AICPA ISSUES PAPERS — “PUSH DOWN” ACCOUNTING
Prepared by: Task Force on Consolidation Problems
Accounting Standards Division
AICPA — October 30, 1979
INTRODUCTION
1.
This paper addresses issues relating to the "push down" basis of accounting, which for the purposes of this paper is the establishment of a new accounting and reporting basis for an entity in its separate financial statements, based on a purchase transaction in the voting stock of the entity that results in a substantial change in the ownership of the outstanding voting stock of the entity. A primary question to be considered in push down accounting is whether there are circumstances in which the cost to the acquiring entity in a business combination accounted for by the purchase method1
3should be imputed to the acquired entity. Also, inconsistency has developed in practice in the accounting treatment followed when ownership of a subsidiary or other component of a business entity is transferred to new owners or when the ownership of an entire business entity is substantially changed.
2.
Proponents of push down accounting believe that transactions in an entity's voting stock that result in a substantial change in the ownership of the entity should result in a new basis of accounting (push down accounting) for the entity's assets, liabilities, and equity based on values established in the transactions. They believe that the accounting basis of the stock to the new owners should be "pushed down" to the entity and used to establish a new accounting basis in its financial statements. In push down accounting, the carrying amount of the stock to the entity's new ownership control group is deemed to be the cost of the net assets of the entity under "new entity" or "new basis" accounting.4
3.
This paper explores whether and to what extent there are circumstances in which push down accounting should be required, permitted, or prohibited after changes of ownership of the following types:
- Acquisition of an entity in a business combination accounted for by the purchase method. Should the new accounting basis recorded in the financial statements of the acquiring entity also be recognized in any separate financial statements of the acquired entity?
- Acquisition by new owners of all or a substantial portion of the voting stock of an existing company or the sale in a secondary public offering5 of all or a substantial portion of the voting stock of a company that was previously privately owned or was a subsidiary of a public company. Should the basis of the stock in the secondary offering be reflected in the financial statements of the entity?
- Spinoffs or splitoffs by the distribution of shares of a subsidiary to the stockholders of a parent company. Should the transactions create a new basis of accounting in the financial statements of the company whose shares were distributed? How should that basis be determined?
4.
As previously stated, push down accounting is the establishment of a new accounting and reporting basis for an entity in its separate financial statements based on a substantial change in the ownership of the outstanding stock of the entity. Push down accounting, however, is not a current value, consolidation, or business combination issue. Accordingly, the division urges the Financial Accounting Standards Board to consider the issues raised in this paper separately from its projects in those areas.
RELEVANT ACCOUNTING LITERATURE
5.
The authoritative accounting literature contains no specific requirements relating to push down accounting. The Accounting Principles Board (APB), in APB Opinion 16, "Business Combinations," did not address push down accounting in the separate financial statements of acquired entities. However, the literature contains principles and concepts in related areas that may be applicable to the issues raised in this paper.
APB Opinion 16
6.
APB Opinion 16, "Business Combinations," establishes the principle that when an entity purchases the business of another entity, a new cost basis, based on the exchange transaction, is established for the assets and liabilities of the acquired entity in the consolidated statements of the acquirer. The Opinion also provides principles for the acquiring entity to assign values to the assets and liabilities of the acquired entity, but does not address whether those new values should be reflected in the separate statements of the acquired entity. The principles in that Opinion may have implications for the issues raised in this issues paper.
Paragraph 21 of that Opinion states:
Reporting economic substance. The purchase method adheres to traditional principles of accounting for the acquisition of assets. Those who support the purchase method of accounting for business combinations effected by issuing stock believe that an acquiring corporation accounts for the economic substance of the transaction by applying those principles and by recording:
- All assets and liabilities which comprise the bargained cost of an acquired company, not merely those items previously shown in the financial statements of an acquired company.
- The bargained costs of assets acquired less liabilities assumed, not the costs to a previous owner.
- The fair value of the consideration received for stock issued, not the equity shown in the financial statements of an acquired company.
- Retained earnings from its operations, not a fusion of its retained earnings and previous earnings of an acquired company.
- Expenses and net income after an acquisition computed on the bargained cost of acquired assets less assumed liabilities, not on the costs to a previous owner.
FASB Discussion Memorandum
7.
In its 1976 Discussion Memorandum on "Accounting for Business Combinations and Purchased Intangibles" (pages 114 to 116), the FASB raised the following implemental issue:
IMPLEMENTAL ISSUE THIRTEEN: Should a new accounting basis recognized for a constituent company in a combined enterprise's financial statements also be recognized in any separate financial statements of the constituent company?
For a number of reasons (e.g., the existence of minority interests or financing arrangements with others) a constituent company may need to issue separate financial statements at the time of, or subsequent to, a combination. Also, resolution of Implemental Issue Eleven concerning disclosures for combinations that give rise to a new accounting basis may call for presentation of separate financial statements or summaries of a constituent company. APB Opinion No. 16 is silent about whether a new accounting basis for a constituent company's assets and liabilities recognized in a combined enterprise's financial statements should also be recognized for those assets and liabilities in separate financial statements of the constituent company.
8.
