 160,000 Intercompany receivable 130,000 Inventory 220,000 Buildings and equipment, net 1,195,000 Goodwill 200,000 Gain 677,000 Financial reporting developments Consolidated and other financial statements A-12

112 B Comparison of ASC 810 to IAS 27(R) The following table compares certain aspects of the major tenets of ASC 810 and IAS 27(R), Consolidated and Separate Financial Statements. The table below only addresses consolidated financial statements (that is, it does not address parent-only financial statements). In May 2011, the IASB issued IFRS 10, Consolidated Financial Statements, which replaces portions of IAS 27(R). IFRS 10 is effective for years beginning after 1 January 2013 with early adoption permitted. IFRS 10 did not modify the IAS 27 (R) accounting requirements depicted in the table below. Valuation of noncontrolling interest in a business combination achieved in stages (commonly referred to as a step acquisition ). Reporting noncontrolling interest in the consolidated statement of financial position ASC 810 Noncontrolling interest s share of identifiable net assets recognized at fair value at date control is obtained. Step acquisitions/disposals are to be accounted for as equity transactions while control is maintained. Redeemable noncontrolling interest is measured pursuant to ASC S99-3A for SEC registrants Noncontrolling interest is reported as a separate component of consolidated stockholder s equity. Redeemable noncontrolling interest is classified pursuant to ASC S99-3A for SEC registrants Losses are allocated to the noncontrolling interests even if the losses exceed the noncontrolling interests basis in the equity capital of the subsidiary, thus resulting in a contra-equity (that is, deficit) balance IAS 27 (R) Companies may elect to recognize the noncontrolling interest at fair value (consistent with current ASC 810) or its proportionate share of the fair value of identifiable net assets. If the fair value method is elected, 100% of the goodwill is recognized in the parent s consolidated financial statements (consistent with Statement 160). If the proportionate share method is elected, only the controlling interest s share of goodwill is recognized Consistent with current ASC 810, except for redeemable noncontrolling interest Consistent with current ASC 810 Reporting the noncontrolling interest in the consolidated income statement Amounts that are attributed to the noncontrolling interest are to be reported as part of consolidated net income and not as a separate component of income or expense. Disclosure of the attribution between controlling and noncontrolling interests on the face of the income statement is required Consistent with current ASC 810 Reporting the noncontrolling interest in the consolidated income statement (continued) Earnings and comprehensive income are attributed to the controlling and noncontrolling interests based on a substantive profit sharing agreement (or relative ownership percentage in the absence of a substantive profit sharing arrangement). Consistent with current ASC 810 Financial reporting developments Consolidated and other financial statements B-1

113 B Comparison of ASC 810 to IAS 27(R) Changes in ownership interest in a subsidiary without loss of control ASC 810 Transactions that result in decreases in a parent s ownership interest in a subsidiary in either of the following without a loss of control are accounted for as equity transactions in the consolidated entity (that is, no gain or loss is recognized): 1. A subsidiary that is a business or a nonprofit activity, except for either of the following: a. A sale of in-substance real estate b. A conveyance of oil and gas mineral rights 2. A subsidiary that is not a business or a nonprofit activity if the substance of the transaction is not addressed directly by other ASC Topics IAS 27 (R) Consistent with US GAAP, except that the guidance in IAS 27(R) applies to all subsidiaries, even those that are not businesses or nonprofit activities or those that involve sales of in-substance real estate or conveyance of oil and gas mineral rights. IAS 27(R) also does not address whether that guidance should be applied to transactions involving nonsubsidiaries that are businesses or nonprofit activities. Loss of control of a subsidiary In certain transactions that result in a loss of control of a subsidiary or a group of assets, any retained noncontrolling investment in the former subsidiary or group of assets is remeasured to fair value on the date control is lost. The gain or loss on remeasurement is included in income along with the gain or loss on the ownership interest sold. This accounting is limited to the following transactions: 1. Loss of control of a subsidiary that is a business or a nonprofit activity, except for either of the following: a. A sale of in-substance real estate b. A conveyance of oil and gas mineral rights 2. Loss of control of a subsidiary that is not a business or a nonprofit activity if the substance of the transaction is not addressed directly by other ASC Topics 3. The derecognition of a group of assets that is a business or a nonprofit activity, except for either of the following: a. A sale of in-substance real estate b. A conveyance of oil and gas mineral rights Consistent with US GAAP, except that the guidance in IAS 27(R) applies to all subsidiaries, even those that are not businesses or nonprofit activities or those that involve sales of in-substance real estate or conveyance of oil and gas mineral rights. IAS 27(R) also does not address whether that guidance should be applied to transactions involving nonsubsidiaries that are businesses or nonprofit activities. IAS 27(R) does not address the derecognition of assets outside the loss of control of a subsidiary. Financial reporting developments Consolidated and other financial statements B-2