Related questions to be addressed were presented as follows:
If a new accounting basis is to be recognized in any separate financial statements of a constituent company, the balance sheet would presumably be restated to reflect the parent company's cost, including any goodwill recognized in the combination. Likewise, the income statement would be restated to show depreciation, amortization, and other charges or credits based on the parent company's cost. Additional questions that need to be addressed if a new accounting basis is to be recognized in a constituent company's financial statements include:
- Should that accounting treatment apply to a combinee that has significant minority interests after the combination?
- If so, how should amounts be assigned to identifiable assets and liabilities, minority interests, and to goodwill in those financial statements?
- Should the stockholders' equity section be restated to recognize retained earnings only for periods subsequent to the combination?
- What special disclosure should be provided in those financial statements (e.g., the accounting basis followed, the parent company's ownership percentage, and legally available retained earnings)?
Resolution of these questions and others would presumably be influenced by how the related issues concerning a combined enterprise's financial statements are resolved. Specifically: Implemental Issue Nine addresses special measurement problems in a combined enterprise's financial statements where minority interests in the combinee remain; Implemental Issues Eleven and Twelve address financial disclosures and presentation for a combined enterprise's financial statements in which a new accounting basis is recognized for one or more of the constituent companies. Accordingly, respondents to this Memorandum are urged to respond to the above questions in the light of their responses to those related issues.
If a new accounting basis is not to be recognized, the only additional question that may need to be addressed is: What special disclosures should be provided? Possibilities include the accounting basis followed, the parent company's ownership percentage, and a summary of the amounts for the separate company used in the combined enterprise's financial statements.
The FASB has deferred consideration of the Discussion Memorandum until further progress has been made on its conceptual framework project.
AICPA Technical Practice Aids
9.
The AICPA's Technical Practice Aids, which provide non-authoritative examples and commentaries on accounting issues, addressed the issue concerning the accounting basis for assets of an entity acquired in a business combination in the separate financial statements of the entity. The inquiry and response were, however, later deleted from the Technical Practice Aids. They are included here only to illustrate the type of question raised in practice because of the absence of authoritative literature in this area. The following are the inquiry and the response:
Inquiry — A company was acquired which has real estate properties whose value is in excess of the recorded historical cost. In the negotiations for the acquired company, the individual assets were assigned specific prices. After the acquisition, the acquired company continued as a separate entity. The acquired company has various bond and mortgage debt outstanding with restrictions as to the amount of dividends that can be paid out of the net income of the acquired company.
What is the proper reporting to the mortgage and bondholders with respect to the separate statements of the acquired company, inasmuch as the borrowing agreements do provide for separately audited statements? In these statements, should the properties of the acquired company continue to be reported at their historical cost basis prior to the acquisition date, or is it appropriate to restate the asset values based on the price paid by the acquiring corporation?
If the reporting on the separate statements of the acquired company is to continue at the old historical cost basis, how can confusion in the minds of the lenders be avoided when they compare the income figures in the separate company statements with the income figures of the consolidated parent group?
Reply — Paragraph 17 of Accounting Principles Board Opinion No. 6 states, "The Board is of the opinion that property, plant and equipment should not be written up by an entity to reflect appraisal, market, or current values which are above cost to the entity." This statement is not intended to change accounting practice followed in connection with quasi-reorganizations or reorganizations. The acquisition of a company by another company would not by itself constitute a "reorganization." It would not be proper to restate the assets in the financial statements of the acquired corporation.
If there is any likelihood that financial statements based on cost to the acquired company and financial statements of the same operation based on cost to the parent company were being prepared for distribution to others (and if an auditor's opinion is expressed, such distribution should be assumed), it would appear necessary to footnote one of the financial statements to indicate that other statements were being prepared on a different basis. It would be more appropriate to prepare such a footnote for the financial statements of the acquired company.
Montgomery's Auditing
10.
Montgomery's Auditing discusses the acceptability of the push down theory as follows (page 692 of the Ninth Edition, published 1975):
Traditionally, a company was acquired and thereafter retained forever, sold as a unit to a third party, or liquidated. Goodwill was assumed to be an asset solely of the acquiring or parent company. Financial statements of the acquired company were on a separate company basis and remained the same (on its books) as before the acquisition. Revaluation of the assets acquired and determination of the parent's portion of goodwill arose only in consolidation and goodwill was recorded in a consolidating entry reflecting that the parent's investment in the acquired company exceeded the reported net book value of the company. When the subsidiary was sold, the goodwill disappeared from the consolidated balance sheet along with the net assets of the subsidiary, and gain or loss thereon was computed and recorded. The theoretical problems of minority interests in good will were ignored.
Those problems cannot be ignored if an interest in a subsidiary is sold in a public offering or for any other reason the subsidiary is required to present separate financial statements. It is impossible to ignore the fact that a transaction has taken place, establishing a new basis of accountability, whenever a business is sold or acquired in an arm's-length transaction, even though nothing has occurred within the entity itself to warrant a new basis of accountability. The occurrence of a sale and purchase, rather than internal changes or lack of them, must be the basis for recording changes in cost. The abrupt revaluation of assets, of course, affects comparability of the net income stream of the acquired entity, but it is preferable to ignoring the accounting result of changed ownership.
The principle of recording asset values and goodwill in the accounts of a company to reflect the purchase of its stock by another entity or group of stockholders has been called the "push-down" theory. At present, the question of how far it should be carried is unanswered...Until all of the ramifications of the push-down theory are fully explored, we would prefer to see its implementation limited to 100% (or nearly 100% — the pooling theory's 90% would be a good precedent) transactions.
Securities and Exchange Commission
11.
The Securities and Exchange Commission (SEC) has no published guidelines on push down accounting. However, in some circumstances it has permitted or required push down accounting in financial statements filed with the SEC. In 1972, the SEC staff considered, but did not issue, a draft Accounting Series Release on "Accounting for Changes in Corporate Ownership." The draft release would have prescribed accounting for the transfer of the ownership of a division, subsidiary, or other component of a business entity to new owners or for a substantial change in the ownership of an entire business. The draft release stated:
It is a well-established principle of accounting that when a corporation is purchased by another, cost based accounting requires that the cost paid by the new stockholder be the basis of accountability in financial statements reflecting the new stockholder's position. Accounting Principles Board Opinion Nos. 16 and 17 describe the acceptable method of allocating cost to particular assets in such a situation.
This principle is also applicable to situations where the purchaser of a corporation or a segment of a corporation is not a single corporate entity but is a stockholder group. Where the ownership of a corporation is sold, a new basis of accountability arises based on the sale price. Sale price in such a situation would normally represent the price paid by acquiring shareholders less the cost of registering and issuing equity securities as set forth in paragraph 76 of APB 16....
In the absence of evidence to the contrary, the sale of more than 50 percent of the common stock within a twelve month period should lead to a presumption that a change in ownership has occurred. The facts of the case must govern, however. For example, the existence of voting preferred stock, preferred stock with a participation in profits, convertible securities or other situations in which ownership is not reasonably measured by the common stock alone may require adjustment of the normal criterion. When a change in ownership occurs as a result of a sale of less than all the common stock of an entity, the new accounting basis should apply to all assets and liabilities and cost should be measured by the sales price adjusted to reflect the transaction as if all the common stock had been sold.
Change in ownership which does not occur as a result of a sale does not give rise to a new basis of accountability, since no transaction has occurred nor has a cost been incurred. Hence, a spinoff of the distribution of shares or assets as a dividend to current stockholders would not represent an event which would call for a new basis of accounting.
PUSH DOWN ACCOUNTING IN PRACTICE
12.
Some companies, both private and public, have applied push down accounting while others have not in apparently similar circumstances. Examples in which push down accounting were and were not applied are presented in the appendix to this paper. The division believes that there are more examples, but has not found them. If there are more, they more than likely involve private companies whose financial statements are not readily available for general distribution and constituents of consolidated groups that do not file separate entity financial statements. Accordingly, the results of a NAARS search proved inconclusive. The examples appearing in the appendix to this paper were the most recent examples found and are summarized below.
| Name of Company | Source of Information | Type of Transaction |
|---|---|---|
| Companies Applying Push Down Accounting | ||
Hughes Tool Company | 1972 Form S-I Registration
1973 and 1974 Forms 10-K | Secondary Public Offering |
Virginia International Company | 1977 Form 10-K | Merger |
The Anaconda Company | 1977 Form 10-K | Merger |
Dixilyn Corporation | 1977 Annual Report | Purchase |
Armour and Company | 1975 Form S-1 | Merger |
Verex Corporation | 1978 Annual Report | Purchase and Merger |
Hyatt Corporation | 1978 Annual Report | Tender offer to go private |
Companies Not Applying Push Down Accounting | ||
Marcor, Inc. | 1975 Annual Report
1978 Form 10-K | Tender offer leading to purchase |
UOP, Inc. | 1975 Annual Report | Tender offer leading to purchase |
Filtrol Corporation | 1978 Annual Report | Tender offer leading to purchase |
ISSUES
Basic Issue
13.
The basic issue to be addressed is whether there are circumstances in which push down accounting should and should not be required or prohibited.
14.
Some believe that a new basis of accounting for an entity should be required following a purchase transaction in the voting stock of the entity that results in a substantial change in the ownership of its outstanding voting stock. They view the transaction as essentially the same as if the new owners had purchased the net assets of an existing business and established a new entity to continue that business. They believe that reporting on a new basis in the separate financial statements of the continuing entity would provide information that is more relevant to financial statement users. They contend that in the transaction in which a change of ownership has occurred, the acquiring entity's basis should be imputed to the acquired entity.
15.
Some of the arguments in support of that view are summarized as follows:
- When there is a substantial change in ownership, the price paid for their interest by the new owners is the most relevant basis for measuring the assets and liabilities and results of operations of the entity from the perspective of the owners and should be reflected in the entity's financial statements.
- The substance of transactions resulting in substantial changes in ownership is the acquisition by new owners of an existing business, and the transactions should be accounted for as such. Those transactions are the same as if the new owners purchased the net assets of an existing business and established a new entity to continue the business.
- Under APB Opinion 16, a business purchased in a business combination is required to be stated in consolidated financial statements at the basis established in the transaction. Therefore, to achieve symmetry, the separate financial statements of the acquired entities should be presented in the same manner.