114 C Summary of important changes The following highlights important changes to this FRD in this October 2012 update: Chapter 2: Chapter 3: Chapter 4: Chapter 5: Chapter 6: Nature and classification of the noncontrolling interest Made certain enhancements to the interpretive guidance related to noncontrolling interest classification and measurement issues. Attribution of net income or loss and comprehensive income or loss Question 3-1 was added to provide interpretive guidance related to whether the hypothetical liquidation at book value method can be used to attribute net income or loss and comprehensive income or loss Changes in a parent s ownership interest in a subsidiary while control is retained Section was added to provide interpretive guidance related to stock options of subsidiary stock. Intercompany eliminations Question 5-1 was added to provide interpretive guidance on the attribution of intercompany eliminations to the noncontrolling interests for consolidated variable interest entities. Loss of control over a subsidiary or a group of assets Interpretive guidance updated to highlight recent discussion of the Emerging Issues Task Force (EITF) regarding a parent s accounting for the cumulative translation adjustment upon the loss of a controlling financial interest in certain subsidiaries or assets. Question 6-1 was added to highlight the issuance of ASU , which addresses the deconsolidation of entities that are in-substance real estate. Chapter 9: Presentation and disclosures Interpretive guidance and examples updated to conform with the guidance in ASU and ASU , which address the presentation of comprehensive income. Section was added to provide interpretive guidance on the cash flow statement classification of transaction costs related to changes in a parent s ownership in a subsidiary that do not result in a loss of control. Financial reporting developments Consolidated and other financial statements C-1

115 D Abbreviations used in this publication Abbreviation ASC 230 ASC 250 ASC 310 ASC 320 ASC 323 ASC 350 ASC 360 ASC 450 ASC 460 ASC 470 ASC 480 ASC 605 ASC 740 ASC 805 ASC 810 ASC 815 ASC 825 ASC 830 ASC 835 ASC 845 ASC 860 ASC 932 ASC 944 ASC 958 ASC 970 ASC 976 ASU ASU ASU FASB Accounting Standards Codification FASB ASC Topic 230, Statement of Cash Flows FASB ASC Topic 250, Accounting Changes and Error Corrections FASB ASC Topic 310, Receivables FASB ASC Topic 320, Investments Debt and Equity Securities FASB ASC Topic 323, Investments Equity Method and Joint Ventures FASB ASC Topic 350, Intangibles Goodwill and Other FASB ASC Topic 360, Property, Plant, and Equipment FASB ASC Topic 450, Contingencies FASB ASC Topic 460, Guarantees FASB ASC Topic 470, Debt FASB ASC Topic 480, Distinguishing Liabilities from Equity FASB ASC Topic 605, Revenue Recognition FASB ASC Topic 740, Income Taxes FASB ASC Topic 805, Business Combinations FASB ASC Topic 810, Consolidation FASB ASC Topic 815, Derivatives and Hedging FASB ASC Topic 825, Financial Instruments FASB ASC Topic 830, Foreign Currency Matters FASB ASC Topic 835, Interest FASB ASC Topic 845, Nonmonetary Transactions FASB ASC Topic 860, Transfers and Servicing FASB ASC Topic 932, Extractive Activities Oil and Gas FASB ASC Topic 944, Financial Services Insurance FASB ASC Topic 958, Not-for-Profit Entities FASB ASC Topic 970, Real Estate General FASB ASC Topic 976, Real Estate Retail Land Accounting Standards Update No , Presentation of Comprehensive Income Accounting Standards Update No , Derecognition of in Substance Real Estate a Scope Clarification Accounting Standards Update No , Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No Financial reporting developments Consolidated and other financial statements D-1

116 D Abbreviations used in this publication Abbreviation Concepts Statement 6 SAB Topic 5-E Other Authoritative Standards FASB Statement of Financial Accounting Concepts No. 6, Elements of Financial Statements Codified Staff Accounting Bulletins, Topic 5-E, Accounting For Divesture Of A Subsidiary Or Other Business Operation Abbreviation EITF 00-4 SAB Topic 5-H Statement 141 Statement 141(R) Statement 160 Non-Authoritative Standards EITF Issue No. 00-4, Majority Owner's Accounting for a Transaction in the Shares of a Consolidated Subsidiary and a Derivative Indexed to the Minority Interest in That Subsidiary Staff Accounting Bulletins, Topic 5-H, Accounting for Sales of Stock by a Subsidiary FASB Statement No. 141, Business Combinations FASB Statement No. 141(R), Business Combinations FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 Financial reporting developments Consolidated and other financial statements D-2

117 E Index of ASC references in this publication ASC Reference Section Consolidated statement of cash flows presentation Consolidated statement of cash flows presentation Subsequent accounting for retained noncontrolling investment Subsequent accounting for retained noncontrolling investment Subsequent accounting for retained noncontrolling investment A Attribution of goodwill impairment A Attributions related to business combinations effected before Statement 160 and Statement 141(R) were adopted Scope exception for in-substance real estate transactions Deconsolidation through a bankruptcy proceeding Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Accounting for contingent consideration in deconsolidation Accounting for contingent consideration in deconsolidation Is the equity derivative embedded in the noncontrolling interest or freestanding? Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Financial reporting developments Consolidated and other financial statements E-1