- FASB Statement No. 14 requires that separate segment information reflect the parent's cost basis for each segment. Although not every subsidiary is a segment, to achieve symmetry the separate financial statements of the acquired entities should be presented in a like manner. Issuing separate financial statements on a basis other than push down could result in the distribution of some conflicting financial information for the same segment or subsidiary.
Arguments Against Push Down Accounting
16.
Some believe that substantial changes in the ownership of an entity's outstanding stock should not result in a new basis of accounting for an entity in the separate financial statements of the entity and that those statements should retain the existing accounting basis. They believe that transactions in an entity's stock should not affect the entity's accounting under any circumstances.
17.
They believe that a change in ownership of an entity does not establish a new accounting basis in its financial statements under the historical cost accounting framework. Since the reporting entity did not acquire assets or assume liabilities as a result of the transaction, the recognition of a new accounting basis based on a change in ownership, rather than on a transaction on the part of the entity, is undesirable under the historical cost framework. If changes in ownership were to trigger a new accounting basis, several implementation problems would arise, such as that minority interests would not have meaningful comparative financial statements. Furthermore, they observe that the entity may have entered into credit or other agreements with others, with terms related to financial statements or other financial data prepared on the existing accounting basis. Restatement of the financial statements to recognize a new accounting basis could create problems in determining or maintaining compliance with various financial restrictions under those agreements or in calculating amounts that are based on income before income taxes, net income, or other financial data. Also, restatement could cause difficulties in comparing the entity's financial data with those for prior periods, although financial statements for prior periods prepared on a pro forma basis to give retroactive effect to the new accounting basis could help provide comparable data.
18.
Some of the arguments against push down accounting are summarized as follows:
- Transactions of an entity's stockholders are not transactions of the entity and should not affect the entity's accounting.
- A new basis of accounting would be detrimental to interests of holders of existing debt and nonvoting capital stock who depend on comparable financial statements for information about their investments and do not have access to other financial information. Push down accounting would affect the ability of the entity to comply with debt covenants required by outstanding debt and would materially alter the relationships in the entity's financial statements. When minority owners and other investors are entitled to financial statements, those financial statements should be prepared based on transactions of that entity and not transactions of stockholders.
- FASB Statement No. 14 deals with reporting information on segments of a business and is irrelevant to push down accounting.
- There is no logical way to establish limits for determining which owner's transactions should qualify for push down accounting.
Factors That Alter Views on Acceptability
19.
Views on the acceptability of, and arguments for and against, push down accounting differ depending on whether the entity has outstanding debt held by institutional lenders or held by the public and on whether the entity has outstanding a senior or nonvoting class of capital stock that is not involved in the transaction. Views and arguments also differ depending on whether the transaction involves a 100% change in the ownership of the voting stock of an entity or less than a 100% change, leaving a minority interest in the voting stock of the entity.
Corporate Acquisitions Versus Acquisitions by Others
20.
Some view changes in ownership that involve corporate acquisitions differently from changes in ownership that involve acquisitions in which either or both of the entities are not corporations. Others believe that the same principle should apply to all types of major changes in ownership. In rare situations, however, the cost basis of an unconsolidated investor is not known and cannot be determined. For example, an individual who purchases 90% of the stock of an entity may not wish to divulge his purchase price.
Existence of Institutional Debt and Senior Class of Stock
21.
A new basis of accounting would raise some questions if an entity has outstanding debt, held either by institutional lenders or the public, or another class of capital stock. For outstanding debt, the considerations differ for debt held by institutional lenders, such as banks, and for debt held by the public. Some believe, for example, that institutional lenders depend less on comparable financial statements than public holders of debt securities. Some also argue that public holders of debentures issued under an indenture have some expressed or implied quasi-equity rights in the entity that may be affected by a new basis of accounting for the entity in its separate financial statements.
22.
Different considerations may apply to an entity with a class of capital stock outstanding that is senior to its voting capital stock. Complex relationships and contingent rights may exist that should be considered. For preferred stock with a fixed dividend requirement, for example, a new basis of accounting in the separate financial statements of the entity would affect the computation of dividend coverage in a manner that may be unacceptable to the holders of the stock.
Less Than a 100% Change in Ownership
23.
A substantial change in the ownership of an entity that involves less than 100% of its outstanding voting stock raises questions relating to the level at which a change in the ownership of an entity should be deemed to have occurred. In addition to the considerations discussed in paragraphs 21 and 22 there may be other considerations in a less than 100% change in ownership because of minority interests.
The questions that should be considered include:
- What should be the threshold level of a change in ownership for a new basis of accounting? Or, conversely, how large a minority interest may exist after the transaction and still use push down accounting?
- How should amounts be assigned to the identifiable assets, minority interest, and goodwill in the separate financial statements of the entity?
24.
Views on the percentage level of ownership change for which a new basis of accounting should be considered vary. Some believe that substantially all (90%, the percentage required for a business combination accounted for by the pooling of interests method in APB Opinion 16) should be the threshold level. Others believe that the threshold percentage level of ownership change should be at least 80%, the percentage level specified for various tax treatments under present tax law. Some believe that the threshold level of ownership change should be 51%, the percentage ownership generally required for control and for subsidiary accounting, under ARB No. 51.
25.
Views also differ on the method of assigning values to identifiable assets and liabilities, minority interest, and goodwill in the separate financial statements of the entity. This issue is not peculiar to push down accounting. Some believe that values should be assigned based on the market value of the entity as a whole imputed from the transaction. To illustrate, if 60% of the ownership interest in an entity changed hands at a price of $12 million, the market value of the entity should be imputed to be $20 million and values should be assigned on that basis. Others believe that values should be assigned based on the proportional interest that changed hands. They believe that new values should be reflected in the entity only to the extent of the price paid in the transaction. They believe that the approach is consistent with APB Opinion 16 and with the historical cost framework of accounting in that only the actual transaction would be reflected in the new basis. To illustrate, if 70% of the ownership interest of an entity changed hands at a price of $10 million, the basis of the entity's assets would be adjusted proportionally by the difference between the price paid ($10 million) and the book value of a 70% interest in the entity.
Changes of Ownership in Step Transactions
26.
The acquisition over time in accordance with a plan to acquire a sufficient number of shares of an entity's voting stock to constitute a "change in ownership" raises an implementation issue concerning the method of applying push down accounting in those circumstances.
- If changes in ownership are deemed to require a new basis of accounting, should the principle apply to a change that occurs over time in a series of steps in accordance with a plan?
- If the principle should apply to step transactions, how should the new accounting basis be established?
27.
Those who believe that changes in ownership should require a new basis of accounting also believe that a change that occurs in a series of steps should follow the same principle. The arguments for and against that view are the same as the general arguments for and against push down accounting.
28.
Views vary on the method of establishing a new accounting basis as a result of a change in ownership that occurs in a series of steps. Some believe that the new basis should represent the sum of the amounts paid by the new owners in each of the steps in the series. They argue that each acquisition should be evaluated separately because each acquisition is a distinct, measurable event. They believe that the approach is consistent with APB Opinion 16 and in accordance with the historical cost framework of accounting. Others believe that the new accounting basis should represent the valuation of the entity established by the final significant transaction in the series. They believe that the objective is to reflect the economic value of the assets to the entity at the time the change in ownership is completed. Another view is that the new basis should represent the valuation of the entity established by the first transaction in the series. To illustrate, if 20% of an entity's stock is acquired in accordance with a plan to acquire in a series of steps 80% of the entity's stock, a new basis would be established based on the imputed value of the entity from the sales price of the 20% interest.
When the Acquired Entity Is Merged Into an Affiliated Entity Other Than its Parent
29.
In some cases an entity may arrange for a wholly owned subsidiary, usually a newly incorporated or shell corporation, to complete an acquisition by paying the consideration, sometimes the parent's common stock, and receiving the acquired entity's assets and liabilities. There are differing views concerning the accounting for the transaction by the subsidiary. Some believe that whether a parent acquires an entity or causes an affiliate to acquire an entity, the economic substance is identical. In that regard, some believe that push down accounting applies, while others believe that APB Opinion 16, "Business Combinations," applies (the application of either achieves the same result). Still others believe the economic form rather than the economic substance should be the determining factor and view the two distinct transactions as not requiring the application of push down accounting or of APB Opinion 16.
Allocating the New Cost Basis to the Acquired Entity's Assets and Liabilities
30.
Some proponents of push down accounting believe paragraphs 67, 68, 87 and 88 of APB Opinion 16, which discuss how an acquiring entity should allocate the cost of an acquired entity to the assets acquired and the liabilities assumed for consolidated financial statements, should also apply to an acquired entity in allocating such cost in its own financial statements.
Spinoffs and Splitoffs
31.
Spinoffs and splitoffs involve changes in the form of ownership. Spinoff and splitoff transactions are nonreciprocal transfers in which a corporation distributes assets to its stockholders in partial liquidation. That view is expressed in APB Opinion 29 in which those types of transactions are exempt from the measurement principles required for nonmonetary exchanges. The SEC's draft release, referred to in paragraph 11 of this paper, describes a spinoff as a change in ownership that does not occur as a result of a sale. For that reason, a spinoff was not deemed to give rise to a new accounting basis. Some however view those transactions as exchanges in which the stockholders surrender a part of their ownership interest in the corporation for an interest in another corporation. Others believe, however, that though the transactions may be exchanges as to the stockholders they are not exchanges as to the corporation. Also, in many spinoff and splitoff transactions a market value for the transactions can be readily determined. Therefore, an issue that should be considered is whether an entity involved in a spinoff or splitoff should report in its separate financial statements on a new basis as established in the spinoff or splitoff transaction.
Collateral Issues
32.
In addition to the major issues identified, the following collateral issues should be considered if push down accounting is to be permitted or required in any circumstances.
- If a new basis of accounting is established for an entity, should the retained earnings of the predecessor be carried forward? If not, should the retained earnings be dated?
- What special disclosures should be presented in the entity's financial statements (for example, the accounting basis followed, pro forma information, the parent company's ownership percentage, and legally available retained earnings)?
ADVISORY CONCLUSIONS
33.
The following are the advisory conclusions of the Accounting Standards Executive Committee on the issues discussed in this paper.