118 E Index of ASC references in this publication ASC Reference Section Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives deemed to be financing arrangements Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives deemed to be financing arrangements Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests (b) Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests S99-3A Application of the redeemable equity guidance S99-3A Measurement and reporting issues related to redeemable equity securities S99-3A Earnings per share considerations S99-3A Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests S99-3A Redeemable or convertible equity securities and UPREIT structures S99-3A Redeemable noncontrolling interest denominated in a foreign currency S99-3A Gain/loss recognition S99-3A Presentation of redeemable noncontrolling interests in equity reconciliation Accounting for contingent consideration in deconsolidation Effect on effective income tax rate Acquisition through single step Acquisition through multiple steps Measurement and reporting issues related to redeemable equity securities Objectives and scope Financial reporting developments Consolidated and other financial statements E-2

119 E Index of ASC references in this publication ASC Reference Section Consolidated financial statements Objectives and scope Consolidated financial statements Objectives and scope Consolidated financial statements Deconsolidation through a bankruptcy proceeding Differing fiscal year-ends between parent and subsidiary Noncontrolling interests Increases and decreases in a parent s ownership of a subsidiary A 6.1 Deconsolidation of a subsidiary or derecognition of certain groups of assets A Loss of control A Gain/loss recognition A Accounting for a retained creditor interest in deconsolidation A Accounting for accumulated other comprehensive income in deconsolidation A Deconsolidation through a bankruptcy proceeding A Subsequent accounting for retained noncontrolling investment A Deconsolidation by selling entire interest Deconsolidation of a subsidiary or derecognition of certain groups of assets Deconsolidation of a subsidiary or derecognition of certain groups of assets Gain/loss recognition Measuring the fair value of consideration received and any retained noncontrolling investment Accounting for contingent consideration in deconsolidation Gain/loss classification and presentation Accounting for transaction costs incurred in connection with changes in ownership Deconsolidation of a subsidiary or derecognition of certain groups of assets Deconsolidation through multiple arrangements Objectives and scope Procedures for eliminating intercompany balances and transactions Effect of noncontrolling interest on elimination of intercompany amounts Procedures for eliminating intercompany balances and transactions Procedures for eliminating intercompany balances and transactions Procedures for eliminating intercompany balances and transactions Financial reporting developments Consolidated and other financial statements E-3

120 E Index of ASC references in this publication ASC Reference Section Procedures for eliminating intercompany balances and transactions Purpose of and procedures for combined financial statements Procedures applied in combining entities for financial reporting Purpose of and procedures for parent-company financial statements Differing fiscal year-ends between parent and subsidiary Differing fiscal year-ends between parent and subsidiary Proportionate consolidation Noncontrolling interests Noncontrolling interests A 2.1 Noncontrolling interests Noncontrolling interests A 2.1 Noncontrolling interests Effect of noncontrolling interest on elimination of intercompany amounts Attribution procedure Attribution procedure Attribution procedure A 4.1 Increases and decreases in a parent s ownership of a subsidiary A Decreases in a parent s ownership interest in a subsidiary without loss of control A Accumulated other comprehensive income considerations A Accounting for transaction costs incurred in connection with changes in ownership A Chart summarizing accounting for changes in ownership A 4.2 Comprehensive example A Consolidated statement of cash flows presentation A A Comprehensive example Increases and decreases in a parent s ownership of a subsidiary Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Increases and decreases in a parent s ownership of a subsidiary Issuance of preferred stock by a subsidiary Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences Increases and decreases in a parent s ownership of a subsidiary Certain presentation and disclosure requirements related to consolidation A 9.1 Certain presentation and disclosure requirements related to consolidation A Presentation of redeemable noncontrolling interests in equity reconciliation A Interim reporting period requirements Financial reporting developments Consolidated and other financial statements E-4

121 E Index of ASC references in this publication ASC Reference Section A Consolidated statement of financial position presentation A 9.2 Comprehensive example B Measuring the fair value of consideration received and any retained noncontrolling investment B 9.1 Certain presentation and disclosure requirements related to consolidation B 9.2 Comprehensive example Differing fiscal year-ends between parent and subsidiary B 7.1 Purpose of and procedures for combined financial statements A 6.1 Deconsolidation of a subsidiary or derecognition of certain groups of assets Noncontrolling Interests Consolidated statement of financial position presentation S Gain/loss recognition Equity derivatives considered embedded Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Equity derivatives considered embedded (a) Equity derivatives considered embedded (a) Equity derivatives considered freestanding Equity derivatives considered embedded C 2.1 Noncontrolling interests C Equity derivatives considered embedded C Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Redeemable or convertible equity securities and UPREIT structures through through Application of the redeemable equity guidance Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests Accounting for contingent consideration in deconsolidation Scope exception for oil and gas conveyances Scope exception for oil and gas conveyances Redeemable noncontrolling interest denominated in a foreign currency Redeemable noncontrolling interest denominated in a foreign currency Redeemable noncontrolling interest denominated in a foreign currency Proportionate consolidation Substantive profit sharing arrangements Scope exception for in-substance real estate transactions Financial reporting developments Consolidated and other financial statements E-5

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