- There are circumstances in which the cost to new owners in a transaction that results in a substantial change in ownership, as in the acquisition of an entity in a business combination accounted for by the purchase method, should be imputed to the acquired entity,
- when the acquired entity remains a subsidiary (8 yes, 5 no)
- when the acquired entity is merged into an affiliated entity other than its parent (8 yes, 5 no)
- A substantial change in ownership that justifies a new basis of accounting should be deemed to have occurred when there is a:
- l00% change (8 yes, 5 no)
- At least 90% change (7 yes, 6 no)
- At least 80% change (4 yes, 9 no)
- At least 51% change (0 yes, 12 no)
- At least 20% change (0 yes, 13 no)
- Splitoff and spinoffs should not give rise to a new accounting basis. (13 yes, 0 no)
- If a new basis is established in a series of step transactions, it should be consistent with the parent's basis determined under the rules for the purchase method of accounting. (12 yes, 0 no)
- Push down accounting should be applied when substantial changes in ownership result from related market transactions in an entity's stock. The relationship can arise as a result of plans or actions of sellers, for example, a secondary public offering, or of purchasers, for example, individuals acting in concert. (10 yes, 5 no)
- If a new basis of accounting is established for an entity, the retained earnings of the predecessor should not be carried forward. (15 yes, 0 no) If retained earnings are not carried forward, subsequent retained earnings should be dated. (10 yes, 4 no)
APPENDIX
Examples of Companies Using, and of Companies Not Using, Push Down Accounting
Companies Using Push Down Accounting
The following excerpts from SEC filings and annual reports describe examples of push down accounting adopted by companies based on transactions that resulted in major changes in the ownership of the entity.
- Hughes Tool Company's 1972 Form S-I registration statement and its Form 10-K reports for 1973 and 1974. The following note from the 1973 Form 10-K describes the change in ownership and the resulting accounting basis.ORGANIZATIONOn December 14, 1972 the Company, which was incorporated in Delaware on September 14, 1972, acquired the net assets connected with the operations and business of Summa Corporation — Oil Tool Division and Certain Affiliates (the "Predecessor") in exchange for 5,000,000 shares of its common stock which were immediately sold by Summa Corporation ("Summa") in a public offering. The total assets so acquired were assigned a value equal to the net proceeds received by Summa from this sale, plus the amount of liabilities assumed by the Company. Part of the excess of that value over the Predecessor's carrying basis of the individual assets was allocated to property and certain other noncurrent assets based on an independent appraisal. The resulting cost in excess of net tangible asset values acquired has been assigned to an intangible asset, "excess of cost over values assigned to net assets acquired."
- Virginia International Company (a subsidiary of Alaska Interstate Company), 1977 Form 10-K report. The following note from the financial statements describes the transaction and the basis of accounting.(2) Merger of Virginia International Company into Alaska Interstate CompanyVirginia International Company, a Delaware corporation, was formed as a result of a merger on July 28, 1977 of Virginia International Company, a Virginia corporation, into Alaska Interstate Indonesia, Inc., a wholly owned subsidiary of Alaska Interstate Company. The agreement and plan of merger provided that all outstanding shares of the old Virginia International Company (except that stock owned by Alaska Interstate Company) would be converted into shares of common stock of Alaska Interstate Company. In addition, the shareholders of the old Virginia International Company, including Alaska Interstate Company, received one share of Special Stock of Virginia International Company, a Delaware corporation, for each share of old Virginia International Company stock. The common stock of Alaska Interstate Company and the shares of Special Stock of Virginia International Company, a Delaware corporation, issued in the transaction were registered on Form S-14, Registration Statement No. 2-58834.The transaction was recorded as a purchase and the asset valuation recorded by the Company is based on the cost of the purchase to Alaska Interstate Company. No comparative information is presented since the results would not be meaningful. Pro form results (unaudited) of operations for the year ended December 31, as if the purchase had occurred on January 1, 1976, are as follows....
- The Anaconda Company (a subsidiary of Atlantic Richfield Company), 1977 Form 10-K report. The following note to the financial statements describes the change in ownership and the resulting accounting basis. The Anaconda Company (a Montana Corporation) was merged into the Anaconda Delaware Corporation (a Delaware Corporation) on January 12, 1977. Anaconda Delaware Corporation on the same date was merged into a wholly-owned subsidiary of Atlantic Richfield Company. The merger was accounted for under the purchase method which resulted in a new cost basis of valuing the assets and liabilities of the newly created entity, The Anaconda Company (a Delaware Corporation).The consolidated balance sheet of The Anaconda Company (Anaconda) reflects the economic value of the entity as determined by the arms-length acquisition. The equity of the new entity amounted to approximately $400 million, a reduction of $800 million from the pre-merger basis. The major adjustments, were reflected in a write-down of the property, plant and equipment accounts by $550 million; an increase in deferred liabilities and credits of $440 million (Note 11); and a write-up in Inventories of $240 million reflecting current cost. These new costs result in lower operating expenses of the new entity. As a result of such adjustments, the financial statements contained herein are not comparable to those of the predecessor entity.
- Dixilyn Corporation (a subsidiary of Panhandle Eastern Pipeline Company), 1977 Annual Report. The following paragraph from the accountants' report and portions of related notes from the financial statements describe the change in ownership and the resulting accounting basis. As more fully explained in note 2 to the consolidated financial statements, on May 5, 1977, all of the outstanding common stock of the Company was acquired by Panhandle Eastern PipeLine Company in a transaction accounted for as a purchase. In connection with this acquisition, the accounts of the Company have been restated to reflect the allocation of the consideration paid for the common stock to the respective net assets acquired on the same basis as in consolidation with the parent company.. . .(1) Basis of Accounting and Summary of Significant Accounting Policies
- Basis of Accounting
On May 5, 1977, the Company was merged into a wholly-owned subsidiary of Panhandle Eastern Pipe Line Company in a transaction accounted for as a purchase effective as of May 1, 1977. In connection with this acquisition, the accounts of the Company have been restated to reflect the allocation of the consideration paid for the common stock to the respective net assets acquired on the same basis as in consolidation with the parent company.. . .(2) Acquisition by Panhandle Eastern Pipe Line CompanyEffective May 1, 1977, the Company was merged into a wholly-owned subsidiary of Panhandle Eastern Pipe Line Company in a transaction accounted for as a purchase. The consideration paid for the Company was $22,725,000, which exceeded the net assets by approximately $1,650,000. Accordingly, in order to reflect the excess of consideration paid over the net assets acquired, the following adjustments were made in the accounts as of May 1, 1977.... - Armour and Company (a subsidiary of the Greyhound Corporation) , 1975 Form S-1 Registration Statement (Amendment No. 2) for $75,000,000 of sinking fund debentures. The following notes from the audited 1974 financial statements of the company included in the Registration Statement describe the basis of accounting. The Greyhound Corporation ("Greyhound") is the owner of all the authorized common stock of Armour. The consolidated financial statements include the accounts of Armour and its domestic subsidiaries and, beginning in 1971, are prepared to state such accounts on the Greyhound cost basis, the same basis as in Greyhound's consolidated fnancial statements. Investments in foreign subsidiaries are carried at equity in underlying net assets plus the unamortized balance of intangibles arising at dates of acquisition. All intercompany transactions and accounts are eliminated in consolidation except for immaterial profits included in the carrying value of inventories.Note B—Basis of Preparation—Greyhound Cost Basis:The merger of Armour and a wholly-owned subsidiary of Greyhound became effective in December, 1970 and on that date Greyhound became the owner of all of Armour's authorized and outstanding common stock. The acquisition of Armour common stock by Greyhound is described in "Relations with Greyhound," elsewhere herein. In connection with the merger, each previously existing share of Armour's $5 par value common stock (except shares held in the treasury and shares held by Greyhound, all of which were cancelled) was converted into 3.25 shares of common stock of Greyhound. The shares of the Greyhound subsidiary were converted into 6,662,311 shares of a new Armour $1 par value common stock, all of which are held by Greyhound. The merger made no change in the $4.75 preferred stock of Armour.Greyhound reflected the acquisition of Armour in its accounts as of January 3, 1979, and as of that date the accounts of Armour have been retroactively adjusted to reflect the fair value of Armour's net assets on the Greyhound cost basis, the basis at which the accounts of Armour are carried in Greyhound's consolidated financial statements.The adjustments to Armour's accounts at January 3, 1979, consisted of the following:
- The excess of $107,527,000 of Greyhound's carrying cost of its investment in Armour shares over Armour's net assets at January 3, 1970 (after reflecting the vacation pay adjustment of $6,595,000 described in Note 4 to the consolidated income statement) has been credited to capital surplus as a contribution to capital by Greyhound.
- The determination of the fair value of Armour's net assets as of January 3, 1970 resulted in valuation adjustments aggregating $36,119,000 (net after tax). These valuation adjustments were comprised of realized and anticipated net losses arising from the sale of businesses during 1970, 1971 and 1972, described in Notes 4 and 5 to the consolidated income statement ($14,427,000): reserves provided for unfunded pension and insurance costs principally attributable to retired employees of closed plants ($14,720,000): net costs and expenses associated with combining Greyhound and Armour administrative functions ($3,135.000): and other adjustments ($3,837,000).
The adjustments to reflect the Greyhound cost basis and the valuation adjustments were charged to intangibles, of which $139,236,000 was considered attributable to Armour's investment in Dial.As described in Note C, Armour acquired the minority interest in Dial in 1972. Greyhound considered the acquisition of the minority interest in Dial as the completion of the acquisition of Armour voting securities as contemplated prior to the effective date of Opinion No. 17 of the Accounting Principles Board of the American Institute of Certified Public Accountants. The intangible arising on the acquisition of the minority interest in Dial ($37,007,000 including $6,906,000 of intangibles previously reported in the accounts of Dial) was also considered to be attributable to the investment in Dial. - Verex Corporation 1978 Annual Report. The following notes describe the company's basis of presentation and principal adjustments to restate the basis of its net assets to that which was established by its parent. BASIS OF PRESENTATION:The Greyhound Corporation ("Greyhound") owns all of the outstanding common stock of Verex.The consolidated financial statements for 1978 include the accounts of Verex and its subsidiaries on the same basis as they are included in Greyhound's consolidated financial statements, which gives effect to allocating the cost of Greyhound's investment in Verex ("Greyhound's cost basis") as though it was acquired on January 1, 1978. The consolidated financial statements for 1977 are presented on the historical basis of accounting of Verex and include the accounts of Verex and its subsidiaries. For comparative purposes, a pro forma consolidated income statement for the year ended December 31, 1977 has also been presented reflecting the acquisition by Greyhound as if it occurred on January 1, 1977.All material intercompany transactions and accounts are eliminated in consolidation. Certain balances in the accompanying financial statements of 1977 have been reclassified to make the presentation consistent with the classifications used for 1978.NOTE A - Greyhound's Investment in Verex:Through March of 1978 Greyhound had acquired approximately 95 per cent of the common stock of Verex as a result of a tender offer. An accrual for the purchase of the remaining outstanding shares of Verex was established as of March 31, 1978 by Greyhound. The remaining 5 per cent interest was acquired through subsequent purchases and the merger of Verex into a wholly-owned subsidiary of Greyhound. The aggregate cost of the investment in Verex by Greyhound was approximately $109,372,000...The carrying values of bonds and notes and land, office building and equipment were adjusted to estimated fair market value.
- Hyatt Corporation, 1978 annual report. The following note describes a tender offer to go private. The acquisition of the Company's shares will be accounted for in the merger as a purchase by New Hy. Accordingly, the historical shareholders' equity of the Company will be eliminated and 526,046 shares held in the Company's treasury will be canceled. The excess of New Hy's purchase costs over the Company's historical shareholders' equity, which excess is estimated at $22,039,000, will be allocated to property and equipment, operating leases and management contracts.
Companies Not Using Push Down Accounting
The following excerpts from SEC filings and annual reports present examples of companies not applying "push down" accounting on the basis of transactions that resulted in a substantial change in the ownership of the entity.
- Marcor, Inc., 1975 annual report and 1978 Form 10-K. The following notes describe the acquisition by Mobil Oil Corporation of a 54% interest in Marcor in 1974. Acquisition of voting control of Marcor by Mobil Oil Corporation was completed in September, 1974 when Mobil Oil Corporation purchased 8,000,000 shares of Series B preferred stock from Marcor for $200,000,000. This stock, together with other equity securities of Marcor, Inc. acquired by Mobil in connection with a tender offer and securities previously acquired, provide Mobil with approximately 54% of the voting power of outstanding equity securities of Marcor, Inc.A note from the 1978 Form 10-K report indicates that, subsequent to 1974, Mobil acquired all of the voting stock of Marcor, which is now a wholly owned subsidiary of Mobil.
- UOP, Inc., 1975 annual report. The following note describes the acquisition by Signal Companies, Inc. of a 50.5% interest in UOP in 1975. On April 18, 1975, the company and The Signal Companies, Inc. (hereinafter referred to as "Signal") entered into a Stock Purchase Agreement under which Signal made a cash tender offer for 4,300,000 shares of common stock at $21 per share and purchased on May 13, 1975, 1,500,000 shares of common stock at $21. As a result of both transactions, Signal now holds 5,800,000 of the 11,480,000 shares outstanding, or 50.5%.Transactions in the common stock account for 1974 and 1975 are summarized as follows:
1974 1975 Shares issued at the beginning of year10,130,87910,130,879Shares purchased by Signal01,500,000Shares issued at end of year10,130,87911,630,879 - Filtrol Corporation (a subsidiary of United States Filter Corporation), 1978 annual report. In March 1978, the Company initiated a tender for the remaining outstanding shares of Filtrol at a purchase price of $18 per share and, as a result, increased its ownership from 50.7% to approximately 86%. The cost of the additional investment approximated $17,300,000. Accordingly, the Company has included the accounts of Filtrol in its 1978 consolidated financial statements, effective January 1, 1978. The entire 1978 investment and a portion of the original investment has been allocated to certain tangible assets based on their fair values existing as of the respective acquisition dates of the investments. Of the original investment, acquired in 1969, $50,175,000 is included in cost in excess of net assets of companies acquired and is not being amortized since, in the opinion of management, it has not diminished in value.The separate 1978 financial statements of Filtrol Corporation indicate no change in the carrying amount of its net assets due to a pushing down of the basis established by United States Filter Corporation in the transaction.
Footnotes
11
Push Down Accounting, Footnote 1 — The push down principle can be applied to all business combinations in which there has been an acquisition. Paragraph 12 of APB Opinion 16, "Business Combinations," states, however that:
2
The pooling of interests method accounts for a business combination as the uniting of the ownership interests of two or more companies by exchange of equity securities. No acquisition is recognized because the combination is accomplished without disbursing resources of the constituents. Ownership interests continue and the former bases of accounting are retained. The recorded assets and liabilities of the constituents are carried forward to the combined corporation at their recorded amounts.
3
Accordingly, push down accounting is inapplicable in business combinations accounted for by the pooling of interests method.
42
Push Down Accountng, Footnote 2 — The term "new entity" or "new basis" accounting is used to describe the circumstances in which an existing entity is deemed to have established a new basis to record its assets and liabilities.
53
Push Down Accounting, Footnote 3
A secondary public offering of stock is a registered, public offering usually through underwriters of a block of the outstanding stock of an entity by a single controlling stockholder or a group of controlling stockholders.